ACCOUNTING PRINCIPLES 6TH CANADIAN EDITION (VOLUME 2) BY WEYGADNT, KIESO KIMMEL TRENHOLM KINNEAR BAR by QuentinAxel

ACCOUNTING PRINCIPLES 6TH CANADIAN EDITION (VOLUME 2) BY WEYGADNT, KIESO KIMMEL TRENHOLM KINNEAR BARLOW (CHAPTER 9_18) SOLUTIONS MANUAL

CHAPTER 9 Long-Lived Assets ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Brief Problems Problems Questions Exercises Exercises Set A Set B

1. Determine the cost of property, plant, and equipment.

1, 2, 3, 4, 1, 2, 3, 4 5

2. Explain and calculate depreciation.

6, 7, 8, 9, 5, 6, 7, 8, 2, 3, 4, 5, 2, 3, 6, 7, 2, 3, 6, 7, 10, 11 9 12 8, 9 8, 9, 12

10, 11 3. Explain the factors that cause 10, 12, 13, 14, 15 changes in periodic depreciation and calculate revisions.

1, 2, 3, 12 1, 2, 3, 4, 1, 2, 3, 4, 7 6

6, 7, 8

4, 5, 6, 12 4, 5, 6

4. Account for the disposal of property, plant, and equipment.

16, 17, 18, 19

12, 13, 14 9, 10

6, 7, 8, 9 6, 7, 8, 9

5. Calculate and record depreciation of natural resources.

20, 21

6. Identify the basic accounting 22, 23, 24 16 issues for intangible assets and goodwill. 25, 26 7. Illustrate the reporting and analysis of long-lived assets.

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17, 18, 19 15, 16

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Difficulty Time Level Allotted (min.)

Description

Record property transactions.

Simple

20-30

Allocate cost and calculate partial period depreciation.

Moderate

20-30

Determine cost; calculate and compare depreciation under different methods.

Moderate

30-40

Account for operating and capital expenditures and asset impairments.

Moderate

20-30

Record impairment and calculate revised depreciation.

Moderate

20-30

Record acquisition, depreciation, impairment and disposal of land and building.

Moderate

25-35

Calculate and compare depreciation and gain or loss on disposal under three methods of depreciation.

Moderate

30-40

Record acquisition, depreciation and disposal of equipment.

Moderate

30-40

Record property, plant and equipment transactions; prepare partial financial statements.

Complex

40-50

10A

Correct errors in recording intangible asset transactions.

Complex

20-25

11A

Record intangible asset transactions; prepare partial balance sheet.

Moderate

30-40

12A

Record natural resource transactions; prepare partial financial Moderate statements.

30-40

13A

Calculate ratios and comment.

Moderate

15-25

Record property transactions.

Simple

20-30

Allocate cost and calculate partial period depreciation.

Moderate

20-30

Determine cost; calculate and compare depreciation under different methods.

Moderate

30-40

Account for operating and capital expenditures and asset impairments.

Moderate

20-30

Record impairment and calculate revised depreciation.

Moderate

20-30

Record acquisition, depreciation, impairment and disposal of land and buildings.

Moderate

25-35

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Difficulty Time Level Allotted (min.)

Description

Calculate and compare depreciation and gain or loss on disposal under three methods of depreciation.

Moderate

30-40

Record acquisition, depreciation and disposal of furniture.

Moderate

30-40

Record property, plant and equipment transactions; prepare partial financial statements.

Complex

40-50

10B

Correct errors in recording intangible asset transactions.

Complex

20-25

11B

Record intangible asset transactions; prepare partial balance sheet.

Moderate

30-40

12B

Record equipment, notes payable and natural resource transactions; prepare partial financial statements.

Moderate

30-40

13B

Calculate ratios and comment.

Moderate

15-25

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom's Taxonomy, Study Objectives and End-ofChapter Exercises and Problems Study Objective

Knowledge Comprehension Application Q9-1 BE9-1 P9-2A Q9-2 BE9-2 P9-3A Q9-3 BE9-4 P9-4A Q9-4 E9-1 P9-1B Q9-5 E9-2 P9-2B E9-3 P9-3B E9-12 P9-4B P9-1A P9-6B 2. Explain and Q9-8 Q9-6 BE9-5 P9-6A calculate Q9-7 BE9-6 P9-7A BE9-7 Q9-9 P9-8A depreciation. BE9-8 Q9-10 P9-9A Q9-11 BE9-9 P9-2B E9-2 P9-3B E9-3 P9-6B E9-4 P9-7B E9-5 P9-8B E9-12 P9-9B P9-2A P9-12B P9-3A 3. Revise periodic Q9-10 BE9-10 P9-5A depreciation. Q9-12 BE9-11 P9-6A Q9-13 E9-6 P9-12A Q9-14 E9-7 P9-4B Q9-15 E9-8 P9-5B E9-12 P9-6B P9-4A P9-12B 4. Account for the Q9-18 Q9-16 BE9-12 P9-8A disposal of property, Q9-17 BE9-13 P9-9A plant, and Q9-19 BE9-14 P9-6B E9-9 P9-7B equipment. E9-10 P9-8B P9-6A P9-9B P9-7A 5. Calculate and record Q9-20 Q9-21 BE9-15 P9-12A depreciation of E9-11 P9-12B

Analysis Synthesis Evaluation

1. Apply the cost BE9-3 principle to property, plant, and equipment.

natural resources. 6. Identify the basic accounting issues for intangible assets. 7. Illustrate the reporting and analysis of longlived assets.

Q9-22 Q9-23 Q9-24 Q9-25 BE9-17

BE9-16 E9-12 E9-13 E9-14 BE9-18 BE9-19 E9-15 P9-9A

P9-10A P9-11A P9-10B P9-11B P9-11A E9-16 P9-12A P9-13A P9-9B P9-13B P9-11B P9-12B Continuing BYP9-4 Cookie Chronicle BYP9-1 BYP9-2 BYP9-3

Q9-26

Broadening Your Perspective

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ANSWERS TO QUESTIONS 1.

Three characteristics of property, plant, and equipment include: they (1) have a physical substance (a definite size and shape), (2) are used in the operations of the business, and (3) are not intended for sale to customers. They are similar to inventory, in that they have physical substance. They are different in they are used in operations, and not intended for resale, as is the case for inventory.

The cost of an item of property, plant, and equipment includes: (1) the purchase price, plus any non-refundable taxes, less any discounts or rebates (2) the expenditures necessary to bring the asset to the location and condition necessary to make it ready for its intended use and (3) if there are obligations to dismantle, remove, or restore the asset when it is retired, an initial estimate of these costs is also included in the cost of the long-lived asset.

The invoice cost, the cost of the safety inspection, and the cost for the required logo painted on the vehicle are capitalized, as they are required costs to put the vehicle into use. The insurance costs benefit the business for the term of the policy and so the costs should be allocated to the period of benefit from the policy, typically by initially recording the payment as prepaid insurance and then reducing the prepayment, charging insurance expense as the policy expires.

Land improvements are structural additions made to the land such as parking lots and fences. Clearing and grading the land are not land improvements but are part of the land cost as they are required to get the land ready for its intended use.

The purchase cost must be split between the land and building because the building is depreciated and the land is not. In addition, the cost of each item will be needed to determine any gain or loss on disposal if either one is later sold.

Justine’s arguments are somewhat valid, with respect to more useful information being provided when using the revaluation model. Where I do not agree with Justine is about the possibility that the revaluation model would only be applied to undervalued assets. For reasons of consistency, the method cannot be applied only to a select group of assets.

Depreciation (a) is a form of cost allocation. Depreciation’s purpose is not (b) asset valuation and (c) does not involve any cash.

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QUESTIONS (Continued) 8.

The three factors that affect calculation of depreciation include: cost, useful life and residual value. The cost of a depreciable asset must include all necessary costs get the asset ready for use. The useful life is the period of time an asset is expected to be available for use. This length may be measured as a function of time or number of units of production. The residual value is the estimated amount that a company would obtain from disposing of the asset at the end of its useful life.

The amount of annual depreciation and profit is different over the useful life of an asset depending on which of the three depreciation methods are being used. The straight-line method creates a constant amount of depreciation over the useful life. The diminishing-balance method is devised to charge a higher amount of depreciation in the earlier part of the useful life of the asset. Lastly, the unit-of-production method is less predictable in that is based on the amount of use that is being made of the asset. The lower the depreciation charge, the higher the profit. By the end of the useful life of the asset, the total amount of depreciation recorded under each of the three methods will be the same.

10.

A company should choose the depreciation method it believes will best reflect the pattern over which the asset’s future economic benefits are expected to be consumed. The depreciation method must be revised if the expected pattern of consumption of the future economic benefits has changed.

11.

Ralph’s plan will not work. For accounting purposes, a company should choose the depreciation method that best matches the estimated pattern in which the asset’s economic benefits are expected to be. For tax purposes income tax regulations require a company to use the single diminishing-balance method and in some case, the straight-line basis. Depreciation is calculated on a class basis and a specified rate is provided by Canada Revenue Agency for specific classes of assets.

12.

Operating expenditures are ordinary repairs made to maintain the operating efficiency and expected productive life of the asset. Because they are recurring expenditures and normally benefit only the current accounting period, they are expensed when incurred. Capital expenditures are additions and improvements made to increase efficiency, productivity, or expected useful life of the asset. Because they benefit future periods, capital expenditures are debited to the asset account affected. Once capitalized, these expenditures are depreciated over their benefiting period.

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QUESTIONS (Continued) 13.

Revision of the depreciation generally occurs when there is a change to any of the three factors that affect the calculation of depreciation: the asset’s cost, useful life, or residual value. Depreciation needs to be revised if there are capital expenditures, impairments in the asset’s recoverable amount, changes in the depreciation method, or changes in the estimated remaining useful life or residual value. The revisions are not correction of errors and so there is no revision of depreciation previously recorded in past accounting periods.

14.

Factors that may contribute to an impairment loss include: obsolescence of a piece of equipment, loss of a market for a product manufactured, bankruptcy of the supplier of replacement parts for equipment, environmental concerns causing extra costs of disposal at the end of the useful life. Under International Financial Reporting Standards (IFRS) a company may write up the carrying amount of the asset if there is a reversal in a previously recorded impairment. The write up is limited to the amount required to increase the asset’s carrying amount to what it would have been if the impairment loss had not been recorded. Also under IFRS, a company will write up its property, plant, and equipment if it is using the revaluation model and the fair value increases. Adoption of the revaluation model is optional, and very rare.

15.

Extending the total service life and consequently the estimated remaining useful life of a depreciable asset will reduce the amount depreciation recorded in the remaining years of use. On the other hand, the depreciation recorded in the previous periods will not be affected. Also, the total amount of depreciation over the asset’s useful life will not change.

16.

Depreciation must be updated from the last time depreciation entries were recorded to the date of the sale because the depreciation expense must properly reflect the total period over which the asset’s economic benefits are used. Updating depreciation also aids in determining the correct amount of the gain or loss on disposition.

17.

The asset and related accumulated depreciation should continue to be reported on the balance sheet, without further depreciation or adjustment, until the asset is retired. Reporting the asset and related accumulated depreciation on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully depreciated, no additional depreciation should be taken on this asset, even if it is still being used. In no situation can the accumulated depreciation exceed the cost of the asset.

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QUESTIONS (Continued) 18.

In a sale of property, plant, or equipment, the carrying amount of the asset is compared to the proceeds from the sale. If the proceeds of the sale exceed the carrying amount of the asset, a gain on disposal occurs. If the proceeds of the sale are less than the carrying amount of the asset sold, a loss on disposal occurs. In an exchange, a new asset is received in an exchange for the old asset given up. The gain or loss is calculated by comparing the fair value of the asset given up to its carrying amount. The trade-in allowance on the asset given up is not relevant because it rarely reflects the fair value of the asset that is given up. Instead of using the trade-in allowance, the fair value of the asset given up is used to calculate the gain or loss on the asset being given up. A loss results if the carrying amount of the asset being given up is more than its fair value. A gain results if the carrying amount is less than its fair value.

19.

Carrying amount of an item of property, plant, or equipment is a sub-total amount representing the net amount of the cost less the accumulated depreciation. The amount is not a general ledger account and so is not used in journal entries used to record dispositions. Instead, the asset and accumulated depreciation accounts are used in the journal entry.

20.

Both natural resources and property, plant, and equipment are tangible long lived assets which are expected to last beyond one year and are therefore classified on the balance sheet as non-current. Both these types of assets are depreciated. Cost is determined in the same way for both. Asset retirement costs may be higher with natural resources. Unlike property, plant, and equipment where the depreciation recorded in a year becomes an expense that causes profit to be reduced, the depreciation (often called depletion) of natural resources results in the increase in another asset, inventory which is subsequently sold. Another difference between these assets is that the natural resources are physically extracted in operations such as mining, cutting, or pumping and only an act of nature can replace them.

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QUESTIONS (Continued) 21.

The units-of-production method for depreciation is a common and ideal method of depreciating natural resources. There is a finite quantity of units of natural resource to be extracted. As extraction occurs, the conversion from one asset (natural resource) to another (inventory) can be measured in units and cost of the units can be fairly applied. Consequently, a more precise charge for depreciation can be arrived at that corresponds to the asset created (inventory) when the natural resource is reduced. The process of reducing the natural resource is called depletion which corresponds more directly to the meaning of the reduction of the asset through conversion to another asset (inventory). This term is in contrast to the term depreciation which is more closely associated with consumption or loss of use of depreciable assets.

22.

The accounting for tangible and intangible assets is much the same. Tangible and intangible assets are reported at cost, which includes all expenditures necessary to prepare the asset for its intended use. Both tangible and intangible assets with finite lives are amortized over their useful life. In the case of long-lived tangible assets, the useful life or the physical life of the asset will be used as a limit of the length of time the assets will be depreciated. In the case of intangible life, there is no physical limitation in the usefulness of asset and the length of time the asset will be amortized is the shorter of its useful life or its legal life, usually on a straight-line basis. Due to their lack of substance, intangible assets are more likely to have indefinite useful lives and not need to be amortized, but only tested for impairment. This characteristic is the main difference between the accounting of tangible and intangible assets.

23.

Impairment losses are treated as follows: (a) For finite life intangible assets, an impairment loss often brings about a change in the estimated remaining useful life for amortization recorded following the impairment. This is not the case with indefinite life intangibles since there is no amortization recorded for these types of intangible assets. (b) Under IFRS, indefinite life intangible asset must be tested for impairment at least one a year and reversals of impairment losses can be recorded. Under ASPE, the impairment test need not be performed annually, but must be performed if indicators of impairment are present. Reversals of impairment losses are not recorded under ASPE. (c) For goodwill, reversals for impairment are not recorded under either IFRS or ASPE.

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QUESTIONS (Continued) 24.

Goodwill is the value of many favourable attributes that are intertwined in a business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill is only recorded on the purchase of a business if the purchaser pays a price that is greater than the fair value of the net assets of the business.

25.

Property, plant, and equipment and natural resources are often combined and reported in the balance sheet as “property, plant, and equipment” or “capital assets”. Intangible assets are listed separately after property, plant, and equipment. Goodwill must be disclosed separately. For assets that are depreciated or amortized, the balances of the accumulated depreciation and/or amortization must be disclosed in the balance sheet or in the notes to the financial statements. Depreciation and amortization expense for the period must also be disclosed either on the income statement or in the notes to the financial statements. When impairment losses have occurred they should be shown on a separate line on the income statement, with the details disclosed in a note. The notes to financial statements should disclose the depreciation or amortization methods and rates that are used. The carrying amount of each major class of long-lived assets should also be disclosed. Companies should also disclose their impairment policy in the notes to the financial statements. Under IFRS, companies must disclose in the notes to the financial statements if they are using the cost or the revaluation model for each class of assets, and include a reconciliation of the carrying amount at the beginning and end of the period for each class of long-lived assets. If a company uses the revaluation model, it must also disclose any increases or decreases from revaluation.

26.

I disagree. Higher turnover of assets does not necessarily result in increased profits. A higher asset turnover just means that more revenue or sales are being generated for each dollar of assets. On the other hand, a higher return on assets means a proportionately higher profit has been generated for each dollar of assets.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 (a) (b)

The cost of the land is $95,000 ($85,000 + $1,500 + $5,000 + $3,500). The cost of the land improvements is $5,000.

BRIEF EXERCISE 9-2 The cost of the equipment is $42,000 (invoice price $40,375 + transportation $625 + installation and testing $1,000). The payment of $1,750 for the insurance should be recorded as a prepayment insurance which will later be expensed as it is consumed.

BRIEF EXERCISE 9-3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m)

O C C C O C O C O C C O C

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BRIEF EXERCISE 9-4 Jan. 2

Land [$850,000 × ($352,000 ÷ $880,000)] .... 340,000 Building [$850,000 × ($396,000 ÷ $880,000)] .... 382,500 Equipment [$850,000 × ($132,000 ÷ $880,000)] .... 127,500 Cash................................................ Mortgage Notes Payable ($850,000 − $170,000) .................

170,000 680,000

BRIEF EXERCISE 9-5 Depreciable amount is $36,000 ($42,000 − $6,000). With a 4-year useful life, annual depreciation is $9,000 ($36,000  4). Under the straight-line method, depreciation is the same each year. Thus, depreciation expense is (a) $9,000 for each year of the equipment’s life and (b) $36,000 in total over the equipment’s life.

BRIEF EXERCISE 9-6 The diminishing-balance rate is 50% (1  4 × 2) and this rate is applied to carrying amount at the beginning of the year. Depreciation expense for each year is as follows: (a) Carrying Amount End of Year Beginning Depr. Depr. Accum. Carrying Year Of Year × Rate = Expense Depr. Amount $42,000 2014 $42,000 50% $21,000 $21,000 21,000 2015 21,000 50% 10,500 31,500 10,500 2016 10,500 50% 4,500¹ 36,000 6,000 ¹ Limited to the amount that reduces the carrying amount to the residual value of $6,000 (b) Total depreciation over the truck’s useful life is $36,000.

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BRIEF EXERCISE 9-7 (a)

Depreciable amount per unit: ($38,950 − $4,300)  550,000 km. = $0.063/km.

(b)

Annual depreciation expense: 2013: 90,000 × $0.063 = $5,670 2014: 135,000 × $0.063 = $8,505

BRIEF EXERCISE 9-8 (a) Depreciation expense for each year:

Depreciable Year Amount* × 2014 2015 2016 2017 2018

$36,000 36,000 36,000 36,000 36,000

Depr. Rate

25% × 9/12 25% 25% 25% 25% × 3/12

Depr. Expense $ 6,750 9,000 9,000 9,000 2,250

End of Year Accum. Carrying Depr. Amount $42,000 $ 6,750 35,250 15,750 26,250 24,750 17,250 33,750 8,250 36,000 6,000

*Depreciable amount = $42,000 − $6,000 = $36,000 (b) Total depreciation expense over the equipment’s useful life is $36,000. (See accumulated depreciation at end of 2018 above.)

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BRIEF EXERCISE 9-9 The double diminishing-balance rate is 50% (25% × 2) and this rate is applied to carrying amount at the beginning of the year. Depreciation expense for each year is as follows: (a) Double Diminishing-balance Carrying Amount Beginning Year Of Year × 2014 2015 2016 2017

$42,000 31,500 15,750 7,875

End of Year Depr. Depr. Accum. Carrying Rate = Expense Depr. Amount $ 42,000 50% × 1/2 $ 10,500 $ 10,500 31,500 50% 15,750 26,250 15,750 50% 7,875 34,125 7,875 50% 1,875¹ 36,000 6,000

¹ Limited to the amount that brings the carrying amount to the residual value of $6,000 (b) Total depreciation expense over the equipment’s useful life is $36,000. (See accumulated depreciation at end of 2017 above.)

BRIEF EXERCISE 9-10 (a)

Annual depreciation: ($250,000 − $10,000)  6 = $40,000 Equipment cost ............................................... Less accumulated depreciation ($40,000 × 3) for 2012 to 2014................. Carrying amount Dec. 31, 2014 ......................

(b) Impairment Loss......................................... Accumulated Depreciation—Equipment Carrying amount (a) ........................................ Less: Recoverable amount ............................ Impairment loss............................................... Solutions Manual .

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$250,000 120,000 $130,000 30,000 30,000 $130,000 100,000 $ 30,000 Chapter 9

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BRIEF EXERCISE 9-11 Depreciation expense from 2011 to 2013: [($65,000 − $5,500) ÷ 7 years = $8,500] 2011 2012 2013 Total

$ 8,500 8,500 8,500 $25,500

Carrying amount, Jan. 1, 2014 ($65,000 − $25,500) ....... $39,500 Add: Equipment up-grade ............................................. 10,200 Less: Revised residual value ......................................... (3,200) Remaining depreciable amount ..................................... 46,500 Remaining useful life (9 years − 3 years) ...................... ÷ 6 years Revised annual depreciation expense 2014 .................. $ 7,750

BRIEF EXERCISE 9-12 (a)

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

25,700

(b) Accumulated Depreciation— Equipment................................................... Loss on Disposal........................................ Equipment ..............................................

22,500 3,200

25,700

Cost of equipment.................................................. Less: Accumulated depreciation .......................... Carrying amount at date of disposal..................... Proceeds from retirement...................................... Loss on disposal ....................................................

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25,700 $25,700 22,500 3,200 0 $ 3,200

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BRIEF EXERCISE 9-16 (a) Mar. 31

(b) Mar. 31

Depreciation Expense [($86,400 − $2,200) ÷ 6 × 3/12] ........ Accumulated Depreciation —Equipment .............................

3,508 3,508

Cash ................................................ 15,000 Accumulated Depreciation— Equipment ¹ .................................... 73,675 Gain on Disposal ...................... 2,275 Equipment ................................. 86,400

¹ [($86,400 − $2,200) ÷ 72 months × 63 months] = $73,675 Cost of equipment.................................... Less: accumulated depreciation ............. Carrying amount at date of disposal....... Proceeds from sale .................................. Gain on disposal ...................................... (c) Mar. 31

Cash ................................................ 9,000 Accumulated Depreciation— Equipment....................................... 73,675 Loss on Disposal............................ 3,725 Equipment ................................. 86,400

Cost of equipment.................................... Less: accumulated depreciation ............. Carrying amount at date of disposal....... Proceeds from sale .................................. Loss on disposal ......................................

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$86,400 73,675 12,725 15,000 $ 2,275

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$86,400 52,500 12,725 9,000 $ 3,725

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BRIEF EXERCISE 9-14 Jan. 7

Equipment (new) ........................... Accumulated Depreciation —Equipment .................................. Loss on Disposal........................... Equipment (old) ........................ Cash...........................................

105,000** 78,000 2,000*** 95,000 90,000*

*Cash paid on exchange = list price of new less trade-in allowance: ($110,000 − $20,000 = $90,000) **Cost of new = consideration paid in cash plus fair value of old asset: ($90,000 + $15,000 = $105,000) ***Loss on disposal = Carrying amount − fair value: [($95,000 − $78,000) − $15,000 = $2,000]

BRIEF EXERCISE 9-15 (a)

Depreciable amount = $6,500,000 − $500,000 = $6,000,000 Depreciable amount per unit = $6,000,000 ÷ 25,000,000 tonnes = $0.24 per tonne Depreciation cost for ore extracted in Year 1: $0.24 per tonne × 5,000,000 tonnes = $1,200,000 Aug. 31 Inventory ....................................... 1,200,000 Accumulated Depreciation—Mine 1,200,000 Depreciation to be included in cost of goods sold: $0.24 per tonne × 3,000,000 tonnes = $720,000 Depreciation to be included in inventory: $0.24 per tonne × 2,000,000 tonnes = $480,000

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BRIEF EXERCISE 9-15 (Continued) (b) CUONO MINING CO. Balance Sheet (Partial) August 31, 2014 Assets Current assets Inventory ..................................................

$480,000*

Property, plant, and equipment Ore mine ................................................... $6,500,000 Less: Accumulated depreciation ............ 1,200,000 5,300,000 * Check ($1,200,000 − $720,000 = $480,000)

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BRIEF EXERCISE 9-16 (a)

2014 Jan.

2 Patents ....................................... 150,000 Cash....................................

150,000

(b) Dec. 31 Amortization Expense ($150,000  8) .......................... 18,750 Accumulated Amortization— Patents ...............................

18,750

(c)

2015 Jan.

5 Patents .................................... Cash....................................

30,000 30,000

(d) Original cost of patent ...................................... $150,000 Less: accumulated amortization ................... (18,750) Plus: Legal costs to defend ............................... 30,000 Remaining cost to be amortized ................... 161,250 Remaining useful life (8 years − 1 year) ....... ÷ 7 years Revised annual amortization expense 2015 . $ 23,036

BRIEF EXERCISE 9-17 (a) (b) (c) (d) (e) (f) (g) (h)

PPE NA (expense) I I NA (current asset) PPE NA (investment) I

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PPE NR NA (investment) PPE I NA (expense) NA (current asset) I

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BRIEF EXERCISE 9-20 CANADIAN TIRE CORPORATION, LIMITED Balance Sheet (Partial) December 31, 2011 (in millions) Property, plant, and equipment Land (net of $1.4 of impairments).................. $ 748.8 Buildings ......................................................... $2,589.6 Less: Accumulated depreciation ................... 1,014.8 1,574.8 Fixtures and equipment ................................. 826.0 Less: Accumulated depreciation ................... 545.6 280.4 Leasehold improvements............................... 712.5 Less: Accumulated depreciation ................... 216.5 496.0 Assets under finance lease............................ 267.4 Less: Accumulated depreciation ................... 138.5 128.9 Construction in progress ................................................ 137.0 Total property, plant, and equipment 3,365.9 Intangible assets FGL Sports indefinite-life intangibles ....................... Mark’s Work Wearhouse indefinite-life intangibles... FGL Sports finite-life intangible assets..................... Less: Accumulated amortization ............................... Total intangible assets

316.8 64.1 22.4 403.3 1.5 401.8

Goodwill ..........................................................................

377.6

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BRIEF EXERCISE 9-19 ($ in US millions)

Return on assets

$1,375 [($13,140 + $12,892) ÷ 2] = 10.56%

Asset turnover

$15,470 [($13,140 + $12,892) ÷ 2] = 1.19 times

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SOLUTIONS TO EXERCISES EXERCISE 9-1 (a)

The acquisition cost of a property, plant, and equipment includes all expenditures necessary to acquire the asset and make it ready for its intended use. This includes not only the invoice cost of acquisition, but any freight, installation, testing, and similar costs to get the asset ready for use. For example, the cost of factory equipment includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and installation costs. Costs such as these benefit the life of the factory equipment and not just the current period. Consequently, they should be capitalized and depreciated over the equipment’s useful life.

(b) 1. Land 2. Land 3. Land 4. Land ($4,800 − $900 = $3,900) 5. Vehicles 6. Vehicles 7. Vehicles 8. Licence Expense 9. Prepaid Insurance 10. Plant 11. Land Improvements

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EXERCISE 923 (a) Land Buildings Land Improvements

(b)

(c)

Appraised Value $ 476,000 748,000 136,000 $1,360,000

% of Total 35% 55% 10%

Land ......................................................... Building.................................................... Land Improvements ................................ Cash..................................................... Mortgage Payable ...............................

Cost Allocated $ 448,000 704,000 128,000 $1,280,000 448,000 704,000 128,000 255,000 1,025,000

Depreciable amount for the building is $654,000 ($704,000 – $50,000). With a 60-year useful life, annual depreciation expense is $10,900 ($654,000  60). Depreciable amount for the land improvements is $128,000. With a fifteen year useful life, annual depreciation expense is $8,533 ($128,000  15).

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EXERCISE 924 (a) Cost of equipment Delivery Insurance in transit Testing and installation Total cost

$75,000 1,000 200 2,800 $79,000

(b)

April 1, 2014 because that is the date the equipment was available for use to the company.

(c)

The company should use the straight-line method since the economic benefits are expected to be consumed evenly over the equipment’s useful life.

(d)

Depreciation expense, 2014 = $79,000 ÷ 10 × 9/12 = $5,925 Depreciation expense, 2015 = $79,000 ÷ 10 = $7,900

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EXERCISE 9-4 (a) Straight-line

Depreciable Year Cost* ×

Depr. Rate

Depr. Expense

2013 2014

20% × 1/2 20%

$33,000 66,000

$330,000 330,000

End of Year Accum. Carrying Depr. Amount $345,000 $33,000 312,000 99,000 246,000

* $345,000 − $15,000 = $330,000 (b) Diminishing-balance using double the straight-line rate Carrying Amount Beginning Year of Year ×

Depr. Rate

Depr. Expense

2013 2014

40% × 1/2 40%

$69,000 110,400

(c)

$345,000 276,000

End of Year Accum. Carrying Depr. Amount $345,000 $69,000 276,000 179,400 165,600

Units-of-Production

Units-ofDepr. Year Production × Cost/Unit* =

Depr. Expense

2013 2014

$39,050 65,230

71,000 118,600

$0.55 0.55

End of Year Accum. Carrying Depr. Amount $345,000 $39,050 305,950 104,280 240,720

*Depreciable amount per unit is $0.55 per unit: [($345,000 − $15,000) ÷ 600,000 units = $0.55]

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EXERCISE 9-4 (Continued) (d)

In this particular case, the unit-of-production can be used as management is able to reliably estimate the amount of total production that will be obtained by using the equipment. This method allows for the best matching of depreciation costs with the related benefits obtained from the asset’s use. Another factor affecting the choice of depreciation methods is consistency with methods used in the past for similar type assets. Since this is a rather expensive piece of equipment, Blue Ribbon’s policy of recording a half year’s depreciation in the year of acquisition could conceivably bias the amount charged for depreciation in 2013. Coincidentally, the date of purchase happens to be within one month of the mid-point of the fiscal year. The choice of methods would consequently not differ tremendously between the unit-of-production and the straight-line methods. Future purchases of depreciable assets could nonetheless unfairly charge depreciation in the year of purchase. By choosing the unitof-production, the bias is removed.

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EXERCISE 9-5 (a) (1) Straight-line

Depreciable Year Amount* × 2013 2014 2015 2016 2017

$115,200 115,200 115,200 115,200 115,200

Depr. Rate

Depr. Expense

25% × 8/12 25% 25% 25% 25% × 4/12

$19,200 28,800 28,800 28,800 9,600

End of Year Accum. Carrying Depr. Amount $129,200 $19,200 110,000 48,000 81,200 76,800 52,400 105,600 23,600 115,200 14,000

* $129,200 − $14,000 = $115,200

(2)

Diminishing-balance using double the straight-line rate

Carrying Amount Beginning Year of Year × 2013 2014 2015 2016

$129,200 86,133 43,066 21,533

Depr. Rate =

Depr. Expense

50% × 8/12 50% 50% 50%

$43,067 43,067 21,533 7,533*

End of Year Accum. Carrying Depr. Amount $129,200 $43,067 86,133 86,134 43,066 107,667 21,533 115,200 14,000

** Limited to the amount that brings the carrying amount to the residual value of $14,000.

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EXERCISE 9-5 (Continued) (a) (Continued) (3) Units-of-Production

Year 2013 2014 2015 2016 2017

End of Year Units of Deprec. Depr. Accum. Carrying Production × Amt/Unit* = Expense Depr. Amount $129,200 1,900 $9.60 $18,240 $18,240 110,960 2,800 9.60 26,880 45,120 84,080 3,700 9.60 35,520 80,640 48,560 2,700 9.60 25,920 106,560 22,640 1,100 9.60 8,640** 115,200 14,000

* Depreciation amount per unit is $9.60/hour [($129,200 – $14,000)  12,000 hours = $9.60] ** Limited to the amount that brings the carrying amount to the residual value of $14,000. (b) Over the life of the asset, depreciation expense (in total) will be the same for all three methods. (c)

Cash flow is the same under all three methods. Depreciation is an allocation of the cost of a long-lived asset and not a cash expenditure.

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EXERCISE 929 (a)

(b)

July 1 Equipment.................................. 500,000 2010 Cash.......................................

500,000

Dec. 31 Depreciation Expense ................. 25,000 2010 Accumulated Depreciation— Equipment ($500,000 ÷ 10 × 6/12)

25,000

Dec. 31 Depreciation Expense ................. 50,000 2013 Accumulated Depreciation— Equipment ($500,000 ÷ 10) ...

50,000

Carrying amount of the equipment—Dec. 31, 2013 [$500,000 – ($50,000 × 3.5 years)] ............. $325,000 Recoverable amount .................................. 225,000 Impairment loss.......................................... $100,000 Dec. 31 Impairment Loss ....................... 100,000 2013 Accumulated Depreciation— Equipment .............................

(c)

100,000

January 1, 2014 Carrying amount is $225,000 Depreciation expense for 2014: $225,000 ÷ 6.5 years = $34,615. December 31, 2014 Carrying amount is $190,385 ($225,000 − $34,615).

(d) Carrying amount at Dec. 31, 2014 ............. Carrying amount at Dec. 31, 2014 if no impairment recorded ($325,000 − $50,000) Recoverable amount ..................................

$190,385 275,000 240,000

The reversal of impairment loss can be recognized to increase the carrying amount up to $275,000. Therefore a reversal of impairment loss of $49,615 should be recorded. ($240,000 − $190,385)

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EXERCISE 930 (a)

Annual depreciation — current estimate Building: ($800,000 – $40,000) ÷ 20 yrs = $38,000 per year Equipment: ($125,000 – $5,000) ÷ 5 yrs = $24,000 per year

(b) Carrying amount — Building Jan. 1, 2014: $344,000 [$800,000 – ($38,000 × 12)] Carrying amount — Equipment Jan. 1, 2014: $77,000 [$125,000 – ($24,000 × 2)] (c)

Annual depreciation — revised estimate — 2014 Building: [($344,000 – $60,500) ÷ (30 − 12 yrs)] = $15,750 per year Equipment: [($77,000 – $4,000) ÷ (4 – 2 yrs)] = $36,500 Carrying amount — Building Dec. 31, 2014: $328,250 ($344,000 – $15,750) Carrying amount — Equipment Dec. 31, 2014: $40,500 ($77,000 – $36,500)

(d) Total depreciation expense over the life will be the difference between the cost and the revised residual value: Building: $800,000 – $60,500 = $739,500 Equipment: $125,000 – $4,000 = $121,000

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EXERCISE 931 (a)

Annual depreciation — first two years of equipment’s life ($90,000 – $9,000) ÷ 6 yrs = $13,500 per year

(b) Carrying amount Building Sept. 30, 2014: $63,000 [$90,000 – ($13,500 × 2)] (c)

2014 Oct.

1 Equipment.................................... 15,000 Cash.......................................

15,000

(d) 2015 Sept. 30 Depreciation Expense ................. 36,500 Accumulated Depreciation —Equipment .........................

36,500

Carrying amount Sept. 30, 2014 (b) ............................ $63,000 Add: Upgrade .............................................................. 15,000 78,000 Less: Revised residual value .................................... 5,000 Remaining depreciable amount ................................. $73,000 Remaining useful life (4 − 2) ................................... ÷ 2 years Revised annual depreciation expense ....................... $36,500

(e)

Calculations: Cost ($90,000 + $15,000) ........................................... $105,000 Depreciation year ended Sept. 30, 2013 .... $13,500 Depreciation year ended Sept. 30, 2014 .... $13,500 Depreciation year ended Sept. 30, 2015 .. $36,500 63,500 Carrying amount Sept. 30, 2015 ................................. $41,500

Property, plant, and equipment Equipment ................................................ $105,000 Less: Accumulated depreciation ....... 63,500

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EXERCISE 932 (a) Jan. 2 No depreciation entry Apr. 1 Depreciation Expense ........................ Accumulated Depreciation —Equipment................................... ($45,000 ÷ 10 years × 3/12)

1,125

July 30 Depreciation Expense ........................ Accumulated Depreciation —Equipment................................... ($12,600 ÷ 3 years × 7/12)

2,450

1,125

Nov. 1 Depreciation Expense ........................ 3,125 Accumulated Depreciation—Vehicles ($35,000 − $5,000) ÷ 8 years × 10/12)

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Accounting Principles, Sixth Canadian Edition

EXERCISE 9-9 (Continued) (b)

Cash

Equipment

Accum. Depr.

Total PP&E

Total Assets

Owner's Equity

Profit

Jan. 2

−$8,000

Apr. 1

−$45,000

−$41,6251

−$3,3752

−$3,375

July 30

+$1,100

−$12,600

−$10,8503

−$1,7504

−$6505

−$650

Nov. 1

−$36,000

−$35,000 +$43,0006

−$26,2507

+$34,2508

−$1,7509

−$1,750

Transaction

$41,625 = ($45,000 ÷ 10 years) × (9 years + 3 months) $3,375 = $45,000 − $41,625 3 $10,850 = ($12,600 ÷ 3 years) × (2 years + 7 months) 4 $1,750 = $12,600 − $10,850 5 −$650 = $1,100 − $1,750 6 $43,000 = Fair value of old vehicle$7,000 + cash $36,000 7 $26,250 = [($35,000 − $5,000) ÷ 8 years)] × 7 years 8 $34,250 = $43,000 – ($35,000 − $26,250) 9 $1,750 = Fair value old vehicle $7,000 – Carrying amount $8,750 ($35,000 − $26,250) 2

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EXERCISE 9-9 (Continued) (c) Jan. 2 Accumulated Depreciation —Equipment ...................................... Equipment ...................................... Apr. 1 Accumulated Depreciation —Equipment ....................................... Loss on Disposal................................ Equipment ...................................... July 30 Cash .................................................... Accumulated Depreciation —Equipment ....................................... Loss on Disposal ............................... Equipment ...................................... Nov. 1 Vehicles (New) .................................... Accumulated Depreciation —Vehicles ........................................... Loss on Disposal................................ Vehicles (Old)................................. Cash................................................

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8,000 8,000 41,625 3,375 45,000 1,100 10,850 650 12,600 43,000 26,250 1,750 35,000 36,000

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EXERCISE 9-35 (a)

(1) (2)

Straight-line method: ($48,000 − $4,000) ÷ 4 years = $11,000 per year for 2011, 2012 and 2013. Double diminishing-balance method DDB Rate: ¼ × 2 = 50%

2011: $48,000 × 50% = $24,000 2012: ($48,000 − $24,000) × 50% = $12,000 2013: ($48,000 − $24,000 − $12,000) × 50% = $6,000 (b) (1)

Straight-line method Proceeds − Carrying amount = Gain (loss) $8,000 – [$48,000 – ($11,000 × 3)] = $8,000 – $15,000 = ($7,000) loss

(2)

Double diminishing-balance method Proceeds − Carrying amount = Gain (loss) $8,000 – [$48,000 – ($24,000 + $12,000 + $6,000)] = $8,000 – $6,000 = $2,000 gain

(c) The amount of the loss using the straight-line method is $7,000. The amount of the gain using the doublediminishing-balance method is $2,000. The amounts are not the same because of the difference in the depreciation expense calculation on a year to year basis which impacts the carrying amount of the asset which in turn impacts the gain or loss on disposal. The double-diminishing-balance method records higher depreciation in the early years than the straight-line method, thus giving a lower net book value with the double-diminishing-method in the early years. (d) When comparing the total impact on profit over the threeyear period the amounts are identical. Using the straightline method total depreciation is $33,000 and loss on disposal is $7,000 resulting in a $40,000 decrease in profit over the three year period. Using the double-diminishingbalance method total depreciation is $42,000 and gain on disposal is $2,000 resulting in a $40,000 decrease in profit over the three year period. Solutions Manual .

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EXERCISE 9-36 (a) The units-of-production method is recommended for depreciating natural resources because it best reflects the pattern over which the assets’ future economic benefits are expected to be consumed. It requires that an estimate can be made of the total number of units that are available to be extracted from the resource. (b) Dec. 31 Inventory ($1.50 × 100,000) ....... 150,000 Accumulated Depreciation—Mine

150,000

Depreciable amount $1,300,000 − $100,000 = $1,200,000 Depreciable amount per unit: $1,200,000 ÷ 800,000 tonnes = $1.50 per tonne (c) PHILLIPS EXPLORATION INC. Income Statement (Partial) Year Ended December 31, 2014 Cost of goods sold: (will include this amount plus other costs) ($1.50 × 100,000 tonnes) ............................ $150,000 PHILLIPS EXPLORATION INC. Balance Sheet (Partial) December 31, 2014 Assets Property, plant, and equipment Ore mine ................................................ $1,200,000 Less: Accumulated depreciation ....... 150,000

$1,050,000

(d) Because the market price of the ore ($1.40 per tonne) has fallen below the per unit depreciable amount ($1.50 per tonne), the carrying amount of the remaining natural resource exceeds its realizable value and so an impairment of the mine has taken place.

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EXERCISE 9-12 1.

The original entry to add the cost of removing the old building, legal fees and clearing and grading the land to the Land account is correct. The student’s accounting treatment is incorrect. The costs involved must be added to the cost of land as they were necessary costs to acquire the land and get it ready for its intended use.

Depreciation is the process of allocating the cost of a longlived asset to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and revenue producing ability does not decline. In addition, the useful life of land is indefinite. Therefore it would be incorrect for the student to depreciate the land.

Although consistency is necessary in applying accounting policies, in this case it should not have been the basis for recording depreciation on the trademarks. Trademarks can have usefulness to the business indefinitely. This is the probable reason that depreciation had not been recorded for trademarks in the past. As long as trademarks continue to assist in producing revenue and their carrying amounts have not been impaired, they should not be depreciated. Rather they should be tested regularly for impairment. If a permanent decline in value has occurred, the trademarks must be written down and an impairment loss recorded on the income statement. Therefore, the depreciation entry should be reversed and no decline in value recorded unless an impairment occurs.

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EXERCISE 9-12 (Continued) 4.

This student’s reasoning is faulty and an incorrect application of the principle of consistency in accounting. Adjusting property, plant, and equipment for increases to their fair value occurs when the business uses the revaluation model or fair value model under the International Financial Accounting Standards (IFRS). This is very unlikely the case for Chin Company. As well, current fair values are subjective and not reliable; they are not used to increase the recorded value of an asset after acquisition. The appropriate accounting treatment is to leave the building on the books at its zero carrying amount.

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EXERCISE 9-13 (a) 2013 Jan. 9

Patents ............................................. Cash.............................................

45,000

May 15 Goodwill ........................................... Cash.............................................

450,000

Dec. 31 Amortization Expense ..................... Accumulated Amortization —Patents ($45,000 ÷ 5) ...............

9,000

31 Impairment Loss.............................. Goodwill ($450,000 − $400,000)..

50,000

2014 Jan. 2

45,000

450,000

9,000

50,000

Patents ............................................. Cash.............................................

30,000

Mar. 31 Research Expense .......................... Cash.............................................

175,000

Apr. 1 Copyrights ....................................... Cash.............................................

66,000

July 1 Trademark........................................ Cash.............................................

275,000

Dec. 31

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30,000

175,000

66,000

275,000

Amortization Expense ..................... 21,450 Accumulated Amortization—Patents [($45,000 – $9,000 + $30,000) ÷ 4] Accumulated Amortization— Copyrights [($66,000 ÷ 10) × 9/12]

16,500

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EXERCISE 9-13 (Continued) (a)

(Continued) Impairment test Patents: Cost .................................................. Addition............................................ Amortization 2013 ........................... Amortization 2014 ........................... Carrying amount Dec. 31, 2014 ...... Recoverable amount ....................... Impairment loss...............................

$45,000 30,000 (9,000) (16,500) 49,500 45,000 $ 4,500

Dec. 31 Impairment Loss.............................. Accumulated Amortization —Patents .....................................

4,500

Carrying amount of Goodwill ......................... Recoverable amount .......................................

400,000 425,000

4,500

No recovery of goodwill impairment is recorded under IFRS. (b) Assets Intangible assets Patents ................................................. Less: Accumulated amortization ....... Copyrights............................................ Less: Accumulated amortization....... Trademark ............................................ Total intangible assets ........................ Goodwill ....................................................

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$75,000 30,000 66,000 4,950

$45,000 61,050 275,000 $381,050 $400,000

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EXERCISE 9-41 (a) Patent Purchase price Jan. 1, 2011 Amortization 2011 (1) Amortization 2012 Amortization 2013 Balance Dec. 31, 2013 Amortization 2014 (2) Balance Dec. 31, 2014 (1) (2)

Amort. $50,000 50,000 50,000

$250,000 $83,333 $166,667

($400,000 ÷ 8 years) Carrying amount ÷ (6 – 3 years) = $250,000 ÷ 3

Trademark Purchase price during 2010 Legal defence during 2013 Balance Dec. 31, 2013 Balance Dec. 31, 2014 (3) (3)

Cost $400,000

Carrying Amount

Cost $250,000 50,000 $300,000

Carrying Impairment Amount

$300,000 $25,000 $275,000

Excess of carrying amount of $300,000 over recoverable amount of $275,000

Goodwill Purchase price during 2012 Balance Dec. 31, 2013 Balance Dec. 31, 2014

Cost Impairment $70,000 $70,000 $15,000 No reversal

(b) Income statement – December 31, 2014 Operating expenses: Amortization expense—Patents Impairment loss—Trademark

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Carrying Amount $55,000 $55,000

$83,333 25,000

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EXERCISE 9-15 (a) Account Accumulated amortization — computer software Accumulated amortization — customer relationships Accumulated amortization — other intangible assets Accumulated amortization — prescription files Accumulated depreciation — assets under financing lease Accumulated depreciation — buildings Accumulated depreciation — equipment, fixtures, and computer equipment Accumulated depreciation — leasehold improvements Assets under financing leases

Financial Statement Balance Sheet

Section

Balance Sheet

Intangibles

Balance Sheet

Intangibles

Balance Sheet

Intangibles

Balance Sheet

Property, Plant, and Equipment Property, Plant, and Equipment Property, Plant, and Equipment

Balance Sheet Balance Sheet

Depreciation and amortization Expense Buildings

Income Statement Balance Sheet

Computer software Customer relationships Equipment, fixtures, and computer equipment Goodwill Financing expenses

Balance Sheet Balance Sheet Balance Sheet

Investment property Land

Balance Sheet Income Statement Balance Sheet Balance Sheet

Leasehold improvements

Balance Sheet

Loss on disposal of property, plant, and equipment Other non-current assets Other intangible assets Prescription files Properties under development

Income Statement Balance Sheet Balance Sheet Balance Sheet Balance Sheet

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Intangibles

Property, Plant, and Equipment Property, Plant, and Equipment Operating Expenses Property, Plant, and Equipment Intangibles Intangibles Property, Plant, and Equipment Goodwill Other Expenses Investments Property, Plant, and Equipment Property, Plant, and Equipment Operating Expenses Non-current Assets Intangibles Intangibles Property, Plant, and Equipment

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EXERCISE 9-15 (Continued) (b) Shoppers Drug Mart Corporation Balance Sheet (Partial) December 31, 2011 (in thousands) Non-current assets: Investment property....................................................... Other non-current assets................................................ Property, plant, and equipment Land............................................................................. Properties under development ................................. Buildings ...................................................... $214,043 Less: Accumulated depreciation ............... 24,325 Equipment, fixtures and computer equipment ...............................1,283,062 Less: Accumulated depreciation .............. 792,644 Leasehold improvements............................1,291,445 Less: Accumulated depreciation ...............451,481 Assets under financing lease ................. 127,034 Less: Accumulated depreciation ............... 16,411 Total property, plant, and equipment ................... Intangible assets Prescription files......................................... $133,987 Less: Accumulated amortization ............... 64,372 Customer relationships .............................. 50,736 Less: Accumulated amortization ............... 13,691 Computer software ..................................... 308,478 Less: Accumulated amortization ............... 136,406 Other intangible assets .............................. 9,267 Less: Accumulated amortization ............... 6,262 Total intangible assets...........................................

$16,372 39,289 65,478 71,342 189,718

490,418 839,964 110,623 1,767,543

69,615 37,045 172,072 3,005 281,737

Goodwill ............................................................................... 2,499,722

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EXERCISE 9-16 (a) (in millions) December 31, 2011 Asset $39,337 turnover [($74,777 + $68,607) ÷ 2]

Return on assets

December 31, 2010 $32,003 [($68,607 + $67,799) ÷ 2]

= 0.55 times

= 0.47 times

$4,304 [($74,777 + $68,607) ÷ 2]

$3,829 [($68,607 + $67,799) ÷ 2]

= 6.0%

= 5.6%

(b) Suncor’s asset turnover has increased significantly from 2010 to 2011. Net Revenues have increased from $32.0 billion to $39.3 billion or 23% while total assets have increased from $68.6 billion to $74.8 billion or 9%. Suncor generated more revenues in 2011 than in 2010. Profits have not kept pace with the increase in revenues and have increased by 12.4%. Return on assets has improved from 5.6% to 6.0%. The 9% increase in total assets was exceeded by the increase in profit of 12.4%.

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SOLUTIONS TO PROBLEMS PROBLEM 9-1A (a)

Jan. 12 Land ........................................... 420,000 Cash....................................... Notes Payable .......................

95,000 325,000

16 Land ........................................... Cash.......................................

8,500

31 Land ........................................... 25,000 Cash.......................................

25,000

Feb. 13 Cash ........................................... 10,000 Land.......................................

10,000

28 Land ........................................... Cash.......................................

9,000 9,000

Mar. 14 Building...................................... Cash.......................................

38,000

31 Building...................................... Cash.......................................

15,000

Apr. 22 Building...................................... Cash.......................................

17,000

38,000

15,000

17,000

Sept. 26 Building...................................... 750,000 Cash....................................... Notes Payable ....................... Sept. 30 Prepaid Insurance ..................... Cash.......................................

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150,000 600,000

4,500 4,500

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PROBLEM 9-1A (Continued) (a) (Continued) Oct. 20 Land Improvements .................... 45,000 Cash.......................................

45,000

Nov. 15 Land Improvements .................... 12,000 Cash.......................................

12,000

(b) Date 2014 Jan. 12 16 31 Feb. 13 28

Date 2011 Mar. 14 31 Apr. 22 Sept.26

Date 2014 Oct. 20 Nov. 15

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Explanation

Land Ref.

Debit

Credit Balance

420,000 8,500 25,000 9,000

420,000 428,500 453,500 443,500 452,500

Debit

Credit Balance

38,000 15,000 17,000 750,000

38,000 53,000 70,000 820,000

Land Improvements Explanation Ref. Debit

Credit Balance

45,000 12,000

45,000 57,000

10,000

Explanation

Building Ref.

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PROBLEM 9-1A (Continued) (b) (Continued) The costs that will appear on Kadlec’s December 31, 2014 balance sheet will be: Land $452,500 Building 820,000 Land Improvements 57,000 Taking It Further: Companies should start to record depreciation when the asset is ready for use. In the case of Kadlec, the building was ready for use on September 26, 2014 and land improvements were completed on November 15, 2014 and so depreciation should be calculated from those dates. Kadlec should depreciate only the building and land improvements. Land has an indefinite useful life and therefore is not depreciated.

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PROBLEM 9-2A (a) Land Building Equipment

Appraised Value $275,000 343,750 68,750 $687,500

% of Total 40% 50% 10%

Cost Allocated $260,000 325,000 65,000 $650,000

(b) Building: Straight-line 1. To the nearest whole month

Year

Depreciable Amount* ×

Depr. Rate

Depr. Expense

2013 2014

$300,000 300,000

1/60 × 10/12 1/60

$4,167 5,000

End of Year Accum. Carrying Depr. Amount $325,000 $4,167 320,833 9,167 315,833

*$325,000 − $25,000 = $300,000 2. Half a year in the year of acquisition Depreciable Year Amount* × 2013 2014

$300,000 300,000

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Depr. Rate

Depr. Expense

1/60 × 6/12 1/60

$2,500 5,000

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End of Year Accum. Carrying Depr. Amount $325,000 $2,500 322,500 7,500 317,500

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PROBLEM 9-2A (Continued) (b) (Continued) Equipment: Double diminishing-balance 1. To the nearest whole month Carrying Amount Depr. Depr. Beginning Year of Year × Rate* = Expense 2013 2014

$65,000 51,458

25% × 10/12 25%

$13,542 12,865

End of Year Accum. Carrying Depr. Amount $65,000 $13,542 51,458 26,407 38,593

* 1/8 × 2 = 25% 2. Half a year in the year of acquisition Carrying Amount Beginning Depr. Depr. Year of Year × Rate = Expense 2013 2014 (c)

$65,000 56,875

25% × 1/2 25%

$8,125 14,219

End of Year Accum. Carrying Depr. Amount $65,000 $8,125 56,875 22,344 42,656

Both options are acceptable. When deciding between adopting policy of recording depreciation to the nearest whole month or recording a half year of depreciation in the year of acquisition, ChalkBoard should consider, for purpose of consistency, the policy used in the past. Since this is the first year of business, ChalkBoard should consider what other categories or types assets it will be purchasing in the current and future years that will be depreciated using this policy. If for example, the remaining categories of assets will be depreciated using the units-ofproduction method, the choice will not matter. The impact of the choice will not be significant in the long run, particularly if the assets are bought and sold frequently. Also, the impact is insignificant for assets with very long useful lives, as is demonstrated in part (b) for the building. No matter the choice taken by ChalkBoard, the policy must be followed consistently.

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PROBLEM 9-2A (Continued) Taking It Further: ChalkBoard should not consider depreciating to the exact day of acquisition as this level of precision is not relevant on the long-run particularly for assets with long useful lives, such as is the case for the building. Since the length of the useful life is an estimate, applying a policy of depreciating to the day will provide an amount for the depreciation expense that is insignificantly different from the amount arrived at using to the nearest month policy.

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PROBLEM 9-3A (a)

Invoice price $210,000 Delivery cost 4,400 Installation and testing 5,600 Cost of the equipment $220,000 The $1,975 insurance policy is an annual operating expenditure and not included in the cost of the asset.

(b) 1. STRAIGHT-LINE DEPRECIATION

Depreciable Year Amount × 2013 2014 2015 2016 * **

$207,000* 207,000 207,000 207,000

End of Year Depr. Depr. Accum. Carrying Rate = Expense Depr. Amount $220,000 25%** $ 51,750 $ 51,750 168,250 25% 51,750 103,500 116,500 25% 51,750 155,250 64,750 25% 51,750 207,000 13,000

$220,000 − $13,000 = $207,000 1/4 years = 25%

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PROBLEM 9-3A (Continued) (b) (Continued) 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year ×

Depr. Rate

2013 2014 2015 2016

50%* 50% 50% 50%

$220,000 110,000 55,000 27,500

End of Year Depr. Accum. Carrying = Expense Depr. Amount $220,000 $110,000 $110,000 110,000 55,000 165,000 55,000 27,500 192,500 27,500 14,500** 207,000 13,000

* 1/4 years = 25% × 2 = 50% ** Equal to the amount that brings carrying amount to the residual value of $13,000. 3. UNITS-OF-PRODUCTION Units of Year Production × 2013 2014 2015 2016

15,750 23,900 20,200 15,350

End of Year Depr. Depr. Accum. Carrying Amt/Unit = Expense Depr. Amount $220,000 $2.76* $ 43,470 $ 43,470 176,530 2.76 65,964 109,434 110,566 2.76 55,752 165,186 54,814 2.76 41,814** 207,000 13,000

* Depreciable amount per unit is $2.76 per unit [($220,000 – $13,000)  75,000 = $2.76] ** Equal to the amount that brings the carrying amount to the residual value of $13,000 (actual production exceeded estimated total production).

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PROBLEM 9-3A (Continued) (c)

The unit-of-activity method of calculating depreciation provides the lowest amount of depreciation expense for 2013, which results in the highest amount of profit. Over the life of the asset, all three methods result in the same total depreciation expense (equal to the depreciable amount) and therefore the same amount of profit.

(d) All three methods will result in the same cash flow in 2013 and over the life of the asset. Recording depreciation expense does not affect cash flow. There is no Cash account involved in the entry to record depreciation (Dr. Depreciation Expense; Cr. Accumulated Depreciation). It is only an allocation of the capital cost to expense over an asset’s useful life. Taking It Further: The cost of recycling the equipment at the end of its useful life is an asset retirement cost and the amount must be estimated and added to the cost the equipment — part (a). These costs would consequently be added to the depreciable amount in the calculation of depreciation under all of the methods and would proportionately increase the amount of depreciation charge — part (b).

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PROBLEM 9-4A (a) Transaction

Land

Building

Equip. ment

Jan. 12 Feb. 6 Apr. 24 May 17 July 19 Aug. 21 Sept. 20 Oct. 25 Dec. 31 Dec. 31

NE NE NE NE NE NE NE NE NE NE

NE NE +$75,000 NE NE NE NE NE NE NE

NE NE NE NE NE NE NE NE NE NE +$26,000 NE NE NE +$20,000 NE NE NE NE +$37,500

(b) Jan. 12

Feb.

Accum. Depr.

Total PP&E

Profit

NE −$2,200 NE −$5,400 +$75,000 NE NE −$3,100 NE −$5,900 +$26,000 NE NE −$2,700 +$20,000 NE NE NE −$37,500 −$37,500

Repairs Expense ....................... Cash.......................................

2,200

6 Repairs Expense ....................... Cash.......................................

5,400

2,200

5,400

Apr. 24 Building...................................... 75,000 75,000 Cash....................................... Note: Possibly add to equipment depending on the type of system, and whether it has the same useful life as the rest of the building. May. 17 Training Expense ...................... Cash.......................................

3,100

July 19 Repairs Expense ....................... Cash.......................................

5,900

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3,100 5,900

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PROBLEM 9-4A (Continued) (b) (Continued) Aug. 21 Vehicles ..................................... 26,000 Cash.......................................

26,000

Sept. 20 Repairs Expense ....................... Cash.......................................

2,700

Oct. 25 Equipment.................................. 20,000 Cash....................................... Dec. 31

Impairment Loss ....................... 37,500 Accumulated Depreciation— Equipment ............................ [($150,000 − $62,500) − $50,000]

20,000

37,500

Note: ASPE does not allow the reversal of the impairment loss for the land.

Taking It Further: Given that the engine has to be replaced frequently, consideration should be given to depreciating this component of the equipment using a four year useful life and the remainder of the equipment the twelve year useful life. The major difficulty with this is determining how much of the cost of the equipment to allocate to the engine. One possibility is to use the value of a replacement motor to establish the cost of the original motor at the date of the purchase of the equipment.

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PROBLEM 9-5A (a) Depreciable Year Amount ×

Depr. Rate

2010 2011 2012 2013 2014

10%** 10% 10% 10% 10%

$700,000* 700,000 700,000 700,000 700,000

Depr. Expense $70,000 70,000 70,000 70,000 70,000

End of Year Accum. Carrying Depr. Amount $750,000 $70,000 680,000 140,000 610,000 210,000 540,000 280,000 470,000 350,000 400,000

* Depreciable amount = $750,000 − $50,000 = $700,000 ** 1 ÷ 10 years = 10% (b) Dec. 31 Impairment Loss ....................... 2014 Accumulated Depreciation— Equipment ............................ ($400,000 − $320,000) (c)

80,000 80,000

On Slope’s income statement will be reported depreciation expense in the amount of $70,000 and the impairment loss of $80,000. On Slope’s balance sheet, the equipment will be reported at its cost of $750,000 and accumulated depreciation of $430,000 so that the carrying amount will be $320,000, equal to the impaired amount.

(d) Depreciable Year Amount*** × 2015 2016 2017

$310,000 310,000 310,000

End of Year Depr. Depr. Accum. Carrying Rate = Expense Depr. Amount $430,000* $320,000 33.33%** $103,333 533,333 216,667 33.33% 103,333 636,666 113,334 33.33% 103,334 740,000 10,000

*Accumulated Depreciation = $350,000 end of year before impairment loss + $80,000 impairment loss ** 1 ÷ 3 years remaining (8 – 5 years) = 33.33% *** Carrying amount – revised res. value = $320,000 – $10,000 Solutions Manual .

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PROBLEM 9-5A (Continued) (e)

Accumulated depreciation at the end of this equipment’s useful life will be $740,000. Carrying amount at the end of this equipment’s useful life will be the amount of residual value which is $10,000. Refer to table in part (d).

Taking It Further: One of the major differences between IFRS and ASPE concerns the measurement and reporting of depreciable assets. Under IFRS, it is possible to report these types of assets at their fair value, using the revaluation model, while under ASPE, no revaluation beyond a capital asset’s historical cost is possible. Consistent with this distinction, is the treatment of recoveries of previously recorded impairments. The basis for reporting depreciable assets at their fair value under IFRS is that the value used can be reliably measured. As well, under IFRS the frequency of the scrutiny of the assets to determine any impairment is greater and the measures taken more rigorous. Private companies reporting under ASPE typically do not have the same level of resources needed (as a public company reporting under IFRS) to determine if an impairment exists or if it has been reversed. Under ASPE impairments are recorded less frequently and thus it is reasonable that ASPE does not allow the recording of reversals of impairment losses.

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PROBLEM 9-6A (a) 2012 May

1 Land ........................................... 150,000 Building ...................................... 235,000 Cash....................................... Notes Payable .......................

Dec. 31 Depreciation Expense ................... 6,267 Accumulated Depreciation—Building (1 ÷ 25 = 4%) ($235,000 × 4% × 8/12 = $6,267) 31 Interest Expense ........................... 9,000 Cash....................................... ($270,000 × 5% × 8/12 = $9,000) 2013 Feb. 17 Dec. 31

Repairs Expense ....................... Cash.......................................

115,000 270,000

6,267

9,000

225 225

Depreciation Expense ............... 9,149 Accumulated Depreciation—Building [($235,000 − $6,267) × 4% = $9,149]

9,149

31 Interest Expense ......................... 13,500 Cash....................................... ($270,000 × 5% = $13,500)

13,500

31 Impairment Loss.......................... 30,000 Land....................................... 30,000 ($150,000 − $120,000) Building — no entry as carrying amount = $219,584; ($235,000 − $6,267 − $9,149 = $219,584) which does not exceed the recoverable amount of $240,000.

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PROBLEM 9-6A (Continued) (a) (Continued) 2014 Jan. 31 Depreciation Expense ............... 732 Accumulated Depreciation—Building ($219,584 × 4% × 1/12) 31 Cash ........................................... 320,000 Accumulated Depreciation— Building* ................................... 16,148 Loss on Disposal (see below) .. 18,852 Land....................................... Building ................................. * ($6,267 + $9,149 + $732) Land (Carrying amount)....... Building................................. $235,000 Less: Accumulated dep’n .... 16,148 Carrying amount .................. Proceeds ............................... Loss on disposal .................. Feb.

(b)

1 Interest Expense ($270,000 × 5% × 1/12).............. 1,125 Notes Payable............................ 270,000 Cash.......................................

732

120,000 235,000

$120,000 218,852 338,852 320,000 $ 18,852

271,125

The land may have been impaired due to contamination found on it or surrounding properties. It may also have been because plans for a proposed new development on adjacent land that would have increased the value of NW Tool Supply’s property at the date of purchase, have been permanently shelved.

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PROBLEM 9-6A (Continued) (c)

Oct. 31 Depreciation Expense ................... 7,319 Accumulated Depreciation—Building ($219,584 × 4% × 10/12) Oct. 31 Cash ........................................... 400,000 Accumulated Depreciation —Building*................................. 22,735 Land....................................... Building ................................. Gain on Sale (see below)...... * ($6,267 + $9,149 + $7,319) Land (Carrying amount)....... Building................................. $235,000 Less: Accumulated dep’n .... 22,735 Carrying amount .................. Proceeds ............................... Gain on disposal (sale) ........

7,319

120,000 235,000 67,735

$120,000 212,265 332,265 400,000 $ 67,735

Taking It Further: For purposes of calculating and recording impairments, the recoverable amount of a property is based on the comparison of the carrying amount of the asset against the higher of the fair value of the asset less the cost to sell it, or its value in use. In this case, the property is made up of land and a building which are somewhat inseparable. Consequently, the value in use to NW Tool Supply would be the amount management expects to recover in operations by using the assets together. As for establishing the fair value of the combined assets, property of similar location and type that have been recently sold can be used to make comparisons of what would be obtained on sale. Management should be diligent about looking for possible causes for impairment.

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PROBLEM 9-6A (Continued) Taking It Further: (Continued) When considering impairment of the land on its own, uninsured damages or conditions uncovered during the year may require management to recalculate the value in use or the resale fair value of the land. Under ASPE the review of property, plant, and equipment for possible impairment need not be performed each year, but must be performed on a regular basis, particularly when changes in circumstance or conditions occur. If the company is using IFRS, annual impairment testing is required.

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PROBLEM 9-7A (a)

Invoice price $107,500 Less proceeds from sale 15,000 Cost of ownership $ 92,500

(b) 1. STRAIGHT-LINE DEPRECIATION Depreciable Year Amount × 2012 2013 2014

$97,000* 97,000 97,000

Depr. Rate

33.33%** 33.33% 33.33%

Depr. Expense $32,333 32,333 32,334

End of Year Accum. Carrying Depr. Amount $107,500 $32,333 75,167 64,666 42,834 97,000 10,500

* $107,500 − $10,500 = $97,000 ** 1 ÷ 3 years = 33.33%

2. DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year ×

Depr. Rate

2012 2013 2014

40% 40% 40%

$107,500 64,500 38,700

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Depr. Expense $43,000 25,800 15,480

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End of Year Accum. Carrying Depr. Amount $107,500 $43,000 64,500 68,800 38,700 84,280 23,220

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PROBLEM 9-7A (Continued) (b) (Continued) 3. UNITS-OF-PRODUCTION End of Year Units of Depr. Depr. Accum. Carrying Year Production × Amt/Unit* = Expense Depr. Amount $107,500 2012 10,000 $1.617* $ 16,170 $ 16,170 91,330 2013 20,000 1.617 32,340 48,510 58,990 2014 29,000 1.617 46,893 95,403 12,097 * Depreciable amount per unit is $1.617 per unit [($107,500 – $10,500)  60,000 = $1.617] (c)

(1) (2) Straight- DiminishingLine Balance

Cost ...................................... $107,500 Accumulated depreciation.. 97,000 Carrying amount ................. 10,500 Cash proceeds .................... 15,000 Gain (loss) on sale .............. $ 4,500 (d)

$107,500 84,280 23,220 15,000 $ (8,220)

(1) (2) Straight- DiminishingLine Balance

Depreciation expense ......... $97,000 Add loss (less gain) on sale (4,500) Net expense ......................... $92,500

$84,280 8,220 $92,500

(3) Unit –ofProduction $107,500 95,403 12,097 15,000 $ 2,903 (3) Unit –ofProduction $95,403 (2,903) $92,500

The actual cost of owning in (a) is the same as the net expense under all three methods. The different depreciation methods results in different accumulated depreciation at the date of sale, which in term causes a different gain on sale. Consequently, the total depreciation expense recognized over the life of the asset, plus the loss on sale (or less the gain on sale), results in the same net expense of $92,500 over the life of the asset.

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PROBLEM 9-7A (Continued) Taking It Further: I disagree. Experiencing a gain or loss on the disposal of a depreciable asset is not the result of an error or mistake. Rather, a gain or loss is an expected outcome due to the limitations of the cost allocation that has occurred for the asset up to the date of its disposal. Since estimates are involved in arriving at the factors used in calculating depreciation, such as the estimated useful life and the estimated residual value, it is natural that some differences between the carrying amount and any proceeds of disposition will occur when the asset is ultimately disposed of.

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PROBLEM 9-8A (a)

2012 Mar.

1 Equipment.................................... 95,000 Accounts Payable .................

(b) 2012 Aug. 31 Depreciation Expense ................... 9,500 Accumulated Depreciation —Equipment ......................... $95,000 × 20% × 6/12 months = $9,500 2013 Aug. 31 Depreciation Expense ................. 17,100 Accumulated Depreciation —Equipment ......................... ($95,000 − $9,500) × 20% = $17,100

95,000

9,500

17,100

2014 Aug. 31 Depreciation Expense ................. 13,680 Accumulated Depreciation —Equipment ......................... 13,680 ($95,000 − $9,500 − $17,100) × 20% = $13,680 (c)

2015 Feb.

1 Depreciation Expense ................... 4,560 Accumulated Depreciation —Equipment ......................... 4,560 ($95,000 − $9,500 − $17,100 − $13,680) × 20% × 5/12 = $4,560 Accumulated Depreciation at February 1, 2015: $9,500 + $17,100 + $13,680 + $4,560 = $44,840 Carrying Amount at February 1, 2015: Cost – Accumulated Depreciation $50,160 = $95,000 − $44,840

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PROBLEM 9-8A (Continued) (c) (Continued) 1.

Feb.

1 Accumulated Depreciation —Equipment ................................ 44,840 Loss on Disposal* ....................... 50,160 Equipment .............................

95,000

*Proceeds – Carrying Amount = Gain (loss) $0 – [$95,000 – $44,840] = ($50,160) 2.

Feb.

1 Cash ............................................. 55,000 Accumulated Depreciation —Equipment ................................ 44,840 Gain on Disposal** .................... Equipment ............................. ** $55,000 – [$95,000 – $44,840] = $4,840 1 Cash ............................................. 45,000 Accumulated Depreciation —Equipment ................................ 44,840 Loss on Disposal*** ...................... 5,160 Equipment ............................. *** $45,000 – [$95,000 – $44,840] = ($5,160)

4,840 95,000

Feb.

1 Equipment ($47,000 + $45,000) .................... 92,000 Accumulated Depreciation —Equipment ................................ 44,840 Loss on Disposal**** ..................... 3,160 Cash ($97,000 − $52,000)...... Equipment ............................. **** $47,000 – [$95,000 – $44,840] = ($3,160)

95,000

Feb.

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PROBLEM 9-8A (Continued) Taking It Further: The following are the arguments in favour of recording gains and losses on disposal of property, plant, and equipment as: 1.

Part of profit from operations: Gains and losses are basically just adjustments to depreciation expense and should be recorded in the same section of the income statement. Classifying gains and losses as operations removes the potential for management bias in the selection of depreciation methods or in the estimates concerning useful lives and residual values of the assets. Bias might be at play concerning management’s unwillingness to show losses in operations because management bonuses may be based on the amount of profit from operations.

Non-operating items: The same management bias described above would be applied for gains recognized by the business. A common view is that the disposal of property, plant, and equipment is not an everyday occurrence and gains or losses are not predictable. It can also be argued that selling property, plant, and equipment is not part of normal operations and thus gains or losses should not be reported as part of profit from operations.

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PROBLEM 9-9A (a)

April

1 Land ...........................................2,200,000 Cash....................................... 550,000 Notes Payable ....................... 1,650,000

May

1 Depreciation Expense .................. 46,667 Accumulated Depreciation—Equip. ($1,400,000 ÷ 10 × 4/12) ........

46,667

1 Cash .............................................150,000 Accumulated Depreciation —Equipment .............................1,166,667 Loss on Disposal.......................... 83,333 Equipment ............................. 1,400,000 Cost Accumulated depreciation—equip. [($1,400,000 ÷ 10) × 8 + $46,667)] Carrying amount Cash proceeds Loss on disposal

$1,400,000 1,166,667 233,333 150,000 $ (83,333)

June 1 Cash .............................................450,000 Notes Receivable......................1,350,000 Land....................................... 700,000 Gain on Disposal .................. 1,100,000 July

1 Equipment.................................1,100,000 Cash....................................... 1,100,000

Dec. 31 Depreciation Expense .................. 50,000 Accumulated Depreciation —Equipment ($500,000 ÷ 10)

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PROBLEM 9-9A (Continued) (a) (Continued) Dec. 31 Accum. Depr.—Equipment .........500,000 Equipment ............................. 500,000 Cost $500,000 Accumulated depreciation—equipment ($500,000 ÷ 10 × 10) 500,000 Carrying amount 0 Cash proceeds 0 Gain (loss) on disposal $ 0 (b) Dec. 31 Depreciation Expense .................974,000 Accumulated Depreciation —Building ($48,700,000 ÷ 50) 974,000 31 Depreciation Expense ..............7,365,000 Accumulated Depreciation —Equipment ......................... 7,365,000 $73,100,000* ÷ 10 $1,100,000 ÷ 10 × 6/12

$7,310,000 55,000 $7,365,000

*$75,000,000 − $1,400,000 − $500,000 = $73,100,000

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31 Interest Expense .......................... 74,250 Interest Payable .................... ($1,650,000 × 6% × 9/12)

74,250

31 Interest Receivable....................... 39,375 Interest Revenue ................... ($1,350,000 × 5% × 7/12)

39,375

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PROBLEM 9-9A (Continued) (c) HAMSMITH CORPORATION Balance Sheet (Partial) December 31, 2014 Property, plant, and equipment1 Land................................................ $11,500,000 Buildings ........................................ $48,700,000 Less: Accumulated depreciation.. 32,074,000 16,626,000 Equipment...................................... $74,200,000 Less: Accumulated depreciation.. 32,795,000 41,405,000 Total property, plant, and equipment $69,531,000 1

See T accounts that follow for balances.

Land Jan. 1, 2014 April 1, 2014

10,000,000 June 1, 2014 2,200,000

700,000

Dec.31, 2014 Bal. 11,500,000

Building Jan. 1, 2014

48,700,000

Dec. 31, 2014 Bal. 48,700,000

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PROBLEM 9-9A (Continued) (c) (Continued) Equipment Jan. 1, 2014 July 1, 2014

75,000,000 1,100,000

May 1, 2014 Dec. 31, 2014

1,400,000 500,000

Dec.31, 2014Bal. 74,200,000 Accumulated Depreciation—Building Jan. 1, 2014 Dec. 31, 2014

31,100,000 974,000

Dec. 31, 2014 Bal. 32,074,000 Accumulated Depreciation—Equipment May 1, 2014 Dec. 31, 2014

1,166,667 500,000

Jan. 1, 2014 May 1, 2014 Dec. 31, 2014 Dec. 31, 2014

27,000,000 46,667 50,000 7,365,000

Dec. 31, 2014 Bal. 32,795,000

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PROBLEM 9-9A (Continued) Taking It Further: Although the use of the revaluation model is permitted for those companies adopting the International Financial Reporting Standards (IFRS), its adoption is voluntary, and somewhat rare. The owner should be asked what his motivation is in making this change. Once changed, the business will need to be consistent with the application of the model in the future. Additional evidence will be required each year to support the values that are being used in the revaluation. This could become expensive for Hamsmith Corporation, and these costs may not exceed the benefits of implementing the revaluation model. Comparability with other companies might also be affected. Since the implementation is rare, Hamsmith would have financial results which would be harder to compare to others by outside users and by financial institutions.

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PROBLEM 9-73A 1.

Research Expense ($160,000 × 55%) ........ 88,000 Patents.................................................... Accumulated Amortization—Patents........ Amortization Expense ........................... $88,000 ÷ 15 years = $5,867

5,867

Accumulated Amortization–Goodwill ....... Amortization Expense ........................... ($400,000 ÷ 40 years) × 6/12 = $5,000

5,000

88,000

5,867

5,000

Impairment Loss......................................... 12,500 Trademark ($47,500 − $35,000) .............

12,500

Impairment Loss ($80,000 − $70,000)........ 10,000 Licence ...................................................

10,000

Charitable Donations Expense.................. Goodwill .................................................

8,000

Taking It Further: The majority of intangible assets that are developed internally cannot be recognized as intangible assets on the balance sheet because the expenditures on internally developed intangibles cannot be distinguished from the cost of other research and development performed by the business. The costs cannot be separately measured and must be expensed as incurred.

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PROBLEM 9-11A (a)

Jan.

2 Patent #1 ...................................... 23,200 Cash.......................................

23,200

June 30 Research Expense .................... 180,000 Cash.......................................

180,000

30 Patent #2 ...................................... 60,000 Cash.......................................

60,000

Sept. 1 Advertising Expense ................... 12,000 Cash.......................................

12,000

Oct.

1 Copyright #2 ................................ 18,000 Cash.......................................

18,000

Dec. 31 No entry: Reversals of impairments of goodwill may not be recorded. (b) Dec. 31 Amortization Expense ................. 12,400 Accumulated Amortization— Patent #1* .............................. Accumulated Amortization— Patent #2**.............................

10,900 1,500

* [($80,000 × 1/10) + ($23,200 × 1/8)] At Jan. 1, 2014 Patent # 1 has been amortized 2 years ($16,000 ÷ $80,000 = 2/10) — remaining period to amortize is 8 years. ** [$60,000 × 1/20 × 6/12 = $1,500] 31 Amortization Expense............... 5,550 Accumulated Amortization— Copyright #1.......................... Accumulated Amortization— Copyright #2.......................... [($48,000 × 1/10) + ($18,000 × 1/6 × 3/12)]

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PROBLEM 9-11A (Continued) (c) IP COMPANY (Partial) Balance Sheet December 31, 2014 Assets Intangible assets Patents1 ................................................ Less: Accumulated amortization2...... Copyrights3 .......................................... Less: Accumulated amortization4...... Total intangible assets ........................ Goodwill ....................................................

$163,200 28,400 66,000 34,350

$134,800 31,650 $166,450 $220,000

Cost: Patent #1 ($80,000 + $23,200) + Patent #2 ($60,000) = $163,200 2 Accumulated Amortization: Patent #1 ($16,000 + $8,000 + $2,900) + Patent #2 ($1,500) = $28,400 3 Cost: Copyright #1 ($48,000) + Copyright #2 ($18,000) = $66,000 4 Accumulated Amortization: Copyright #1 ($28,800 + $4,800) + Copyright #2 ($750) = $34,350

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PROBLEM 9-11A (Continued) Taking It Further: Although intangible assets do not have physical substance, they have characteristics common to other assets in that they contribute to the revenue producing ability of a business that owns them. They are owned and controlled by the business and therefore fit the definition of assets.

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PROBLEM 9-12A (a)

2013 Mar. 31 Mine ($2,600,000 + $260,000) . 2,860,000 Cash.................................. 2,860,000 Dec. 31 Inventory ................................. Accumulated Depreciation —Mine...............................

570,000 570,000

($2,860,000 − $200,000) ÷ 560,000 t = $4.75/t × 120,000 t = $570,000 Dec. 31 Cost of Goods Sold ................ Inventory .......................... 2014 Dec. 31 Inventory ................................. Accumulated Depreciation —Mine...............................

570,000 570,000 380,000 380,000

($2,860,000 − $570,000 − $200,000) ÷ 550,000 t = $3.80/t × 100,000 t = $380,000 Dec. 31 Cost of Goods Sold ................ Inventory ..........................

380,000 380,000

(b) YOUNT MINING COMPANY Income Statement (partial) Year Ended December 31, 2014 Cost of goods sold........................................

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PROBLEM 9-12A (Continued) (b) (Continued) YOUNT MINING COMPANY (Partial) Balance Sheet December 31, 2014 Property, plant, and equipment Mine ........................................................ $2,860,000 Less: Accumulated depreciation* ...... 950,000 $1,910,000 * $570,000 + $380,000 = $950,000 Taking It Further: Due to its nature, it is expected that the estimate of the total amount of ore to be extracted from a mine would need to be adjusted as extraction occurs and better estimates can be made. Management should not be influenced by the need for changes in estimates when choosing the units-of-production method for recording depreciation of the mine. It is the depreciation method that best allocates the cost of the mine to the units of ore that are recorded in inventory.

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PROBLEM 9-13A (a) (in thousands) Andruski Company

Brar Company

$552.0 [($702.5 + $662.8) ÷ 2]

$1,762.9 [($1,523.5 + $1,410.7) ÷2]

= 0.81 to 1

= 1.20 to 1

$515.9 [($662.8 + $602.5) ÷ 2]

$1,588.2 [($1,410.7 + $1,318.4) ÷2]

= 0.82 to 1

= 1.16 to 1

Return on assets 2014

$21.4 [($702.5 + $662.8) ÷ 2]

$96.5 [($1,523.5 + $1,410.7) ÷2]

= 3.13%

= 6.58%

Return on assets 2013

$20.6 [($662.8 + $602.5) ÷ 2]

$85.4 [($1,410.7 + $1,318.4) ÷2]

= 3.26%

= 6.26%

Asset turnover 2014

Asset turnover 2013

(b) Brar Company is far more efficient in using its assets to generate sales–its assets turnover of 1.20 times is higher than 0.82 times for Andruski Company and is increasing, while Andruski’s is decreasing. Brar is also more efficient in using assets to produce profit–with a return on assets of 6.58% compared to 3.13% for Andruski Company. Brar’s ratio is increasing while Andruski’s in decreasing.

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PROBLEM 9-13A (Continued) Taking It Further: Although the ability to compare two companies in the same industry using ratios is affected by the depreciation methods adopted by the companies being compared, absolute conclusions cannot be drawn from these differences. Brar uses the straight-line method of depreciation and Andruski uses the diminishing-balance method which results in higher charges of depreciation in the early years and lower amounts in the later years for Andruski. Assets are acquired throughout the life of a company as well so it is not possible to determine the impact of the different methods without more information. Notwithstanding this limitation, and assuming a normal turnover of assets, one could generally conclude that the amount of profit and total assets of Andruski would be lower than that of Brar, simply because of the accelerated method of depreciation being used, which generated a higher expense for depreciation and a lower carrying amount for the assets.

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PROBLEM 9-1B (a)

Feb.

7 Land ........................................... 575,000 Cash....................................... Notes Payable ....................... 9 Land ........................................... Cash.......................................

Mar.

115,000 460,000

7,500 7,500

15 Land ........................................... 19,000 Cash.......................................

19,000

17 Cash ........................................... Land.......................................

8,500

25 Land ........................................... 10,500 Cash.......................................

10,500

2 Building...................................... Cash.......................................

28,000 28,000

15 Building...................................... Cash.......................................

18,000 18,000

Aug. 31 Building...................................... 850,000 Cash....................................... Notes Payable .......................

170,000 680,000

Sept. 3 Land Improvements .................. 40,000 Cash.......................................

40,000

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

3,750

Oct. 31 Land Improvements .................. 37,750 Cash.......................................

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PROBLEM 9-1B (Continued) (b) Date 2014 Feb. 7 9 15 17 25

Date 2014 Mar. 2 15 Aug. 31

Date 2014 Sept. 3 Oct. 31

Explanation

Land Ref.

Debit

Credit Balance

575,000 7,500 19,000 10,500

575,000 582,500 601,500 593,000 603,500

Debit

Credit Balance

28,000 18,000 850,000

28,000 46,000 896,000

Land Improvements Explanation Ref. Debit

Credit Balance

40,000 37,750

40,000 77,750

8,500

Explanation

Building Ref.

The costs that will appear on Weisman’s December 31, 2014 balance sheet will be: Land $603,500 Building 896,000 Land Improvements 77,750

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PROBLEM 9-1B (Continued) Taking It Further: Companies should start to record depreciation when the asset is ready for use. In the case of Weisman, the building was ready for use on August 31, 2014 and land improvements were completed on October 31, 2014 and so depreciation should be calculated from those dates. Weisman should depreciate only the building and land improvements. Land has an indefinite useful life and therefore is not depreciated.

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PROBLEM 9-2B (a) Land Building Equipment

Appraised Value $262,500 337,500 150,000 $750,000

% of Total 35% 45% 20%

Cost Allocated $245,000 315,000 140,000 $700,000

(b) Building: Straight-line 1. To the nearest whole month

Year

Depreciable Amount* ×

Depr. Rate

Depr. Expense

2013 2014

$300,000 300,000

1/60 × 2/12 1/60

$833 5,000

End of Year Accum. Carrying Depr. Amount $315,000 $833 314,167 5,833 309,167

* $315,000 − $15,000 = $300,000 (2) Half a year in the year of acquisition Depreciable Year Amount* × 2013 2014

$300,000 300,000

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Depr. Rate

Depr. Expense

1/60 × 6/12 1/60

$2,500 5,000

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End of Year Accum. Carrying Depr. Amount $315,000 $2,500 312,500 7,500 307,500

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PROBLEM 9-2B (Continued) (b) (Continued) Equipment: Double diminishing-balance 1. To the nearest whole month Carrying Amount Depr. Depr. Beginning Year of Year × Rate* = Expense 2013 2014

$140,000 134,167

25% × 2/12 25%

$5,833 33,542

End of Year Accum. Carrying Depr. Amount $140,000 $5,833 134,167 39,375 100,625

* 1/8 × 2 = 25% 2) Half a year in the year of acquisition Carrying Amount Beginning Depr. Depr. Year of Year × Rate = Expense 2013 2014 (c)

$140,000 122,500

25% × 1/2 25%

$17,500 30,625

End of Year Accum. Carrying Depr. Amount $140,000 $17,500 122,500 48,125 91,875

Both options are acceptable. When deciding between the two policies, Solinger should consider, for purpose of consistency, the policy used in the past. Since this is the first year of business, Solinger should consider what other categories or types assets it will be purchasing in the future that will be depreciated using this policy. If for example, the remaining categories of assets will be depreciated using the units-of-production method, the choice will not matter. The impact of the choice will not be significant in the long run, particularly if the assets are bought and sold frequently. Also, the impact is insignificant for assets with very long useful lives, as is demonstrated in part (b) for the building. No matter the choice taken by Solinger, the policy must be followed consistently.

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PROBLEM 9-2B (Continued) Taking It Further: If Solinger had decided to use the units-of-production method instead of the diminishing-balance method for depreciating its equipment, the decision between the adoption of a policy for deprecating to the nearest month or half a year in the year of acquisition would not matter. When using the units-ofproduction method, the calculation of depreciation is not calculated as a function of the time the asset is used but is based on the amount of use that is being made of the asset, which in turn is based on some units of output or production. There is no pro-ration for time used in the units-of-production method.

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PROBLEM 9-3B (a)

Cost: Cash price Delivery costs Installation and testing Total cost

$442,000 4,000 6,000 $452,000

The one-year insurance policy is not included as it is an operating expenditure, benefiting only the current period. (b) 1. STRAIGHT-LINE DEPRECIATION

Depreciable Year Amount ×

Depr. Rate

2013 2014 2015 2016

25% 25% 25% 25%

* **

$432,000* 432,000 432,000 432,000

End of Year Depr. Accum. Carrying = Expense Depr. Amount $452,000 $ 108,000 $ 108,000 344,000 108,000 216,000 236,000 108,000 324,000 128,000 108,000 432,000 20,000

$452,000 − $20,000 = $432,000 1/4 years = 25%

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PROBLEM 9-3B (Continued) (b) (Continued) 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year ×

Depr. Rate

2013 2014 2015 2016

50% 50% 50% 50%

$452,000 226,000 113,000 56,500

End of Year Depr. Accum. Carrying = Expense Depr. Amount $452,000 $226,000 $226,000 226,000 113,000 339,000 113,000 56,500 395,500 56,500 36,500** 432,000 20,000

* 1/4 years = 25% × 2 = 50% ** Use the amount that brings carrying amount to the residual value of $20,000. 3. UNITS-OF-PRODUCTION DEPRECIATION Units of Depr. Year Production × Amt./Unit* = 2013 2014 2015 2016

22,600 45,600 49,700 32,200

$2.88* 2.88 2.88 2.88

End of Year Depr. Accum. Carrying Expense Depr. Amount $452,000 $65,088 $ 65,088 386,912 131,328 196,416 255,584 143,136 339,552 112,448 92,448** 432,000 20,000

* Depreciation amount per unit: ($452,000 − $20,000) ÷ 150,000 units = $2.88 ** Use the amount that makes carrying amount equal to residual value (actual production exceeded estimated total production).

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PROBLEM 9-3B (Continued) (c)

Units-of-production method of depreciation provides the lowest amount of depreciation expense for 2013, thus resulting in the highest profit that year. Over the life of the asset, all three methods result in the same total depreciation expense (equal to the depreciable amount).

(d) All three methods will result in the same cash flow in 2013 and over the life of the asset. Recording depreciation expense does not affect cash flow. There is no Cash account involved in the entry to record depreciation (Dr. Depreciation Expense; Cr. Accumulated Depreciation). It is only an allocation of the capital cost to expense over an asset’s useful life. Taking It Further: The cost of recycling the equipment at the end of its useful life is an asset retirement cost which must added to the cost of the equipment — part (a). These costs would consequently be added to the depreciable amount in the calculation of depreciation under all of the methods and would proportionately increase the amount of depreciation charge — part (b).

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PROBLEM 9-4B (a) Transaction

Land

Buildings

Equip. ment

Accum. Depr.

Total PP&E

Profit

Jan. 22 NE NE NE NE NE −$4,600 Apr. 10 NE NE +$95,000 NE +$95,000 NE May 6 NE NE NE NE NE −$30,500 July 20 NE NE NE NE NE −$10,000 Aug. 7 NE NE +$35,000 NE +$35,000 NE Aug. 15 NE NE NE NE NE −$1,900 Oct. 25 NE NE +$18,200* NE +18,200 NE Nov. 6 NE +$120,000 NE NE +$120,000 NE Dec. 31 NE NE NE +$85,000** −$85,000 −$85,000 Dec. 31 +$75,000*** NE NE NE +$75,000 +$75,000

*$18,200 = $16,700 + $1,500 **$85,000 = [($250,000 − $75,000) − $90,000] ***$75,000 = $575,000 − $500,000 (b) Jan. 22

Repairs Expense ....................... Accounts Payable .................

4,600 4,600

Apr. 10 Equipment.................................. 95,000 Accounts Payable ................. May

95,000

6 Repairs Expense ....................... 30,500 Accounts Payable .................

30,500

July 20 Repairs Expense ....................... 10,000 Accounts Payable .................

10,000

Aug.

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7 Equipment.................................. 35,000 Accounts Payable .................

35,000

15 Training Expense ...................... Accounts Payable .................

1,900

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PROBLEM 9-4B (Continued) (b) (Continued) Oct. 25 Equipment.................................. 16,700 Accounts Payable .................

16,700

25 Equipment.................................. Accounts Payable .................

1,500

Nov.

1,500

6 Building...................................... 120,000 Accounts Payable .................

120,000

Dec. 31 Impairment Loss ....................... 85,000 Accumulated Depreciation— Equipment .............................

85,000

Dec. 31 Land ........................................... 75,000 Impairment Loss ...................

75,000

Under IFRS, the reversal of the impairment loss is limited to the amount required to increase the asset’s carrying amount to what it would have been if the impairment loss had not been recorded. In this case the original cost of the land was $575,000 and the amount of the impairment recorded to date is $75,000 ($575,000 − $500,000). Since the current recoverable amount of $600,000 is greater than the original cost of the land, before impairment was recorded, the recovery entry is limited to $75,000. Taking It Further: Given that the engine has to be replaced frequently, consideration should be given to depreciating this component of the equipment using a five year useful life and the remainder of the equipment the fifteen year useful life. If the original equipment does not have an amount specified for the engine as a component, it would be reasonable to use the value of a replacement motor to establish the cost of the original motor at the date of the purchase of the equipment.

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PROBLEM 9-5B (a) Depreciable Year Amount ×

Depr. Rate

2010 2011 2012 2013 2014

10% 10% 10% 10% 10%

$575,000* 575,000 575,000 575,000 575,000

End of Year Depr. Accum. Carrying Expense Depr. Amount $600,000 $57,500 $ 57,500 542,500 57,500 115,000 485,000 57,500 172,500 427,500 57,500 230,000 370,000 57,500 287,500 312,500

* Depreciable amount = $600,000 − $25,000 = $575,000 ** 1 ÷ 10 years = 10% (b)

Dec. 31 Impairment Loss.......................... 52,500 2014 Accumulated Depreciation— Equipment ............................ ($312,500 − $260,000)

52,500

(c)

On Short Track’s income statement will be reported depreciation expense in the amount of $57,500 and the impairment loss of $52,500. On Short Track’s balance sheet the equipment will be reported at its cost of $600,000 and the accumulated depreciation of $340,000 so that the book value will be $260,000 equal to the impaired amount.

(d)

Endof Year Depr. Accum. Carrying = Expense Depr. Amount $340,000¹ $260,000 $125,000 465,000 135,000 125,000 590,000 10,000

Depreciable Year Amount × 2015 2016

$250,0002 250,000

Depr. Rate 50%3 50%

¹ Accumulated Depreciation = $287,500 end of year before impairment loss + $52,500 impairment loss 2 Depreciable amount = Recoverable amount at date of impairment less revised residual value of $10,000 3 1 ÷ 2 years (7 – 5 years) remaining = 50%

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PROBLEM 9-5B (Continued) (e) Accumulated depreciation at the end of this equipment’s useful life will be $590,000. The carrying amount at the end of this equipment’s useful life will be the amount of residual value which is $10,000. Refer to table in (d). Taking It Further: One of the major differences between IFRS and ASPE concerns the measurement and reporting of depreciable assets. Under IFRS, it is possible to report these types of assets at their fair value, using the revaluation model, while under ASPE, no revaluation beyond a capital asset’s historical cost is possible. Consistent with this distinction, is the treatment of recoveries of previously recorded impairments. ASPE does not allow recording recoveries of impairment losses. The basis for reporting depreciable assets at their fair value under IFRS is that the value used can be reliably measured. As well, under IFRS, the frequency of scrutiny of the assets to determine any impairment is greater and the measures taken more rigorous. Given that under IFRS recoveries of impairment losses are possible and given that the revaluation model allows for longlived assets to be reported at values in excess of historical cost, the chances of the recoverable amount falling below the carrying amount are vastly increased. Consequently, the recording impairment losses for long-lived assets are more frequent under IFRS than under ASPE.

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PROBLEM 9-6B (a)

2012 Aug.

1 Land ........................................... 340,000 Building ...................................... 255,000 Cash ...................................... Notes Payable ......................

200,000 395,000

Dec. 31 Depreciation Expense ................... 2,500 Accumulated Depreciation—Building 2,500 [($255,000 − $15,000) ÷ 40] × 5/12 = $2,500 31 Interest Expense ........................... 8,229 Cash....................................... ($395,000 × 5% × 5/12 = $8,229) 2013 May 21 Repairs Expense ........................... 2,000 Cash.......................................

8,229

2,000

Dec. 31 Depreciation Expense ................... 6,000 Accumulated Depreciation—Building ($255,000 − $15,000) ÷ 40 = $6,000

6,000

31 Interest Expense ......................... 19,750 Cash....................................... ($395,000 × 5% = $19,750)

19,750

31 Impairment Loss.......................... 60,000 Land....................................... ($280,000 − $340,000 = − $60,000)

60,000

Building — no entry as the carrying amount of $246,500 ($255,000 − $2,500 − $6,000) is less than the recoverable amount of $249,000.

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PROBLEM 9-6B (Continued) (a) (Continued) 2014 Mar. 31 Depreciation Expense ................... 1,500 Accumulated Depreciation—Building [($255,000 − $15,000) ÷ 40] × 3/12 = $1,500 31 Cash .......................................... 480,000 Accumulated Depreciation— Building* ................................... 10,000 Loss on Sale (below) ................ 45,000 Land ...................................... Building ................................ * ($2,500 + $6,000 + $1,500)

1,500

280,000 255,000

Land (Carrying amount) .............. $280,000 Building ....................................... $255,000 Less: Accumulated depreciation 10,000 245,000 Carrying amount ......................... 525,000 Proceeds ...................................... 480,000 Loss on disposal ......................... $ 45,000 Apr.

(b)

1 Interest Expense ($395,000 × 5% × 3/12) .............. 4,938 Notes Payable............................ 395,000 Cash ......................................

399,938

The land may have been impaired due to contamination found on it or surrounding properties, or because plans to develop an adjacent property that would have increased the value of SE Parts Supply’s property may have been permanently delayed.

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PROBLEM 9-6B (Continued) (c)

Nov. 30 Depreciation Expense ................... 5,500 Accumulated Depreciation—Building 5,500 [($255,000 − $15,000) ÷ 40] × 11/12 = $5,500 30 Cash ........................................... 650,000 Accumulated Depreciation— Building* ................................... 14,000 Gain on Sale (below) ............ Land....................................... Building ................................. * ($2,500 + $6,000 + $5,500)

129,000 280,000 255,000

Land (Carrying amount) ......................... $280,000 Building ................................................... $255,000 Less: Accumulated depreciation ........... 14,000 241,000 Carrying amount ..................................... 521,000 Proceeds ................................................. 650,000 Gain on disposal (sale)........................... $129,000 Taking It Further: The recoverable amount of a property is the higher of the fair value of the asset less the cost to sell it or its value in use. In this case, the property is made up of land and a building which are somewhat inseparable. Consequently, the value in use to SE Parts Supply would be the amount management expects to recover in operations by using the assets together. As for establishing the fair value of the combined assets, property of similar location and type that have been recently sold can be used to make estimates of what would be obtained on sale. Under ASPE, full appraisals of the property need not be done every year, particularly if the likelihood of impairment is remote. Management should be diligent about looking for possible causes for impairment when changes in circumstance or conditions occur. If the company is using IFRS, annual impairment tests are required regardless of circumstances.

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PROBLEM 9-6B (Continued) Taking It Further: (Continued) When considering impairment of the land on its own, there might be conditions uncovered during the year or uninsured damages during the year, which might cause management to investigate the effect of these conditions on the value in use or the resale fair value of the land.

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PROBLEM 9-7B (a)

Invoice price Less proceed from sale Cost of ownership

$125,000 21,000 $104,000

(b) 1. STRAIGHT-LINE DEPRECIATION Depreciable Year Amount × 2013 2014 2015

$107,000* 107,000 107,000

Depr. Rate

33.333%** 33.333% 33.333%

Depr. Expense $35,667 35,667 35,666

End of Year Accum. Carrying Depr. Amount $125,000 $35,667 89,333 71,334 53,666 107,000 18,000

* $125,000 − $18,000 = $107,000 ** 1 ÷ 3 years = 33.333%

2. DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year ×

Depr. Rate

2013 2014 2015

45% 45% 45%

$125,000 68,750 37,812

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End of Year Accum. Carrying Depr. Amount $125,000 $56,250 68,750 87,188 37,812 104,203 20,797

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PROBLEM 9-7B (Continued) (b) (Continued) 3. UNITS-OF-PRODUCTION End of Year Units of Depr. Depr. Accum. Carrying Year Production × Amt/Unit* = Expense Depr. Amount $125,000 2013 6,000 $8.917* $ 53,502 $ 53,502 71,498 2014 2,000 8.917 17,834 71,336 53,664 2015 3,800 8.917 33,885 105,221 19,779 * Depreciable amount per unit is $8.917 per unit [($125,000 – $18,000)  12,000 = $8.917] (c)

(1) (2) Straight- DiminishingLine Balance

Cost ...................................... $125,000 Accumulated depreciation.. 107,000 Carrying amount .................... 18,000 Cash proceeds ..................... 21,000 Gain on sale......................... $ 3,000 (d)

(3) Unit –ofProduction

$125,000 104,203 20,797 21,000 $ 203

$125,000 105,221 19,779 21,000 $ 1,221

(1) (2) Straight- DiminishingLine Balance

(3) Unit –ofProduction

Depreciation expense ......... $107,000 Deduct Gain on sale ........... 3,000 Net expense ......................... $104,000

$104,203 203 $104,000

$105,221 1,221 $104,000

The actual cost of owning in (a) is the same as the net expense under all three methods. The different depreciation methods results in different accumulated depreciation at the date of sale, which in term causes a different gain on sale. Consequently, the total depreciation expense recognized over the life of the asset, less the gain on sale, results in the same net expense of $104,000 over the life of the asset.

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PROBLEM 9-7B (Continued) Taking It Further: I disagree. Experiencing a gain or loss on the disposal of a depreciable asset is not the result of an error or mistake. Rather, a gain or loss is an expected outcome due to the limitations of the cost allocation that has occurred for the asset up to the date of its disposal. Since estimates are involved in arriving at the factors used in calculating depreciation, such as the estimated useful life and the estimated residual value, it is natural that some differences between the carrying amount and any proceeds of disposition will occur when the asset is disposed of.

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PROBLEM 9-8B (a)

2012 Feb.

4 Furniture ...................................... 70,000 Accounts Payable .................

(b) 2012 Sept. 30 Depreciation Expense ................... 9,333 Accumulated Depreciation —Furniture ............................ $70,000 × 20% × 8/12 months 2013 Sept. 30 Depreciation Expense ................. 12,133 Accumulated Depreciation —Furniture ............................ ($70,000 − $9,333) × 20% 2014 Sept. 30 Depreciation Expense ................... 9,707 Accumulated Depreciation —Furniture ............................ ($70,000 − $9,333 − $12,133) × 20% (c)

2015 Jan. 26 Depreciation Expense ................... 2,588 Accumulated Depreciation —Furniture ............................ ($70,000 − $9,333 − $12,133 − $9,707) × 20% × 4/12

70,000

9,333

12,133

9,707

2,588

Accumulated Depreciation at January 26, 2015: $9,333 + $12,133 + $9,707 + $2,588 = $33,761 Carrying Amount at January 26, 2015: Cost – Accumulated Depreciation $36,239 = $70,000 − $33,761

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PROBLEM 9-8B (Continued) (c) (Continued) (1)

(2)

(3)

(4)

Jan. 26 Accumulated Depreciation— Furniture ...................................... 33,761 Loss on Disposal* ....................... 36,239 Furniture................................ * $0 – [$70,000 – $33,761] = ($36,239) Jan. 26 Cash ............................................. 30,000 Accumulated Depreciation— Furniture ...................................... 33,761 Loss on Disposal** ........................ 6,239 Furniture................................ ** $30,000 – [$70,000 – $33,761] = ($6,239) Jan. 26 Cash ............................................. 40,000 Accumulated Depreciation— Furniture ...................................... 33,761 Gain on Disposal*** .............. Furniture................................ *** $40,000 – [$70,000 – $33,761] = $3,761

70,000

3,761 70,000

Jan. 26 Furniture ($70,000 + $30,000) .................... 100,000 Accumulated Depreciation— Furniture ...................................... 33,761 Loss on Disposal**** ..................... 6,239 Cash ($115,000 − $45,000).... 70,000 Furniture................................ 70,000 **** $30,000 – [$70,000 – $33,761] = ($6,239)

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PROBLEM 9-8B (Continued) Taking It Further: The following are the arguments in favour of recording gains and losses on disposal of property, plant, and equipment as: 1.

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PROBLEM 9-9B

(a)

April

1 Land ...........................................1,900,000 Cash....................................... 475,000 Notes Payable ....................... 1,425,000

May

1 Depreciation Expense ................. 25,000 Accumulated Depreciation —Equipment ($750,000 ÷ 10 × 4/12) ..........

25,000

1 Cash ........................................... 350,000 Accumulated Depreciation— Equipment ................................. 550,000 Gain on Disposal .................. Equipment .............................

150,000 750,000

Cost $750,000 Accumulated depreciation—equipment 550,000 [($750,000 ÷ 10) × 7 + $25,000)] Carrying amount 200,000 Cash proceeds 350,000 Gain on disposal $150,000 June 1 Cash ........................................... 380,000 Notes Receivable ...................... 820,000 Land....................................... Gain on Disposal .................. July

1 Equipment .................................1,000,000 Accounts Payable ................. 1,000,000

Dec. 31 Depreciation Expense ............... 47,000 Accumulated Depreciation —Equipment ($470,000 ÷ 10)

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PROBLEM 9-9B (Continued) (a) (Continued) Dec. 31 Accumulated Depreciation— Equipment.................................. 470,000 Equipment .............................

470,000

(b) Dec. 31 Depreciation Expense ............... 570,000 Accumulated Depreciation— Building ($28,500,000 ÷ 50) ..

570,000

31 Depreciation Expense ...............4,728,000 Accumulated Depreciation— Equipment ............................. 4,728,000 $46,780,000* ÷ 10 $1,000,000 ÷ 10 × 6/12

$4,678,000 50,000 $4,728,000

*$48,000,000 − $750,000 − $470,000 = $46,780,000

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31 Interest Expense ......................... 64,125 Interest Payable .................... ($1,425,000 × 6% × 9/12) = $64,125

64,125

31 Interest Receivable...................... 28,700 Interest Revenue ................... ($820,000 × 6% × 7/12) = $28,700

28,700

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PROBLEM 9-9B (Continued) (c)

JAINA COMPANY Balance Sheet (Partial) December 31, 2014

Property, plant, and equipment* Land ............................................. $ 5,600,000 Buildings......................................... $28,500,000 Less: Accumulated depreciation . 12,670,000 15,830,000 Equipment ...................................... $47,780,000 Less: Accumulated depreciation . 18,780,000 29,000,000 Total property, plant, and equipment $50,430,000 *See T accounts that follow for balances Land Jan. 1, 2014 April 1, 2014

4,000,000 1,900,000

June 1, 2014

300,000

Dec. 31, 2014 Bal. 5,600,000 Building Jan. 1, 2014

28,500,000

Dec. 31, 2014 Bal. 28,500,000 Equipment Jan. 1, 2014 July 1, 2014

48,000,000 1,000,000

May 1, 2014 Dec. 31, 2014

750,000 470,000

Dec. 31, 2014 Bal. 47,780,000

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PROBLEM 9-9B (Continued) (c) (Continued) Accumulated Depreciation—Building Jan. 1, 2014 Dec. 31, 2014

12,100,000 570,000

Dec. 31, 2014 Bal. 12,670,000 Accumulated Depreciation—Equipment May 1, 2014 Dec. 31, 2014

550,000 470,000

Jan. 1, 2014 May 1, 2014 Dec. 31, 2014 Dec. 31, 2014

15,000,000 25,000 47,000 4,728,000

Dec. 31, 2014 Bal. 18,780,000 Taking It Further: Although the use of the revaluation model is permitted for those companies adopting the International Financial Reporting Standards (IFRS), its adoption is voluntary, and somewhat rare. The owner should be asked what his motivation is in making this change. Once changed, the business will need to be consistent with the application of the model in the future. Additional evidence will be required each year to support the values that are being used in the revaluation. This could become expensive for Jaina Company, and these costs may exceed the benefits of implementing the revaluation model. Comparability with other companies might also be affected. Since the implementation is rare, Jaina would have financial results which would be harder to compare to others by outside users and by financial institutions.

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PROBLEM 9-10B 1.

Research Expense ..................................... 70,000 Patents....................................................

70,000

Patents ........................................................ 21,000 Professional Fees Expense ..................

21,000

Patents ........................................................ 38,000 Legal Fees Expense ..............................

38,000

Amortization Expense................................ 15,050 Accumulated Amortization—Patents ... 15,050 {[($45,000 + $21,000 + $38,000) ÷ 5 years] − $5,750}

No entry needed or allowed under ASPE: Recoverable amount is greater than carrying amount: Balance Patents account ........................... $104,000 Less: Accumulated Amortization initial.... $5,750 Adjusting entry 4. ............................. 15,050 20,800 Carrying amount......................................... $ 83,200 Recoverable amount .................................. $110,000

Taking It Further: The majority of intangible assets that are developed internally cannot be recognized as intangible assets on the balance sheet because the expenditures on internally developed intangibles cannot be distinguished from the costs of other research and development performed by the business. The costs cannot be separately measured and are expensed as incurred.

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PROBLEM 9-11B (a)

Jan.

July

Aug.

Oct.

2 Trademark................................ Cash.....................................

7,000 7,000

1 Research Expense .................. 275,000 Cash.....................................

275,000

1 Patents ..................................... Cash.....................................

50,000 50,000

1 Prepaid Advertising ................ Cash.....................................

45,000 45,000

1 Copyright #2 ............................ 168,000 Cash.....................................

168,000

Dec. 31 Impairment Loss ..................... 9,000 Accumulated Amortization— Trademark ($59,000 − $50,000)

9,000

Trademark – impairment: Balance Jan. 1, 2014 ............... $52,000 Addition Jan. 2, 2011............... 7,000 Carrying amount ..................... $59,000 Recoverable amount ............... $50,000 Goodwill – no impairment Balance Dec. 31, 2014 ............. $150,000 Recoverable amount ............... $170,000 (b) Dec. 31 Amortization Expense............. 1,250 Accumulated Amortization— Patents ................................ [($50,000 ÷ 20) × 6/12] = $1,250]

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PROBLEM 9-11B (Continued) (b) (Continued) Dec. 31

Amortization Expense ................. 19,000 Accumulated Amortization— Copyrights........................... 19,000 [($36,000 × 1/3) + ($168,000 × 1/6 × 3/12)]

(c) GHANI CORPORATION Balance Sheet (Partial) December 31, 2014 Assets Intangible assets Patents ................................................. $ 50,000 Less: Accumulated amortization....... 1,250 $ 48,750 1 Copyrights .......................................... $204,000 Less: Accumulated amortization....... 43,000 161,000 2 Trademark ........................................... 59,000 Less: Accumulated amortization ....... 9,000 50,000 Total intangible assets ............................................. $259,750 Goodwill ............................................................................. $150,000 1

Copyright: Cost $36,000 + $168,000 = $204,000 Copyright: Amortization $24,000 + $19,000 = $43,000 2 Trademark: $52,000 + $7,000 = $59,000 Taking It Further: Although intangible assets do not have physical substance, they have characteristics common to other assets in that they contribute to the revenue producing ability of a business that owns them. They are owned and controlled by the business and therefore fit the definition of assets.

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PROBLEM 9-12B (a)

2013 June 7 Timber Land......................... 50,000,000 Cash................................ 10,000,000 Mortgage Payable .......... 40,000,000 26 Equipment.............................. Cash...................................

196,000 196,000

Dec. 31 Inventory ................................ 5,280,000 Accumulated Depreciation —Timber Land .................. 5,280,000 ($50,000,000 − $2,000,000) ÷ 1,000,000 t = $48/t $48/t × 110,000 t = $5,280,000 31 Cost of Goods Sold ................ 5,280,000 Inventory ........................... 5,280,000 31 Depreciation Expense ........... Accumulated Depreciation —Equipment ..................... $196,000 ÷ 7 × 6/12 = $14,000

14,000 14,000

31 Interest Expense ($40,000,000 × 7% × 7/12)...... 1,633,333 Cash................................... 1,633,333 31 Mortgage Payable.................. 8,000,000 Cash................................... 8,000,000

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PROBLEM 9-12B (Continued) (a) (Continued) 2014 Dec. 31 Inventory ($48/t × 240,000 t) .................. 11,520,000 Accumulated Depreciation —Timber Land .................. 11,520,000 31 Cost of Goods Sold ............... 11,520,000 Inventory ........................... 11,520,000 31 Depreciation Expense ........... Accumulated Depreciation —Equipment ..................... ($196,000 ÷ 7) = $28,000

28,000 28,000

31 Interest Expense ($32,000,000* × 7%) ............... 2,240,000 Cash................................... 2,240,000 *($40,000,000 − $8,000,000) = $ 32,000,000 31 Mortgage Payable ................... 8,000,000 Cash................................... 8,000,000 (b) CYPRESS TIMBER COMPANY Income Statement (partial) Year Ended December 31, 2014 Cost of goods sold .................................

$11,520,000

Operating expenses: Depreciation expense.........................

Other expenses: Interest expense .................................

$ 2,240,000

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PROBLEM 9-12B (Continued) (b) (Continued) CYPRESS TIMBER COMPANY (Partial) Balance Sheet December 31, 2014

Property, plant, and equipment Timber tract ......................................... $50,000,000 Less: Accumulated depreciation1...... 16,800,000 $33,200,000 Equipment ........................................... $196,000 2 Less: Accumulated depreciation ...... 42,000.. 154,000 Total property, plant, and equipment .................$33,354,000 1 2

$5,280,000 + $11,520,000 = $16,800,000 $14,000 (2013) + $28,000 (2014) = $42,000

Taking It Further: Due to its nature, it is expected that the estimate of the total amount of units to be extracted from a timber tract would need to be adjusted as extraction occurs and better estimates can be made. Management should not be influenced by the need for changes in estimates when choosing the units-of-production method for recording depreciation of the timber tract. It is the depreciation method that best allocates the cost of the tract to the units of timber that are recorded to inventory.

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PROBLEM 9-13B (a) (in thousands) Mock Orange Company

Cotoneaster Company

$9,428.0 [($5,829.1 + $5,771.4) ÷ 2]

$3,839.8 [($2,754.5 + $2,504.1) ÷ 2]

= 1.63 to 1

= 1.46 to 1

$8,894.3 [($5,771.4 + $5,343.9) ÷ 2]

$3,656.9 [($2,504.1 + $2,340.3) ÷ 2]

= 1.60 to 1

= 1.51 to 1

Return on assets 2014

$627.7 [($5,829.1 + $5,771.4) ÷ 2]

$143.4 [($2,754.5 + $2,504.1) ÷ 2]

= 10.82%

= 5.45%

Return on assets 2013

$597.8 [($5,771.4 + $5,343.9) ÷ 2]

$137.9 [($2,504.1 + $2,340.3) ÷ 2]

= 10.76%

= 5.69%

Asset turnover 2014

Asset turnover 2013

(b) Mock Orange Company is more efficient in using its assets to generate sales–its asset turnover of 1.63 times is higher than the turnover of 1.46 for Cotoneaster Company and it’s ratio is increasing while Cotoneaster’s in decreasing. Mock Orange is also much more efficient in using assets to produce profit–with a return on assets of 10.82% compared to 5.45% for Cotoneaster Company. Moreover, Mock Orange's ratio is increasing while Cotoneaster’s is decreasing.

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PROBLEM 9-13B (Continued) Taking it Further: Although the ability to compare two companies in the same industry using ratios is affected by the depreciation methods adopted by the companies being compared, absolute conclusions cannot be drawn from these differences. In this particular comparison, in the early years of the useful lives of depreciable assets owed by Mock Orange will have lower amounts of depreciation recorded compared to Cotoneaster and will also have higher carrying amounts for the assets. This is the case because Mock Orange uses the straight-line method of depreciation and Cotoneaster uses the diminishing-balance method which results in high charges of depreciation in the early years and lower amounts in the later years. The opposite effect would occur in the amount of depreciation recorded in the later years of the useful lives of the assets being depreciated. Notwithstanding this limitation, and assuming a normal turnover of assets, one could generally conclude that the amount of profit and total assets of Cotoneaster would be lower than that of Mock Orange, simply because of the accelerated method of depreciation being used, which generated a higher expense for depreciation and a lower carrying amount for the assets.

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CONTINUING COOKIE CHRONICLE (a)

Purchase price ........................................................ Painting .................................................................... Shelving ................................................................... Cost of van...............................................................

$28,400 3,000 1,600 $33,000

(b) 1. STRAIGHT-LINE METHOD Depreciable Year Amount × 2014 2015 2016 2017 2018 2019 Total

$28,000* 28,000 28,000 28,000 28,000 28,000

Depr. Rate

20% × 8/12 20% 20% 20% 20% 20% × 4/12

Depr. Expense $ 3,733 5,600 5,600 5,600 5,600 1,867 $28,000

End of Year Accum. Carrying Depr. Amount $33,000 $ 3,733 29,267 9,333 23,667 14,933 18,067 20,533 12,467 26,133 6,867 28,000 5,000

* ($33,000 − $5,000 = $28,000) 2. DIMINISHING-BALANCE AT DOUBLE THE STRAIGHTLINE RATE METHOD Carrying End of Year Depr. Depr. Amount (Beg. Accum. Carrying Year of Year × Rate = Expense Depr. Amount $33,000 2014 $33,000 40%* × 8/12 $ 8,800 $ 8,800 24,200 2015 24,020 40% 9,680 18,480 14,520 2016 14,520 40% 5,808 24,288 8,712 2017 8,712 40% 3,485 27,773 5,227 2018 5,227 40% 227** 28,000 5,000 $28,000 * 40% = 20% × 2 [double the straight-line rate] **amount required for carrying amount to equal residual value

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CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued) 3. UNITS-OF-PRODUCTION METHOD Units of Depreciable Year Production × Cost/Unit = 2014 2015 2016 2017 2018 2019

30,000 37,500 40,000 47,500 35,000 10,000

$0.14* 0.14 0.14 0.14 0.14 0.14

Depr. Expense

End of Year Accum. Carrying Depr. Amount $33,000 $ 4,200 28,800 9,450 23,550 15,050 17,950 21,700 11,300 26,600 6,400 28,000 5,000

$ 4,200 5,250 5,600 6,650 4,900 1,400 $28,000 * ($33,000 − $5,000) ÷ 200,000 km = $0.14 per km (c)

The straight-line method of depreciation will result in the greatest amount of profit reported for the year ended December 31, 2014 because it has the lowest depreciation expense for the year. There will be no difference in the total profit over the life of the asset.

(d)

As indicated in the three different schedules prepared in part (b), the carrying amount on the balance sheet at December 31, 2014 would be the highest if the straight-line method were used. By the end of the useful life the carrying amount will be the same under all depreciation methods.

(e)

$33,000 will be spent when the van is purchased. The choice of depreciation method or variations in the calculation will not affect cash. There will not be any difference in the cash over the life of the asset.

(f)

I recommend the unit-of-production method of depreciation because this method will provide Natalie with the best pattern to match the economic benefits of the van. It will provide the fairest charge for each year.

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BYP 9-1 FINANCIAL REPORTING PROBLEM (a)

(in thousands)

Land Buildings Fixtures and equipment Leasehold improvements

(1) Cost $5,860 54,163 163,119 182,073 $405,215

(2) Accumulated Depreciation and Impairment Losses $ 22,018 92,429 106,547 $220,994

(3) Net Carrying Amount $ 5,860 32,145 70,690 75,526 $184,221

(b)

Intangible assets

(3) (2) Net (1) Accumulated Carrying Cost Amortization Amount $28,254 $11,197 $17,057

Goodwill

$42,426

(c)

$42,426

As part of the disclosure in note 8 to the financial statements, $6,723,000 is reported as an impairment loss recorded during the year ended January 28, 2012 for property and equipment. Also, this note reports reversal of impairment losses during the year in the amount of $591,000 for leasehold improvements. The loss was arrived at by comparing the carrying amounts of assets with their value-in-use. The balance of Goodwill has not changed over the last three years. The measurement of any possible impairment is arrived at by comparing the carrying amount of goodwill with its value in use.

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BYP 9-1 (Continued)

(d) The amount of depreciation and amortization expense for the fiscal year 2012 was $55,180,000 for depreciation and $3,959,000 for amortization. These expenses were recorded in selling and distribution expenses and administrative expenses in the statement of earnings. (e)

The amount of cash used to buy property and equipment and intangible assets during the 2012 fiscal year was $59,154,000. This amount appears as an outflow in the investing activities of the statement of cash flows.

(f)

Reitmans uses the straight-line method of depreciation for property and equipment as well as limited life intangible assets. The estimated useful lives for property and equipment and intangibles are: Buildings 10 to 50 years Fixtures and equipment 3 to 20 years Leasehold improvements 6.7 to 10 years Software 3 to 5 years

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BYP 9-2 INTERPRETING FINANCIAL STATEMENTS

(a)

Westjet could use unit-of-production method of depreciation for engine, airframe and landing gear overhaul. For safety reasons, the overhaul costs are done at fixed points following the use of the specific overhauled equipment. These fixed points are likely based on the number of hours this equipment is used in flight. If the use of the assets varied over time, or were seasonal, the unitof-production method would provide a better measure of the charge for depreciation against the revenue produced. It is likely that the amount of use of these assets does not vary a great deal over time, which justifies Westjet’s choice of the straight-line method. If the amount of use varies greatly over time Westjet should use the unit-ofproduction method.

(b) Major overhaul expenditures involve equipment that must be overhauled as a function of amount of use, typically hours in flight. These overhauls must be performed for safety reasons. The expected life between overhauls is very predictable, and likely dictated by safety associations or regulators. Since the timing of the benefit is easily measured, the best match of the major overhaul costs to the revenues is achieved by capitalizing the costs and then depreciating the capitalized overhauls over the benefiting periods. This is an appropriate technique as it is the best and fairest way to deal with major overhaul costs. Other fleet maintenance is minor and less predictable and Westjet’s policy to expense these costs immediately is appropriate.

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BYP 9-2 (Continued) (c)

Leasehold improvements and assets under finance leases frequently have physical lives that are longer than the terms of the lease. But since the control and enjoyment of leasehold improvements and assets under finance leases is limited to the term of a lease, it is appropriate to use the term of the lease for purposes of calculating depreciation. Consequently, the maximum length of benefit to the lessee is the term of lease, which is appropriate in the calculation of depreciation. If, on the other hand, the leasehold improvements have a physical life shorter than the term of the lease, the shorter period should be used for purposes of calculating depreciation.

(d) Westjet uses component depreciation for engine, airframe and landing gear overhaul. Engines, in particular are constantly being overhauled, and so spares are needed to ensure that the airplane can be used during the period needed to perform the overhaul. Since the period of benefit of these major overhauls is considerably shorter than the useful life of the aircraft, this technique is a good example of where component depreciation is very appropriate.

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BYP 9-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resources site accompanying this textbook.

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BYP 9-4 COMMUNICATION ACTIVITY Memorandum To: From:

Jason Long, Owner Ken Bond, Controller

Re:

Impairment loss of Long-Lived Assets

Long-lived assets are recorded at cost. In our company’s case those assets include trucks, garages and equipment. The cost of these assets is depreciated over their useful lives, allocating the costs of depreciation against the revenue these assets have helped us generate. The difference between the cost of an asset and its accumulated depreciation is what we refer to as carrying amount. In some circumstances, the carrying amount of a long-lived asset may not be recoverable. If this happens, and the fair value also falls far below the assets’ carrying amount, an impairment has occurred. An impairment may occur because an asset has become obsolete. In our company, an impairment could arise when equipment we have purchased to repair and maintain a truck can no longer perform the necessary service on a truck because of technological change. The impairment loss is equal to the amount by which the carrying amount of the asset exceeds its recoverable amount. In turn, the recoverable amount is the higher of the asset’s fair value less cost to sell and its value in use. The journal entry to record an impairment loss is: Dr. Impairment Loss Cr. Accumulated Depreciation

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BYP 9-4 (Continued) When an impairment loss is recorded, the cost of the long-lived asset does not change. The amount of accumulated depreciation increases by the amount of the impairment loss. The carrying amount of the asset then decreases to reflect the recoverable amount of the asset. When an impairment loss is recorded, profit is decreased in the year recorded. In future years, the annual depreciation expense will need to be revised. Future annual depreciation expense will be based on the revised carrying amount (which is equal to the recoverable amount after the impairment loss is recorded), the revised residual value, and the revised remaining useful life of the asset. It is possible the residual value and the remaining useful life may not need to be changed. In that case future annual depreciation expense will be less than it has been in previous years as a result of the loss. If the residual value and the remaining useful life change, then the future depreciation expense may be greater or lower than the previous depreciation expense.

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BYP 9-5 ETHICS CASE (a)

The stakeholders in this situation are: President of Finney Container Company Controller of Finney Container Company The owners of Finney Container Company Potential investors in Finney Container Company Creditors and others with a financial interest in the company The company’s auditors

(b) The estimate of the useful life of the equipment was tentative when first set by the management and could have been set at any point in the possible range of five to nine years. A change from seven to nine years would not be unethical if it were the result of additional information at the time of the revision. In that case, the goal is to achieve a better allocation of the asset's depreciable amount over the asset's useful life. What makes the proposed changes unethical is that the change has very little to do with the asset, but everything to do with the goal of manipulating profit in order to obtain a bonus. This is a self serving goal on the part of the president and is suggested for no other reason than for personal gain. The fact that the competition uses a longer life on its equipment is not necessarily relevant. The competition's repair and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Finney Container Company. But the change may increase the degree of comparability between Finney and its competitor.

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BYP 9-5 (Continued) (c)

Profit in the year of change is increased $114,286 ($400,000 − $285,714), because depreciation expense is decreased $114,286, by implementing the president's proposed changes.

Old Estimate Asset cost .................................................................. $2,900,000 Estimated residual value .......................................... 100,000 Depreciable amount ............................................... 2,800,000 Estimated useful life .................................................. ÷ 7 years Depreciation expense per year ............................. $ 400,000 Revised Estimate Asset cost ............................................................... $2,900,000 Depreciation taken to date ($400,000 × 2 years) .. 800,000 Carrying amount at time of change in estimate ... 2,100,000 Estimated residual value ....................................... 100,000 Remaining cost to be depreciated ........................ 2,000,000 Remaining useful life (9 years − 2 years) ............. ÷ 7 years Revised depreciation expense per year ............... $ 285,714

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BYP 9-6 “ALL ABOUT YOU” ACTIVITY (a)

Generally, copyright means the sole right to produce or reproduce a work or a substantial part of it in any form. It also includes the right to perform a work, or in the case of a lecture to deliver it, and the right to publish an unpublished work. Copyright applies to all original literary, dramatic, musical, and artistic works. These include books, other writings, music, sculptures, paintings, maps, photographs, films, plays, television and radio programs, and computer programs. Copyright also applies to other subject matter including recordings (such as records, cassettes, DVDs, videos and tapes), performer's performances, and communication signals.

(b) A person acquires a copyright automatically when he or she creates an original work or other subject matter, provided the conditions set out in the Copyright Act have been met. Since you automatically obtain copyright, the law automatically protects you. You do not have to register your copyright in order to be protected. (c)

The Copyright Act provides that a certificate of registration is evidence that the copyright exists and that the person registered is the owner of the copyright. Being on the Register of Copyrights may also assist those wishing to seek permission to use the work.

(d) Registration of a copyright is done by completing an application and sending it to the Copyright Office, along with the appropriate fee.

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BYP 9-6 (Continued) (e)

The fee for filing on-line is $50 and so is so small that it is not material. Consequently most businesses decide to expense the fee immediately. It is possible that with several copyrights, a meaningful amount can be recorded as an asset as the fees have been incurred to protect the right to the works and will bring benefit to the business in the future.

(f)

Copyright infringement refers to unlawful use of copyright material. Plagiarism—passing off someone else's work as your own—is a form of infringement.

(g) The responsibility for monitoring the use of your song rests with the person who owns the copyright.

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CHAPTER 10 Current Liabilities and Payroll ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

Problems Set A

Problems Set B

1. Account for determinable or certain current liabilities.

1, 2, 3, 4, 5, 6, 7, 12

1, 2, 3, 4, 13, 14

1, 2, 3, 4, 5, 9, 13

1, 2, 3

2. Account for estimated liabilities.

8, 9, 10, 11, 12

5, 6, 7, 8, 13

6, 7, 8, 9

3, 4, 5

3. Account for contingencies.

12, 13, 14, 15, 16

9, 10, 13

9, 10

4. Determine payroll costs and record payroll transactions. 5. Prepare the current liabilities section of the balance sheet.

17, 18, 19, 20, 21

11, 12, 13, *18

11, 12, 13, *15

3, 7, 8

22, 23, 24

13, 14, 15

5, 14

1, 2, 3, 6, 9

*6. Calculate mandatory payroll deductions (Appendix 10A).

*25, *26

*16, *17, *18

*15, *16

*10

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number 1A

Description Calculate current and non-current portion of notes payable, and interest payable.

Difficulty Level Moderate

Time Allotted (min.) 15-25

Record note transactions; show financial statement presentation.

Moderate

30-40

Record current liability transactions; prepare current liabilities section.

Moderate

30-40

Record warranty transactions.

Moderate

15-25

Record customer loyalty program and gift card transactions; determine impact on financial statements.

Moderate

15-25

Discuss reporting of contingencies and record provisions.

Moderate

15-25

Prepare payroll register and record payroll.

Moderate

25-35

Record payroll transactions and calculate balances in payroll liability accounts.

Moderate

25-35

Prepare current liabilities section; calculate and comment on ratios.

Moderate

15-25

*10A

Calculate payroll deductions; prepare payroll register.

Moderate

25-35

Calculate current and non-current portion of notes payable, and interest payable.

Moderate

15-25

Record note transactions; show financial statement presentation.

Moderate

30-40

Record current liability transactions; prepare current liabilities section.

Moderate

30-40

Record warranty transactions.

Moderate

15-25

Record customer loyalty program and gift card transactions; determine impact on financial statements.

Moderate

15-25

Discuss reporting of contingencies and record provisions.

Moderate

15-25

Prepare payroll register and record payroll.

Moderate

25-35

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 8B

Description Record payroll transactions and calculate balances in payroll liability accounts.

Difficulty Level Moderate

Time Allotted (min.) 25-35

Prepare current liabilities section; calculate and comment on ratios.

Moderate

15-25

*10B

Calculate payroll deductions; prepare payroll register.

Moderate

25-35

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objectives 1. Account for determinable or certain current liabilities.

Knowledge Comprehension Q10-1 Q10-2 Q10-3 Q10-4 Q10-12 BE10-13

Q10-5 Q10-6 Q10-7 E10-9

2. Account for estimated liabilities.

Q10-12 BE10-13

Q10-8 Q10-9 Q10-10 Q10-11 E10-9

3. Account for contingencies.

Q10-12 BE10-13

4. Determine payroll costs and record payroll transactions.

Q10-19 Q10-21 BE10-13

Q10-13 Q10-14 Q10-15 Q10-16 BE10-9 E10-9 Q10-17 Q10-18 Q10-20

5. Prepare the current liabilities section of the balance sheet.

Q10-22 Q10-23 Q10-24 BE10-13

*6. Calculate mandatory payroll deductions (Appendix 10A).

*Q10-25 *Q10-26

E10-5 E10-13 P10-1A P10-2A P10-3A P10-1B P10-2B P10-3B

BE10-10 E10-10 P10-6A

P10-6B

BE10-11 BE10-12 *BE10-18 E10-11 E10-12 *E10-15

P10-3A P10-7A P10-8A P10-3B P10-7B P10-8B

10-4

Analysis

Synthesis

BYP10-1

BYP10-2 BYP10-5 BYP10-6

P10-3A P10-4A P10-5A P10-3B P10-4B P10-5B

BE10-14 P10-1B BE10-15 P10-2B E10-5 P10-3B E10-13 P10-6B E10-14 P10-9B P10-1A P10-2A P10-3A P10-6A P10-9A *BE10-16 *P10-10A *BE10-17 *P10-10B *BE10-18 *E10-15 *E10-16 Continuing Cookie Chronicle Cumulative Coverage Chapters 3 – 10 BYP10-3 BYP10-4

Broadening Your Perspective

Solutions Manual .

Application BE10-1 BE10-2 BE10-3 BE10-4 BE10-14 E10-1 E10-2 E10-3 E10-4 BE10-5 BE10-6 BE10-7 BE10-8 E10-6 E10-7 E10-8

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ANSWERS TO QUESTIONS 1.

A determinable liability is also referred to as certain liabilities or known liabilities. Examples include accounts payable, salaries payable, HST payable, and CPP and EI payable.

The transaction does not meet the definition of a liability. A liability is defined as a present obligation, arising from past events, to make future payments of assets or services. A commitment to purchase is usually not an obligation and no past event (a purchase) has occurred since goods have not been delivered or services received.

Interest payable is calculated as the product of the principal, the interest rate and the fraction of the year in the accrual. The amount of interest payable at the fiscal year end is calculated with reference to the amount of time since the last interest payment if regular interest payments are required.

An operating line of credit is a pre-authorized bank loan that allows a company to borrow up to a pre-set limit, and repay the loan, as needed. When the company borrows against its line of credit, the cash account balance is increased and notes payable are increased. A bank overdraft occurs when a bank account is overdrawn due to withdrawals and cheques in excess of deposit amounts. In this case, the cash account will show a credit balance. There is no separate liability shown, as the overdraft is itself, a liability.

If the sales tax is included in the selling price, this means that the selling price represents 113% of the retail price. By dividing the selling price (including sales tax) by 113% (100% + the sales tax percentage), you obtain the retail price. The sales tax can then be calculated by multiplying the retail price by 13% or by calculating the difference between the selling price and the retail price. For example, a product sells for $226 including HST. The retail price is calculated as $226 ÷ 113% = $200. The HST is calculated as $200 × 13% = $26.

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QUESTIONS (Continued) 6.

Your roommate is not correct. The determining factor in recording property taxes as expenses is the timing rather than avoidability. Property taxes are recorded as expenses as municipal services are received. This is usually accomplished by recording the expense in a systematic monthly basis regardless of when the tax bill is actually paid. The property tax bill for the calendar year is usually not known until the spring. If a company has a yearend prior to receiving the property tax bill, it would have to accrue an expense and estimated liability (for the months in the current calendar year) based on last year’s property tax bill. Otherwise, most companies would wait until they receive the property tax bill, and record property tax expense and property tax payable (a current liability) for the number of months in the year to date. When the property tax bill is paid, the liability will disappear and the company will record property tax expense for any intervening period of time and prepaid property tax (a current asset) for the remaining months in the year. As time passes, the company would record the property tax expense and credit the prepaid property tax account.

Laurel is not correct. Some long-term debts have portions that will be due in the coming year. This portion is classified as a current liability since it will be paid within one year of the balance sheet date.

I don’t agree. Although you don’t know which specific appliances will be returned for repair, you can estimate the cost of repairs that will be required under warranty based on past experience or industry information. If repair costs are not recorded until units are brought in, liabilities on the balance sheet will be understated and the expenses will not be properly matched with revenue on the income statement. If sales are increasing, this will probably result in an overstatement of income.

Future savings provided to customers through customer loyalty programs reduce future periods’ revenues. Giving customers these rewards creates an obligation in the current period to provide reductions on future selling prices and reduced cash in the future.

10.

The company should estimate the number of vouchers that will likely be used. It should record this estimate as a reduction to revenue (Dr. Sales Discount for Redemption Rewards Issued) in the period of the sale and as an estimated liability (Cr. Redemption Rewards Liability), to recognize the obligation the company has with respect to these coupons.

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QUESTIONS (Continued) 11.

Gift cards are similar to unearned revenues in that they represent cash received from customers for future products or services. They are classified as a liability because they are an obligation for the issuing company to provide assets or services in the future. Unearned passenger revenue usually has a determinable time at which the flight will be taken and the unearned revenue becomes earned. Gift cards however do not have a fixed date at which the obligation will be satisfied, and frequently are not used at all. This is similar to an operating line of credit in that the obligation can be satisfied in the current or long-term. In some cases, a portion or the entire amount of the gift card is not used at all. Over time, companies need to determine if a portion of this unearned revenue can be considered earned since the likelihood of redemption becomes more remote.

12. A determinable liability has a known amount, payee and due date. An estimated liability is an obligation that exists but whose amount and timing are uncertain. There is no uncertainty about the existence of a determinable liability and an estimated liability. Under ASPE, a contingent liability is an obligation that is uncertain with respect to existence, timing and amount. The existence of a contingent liability depends on the resolution of a future event outside of the company’s control. Under IFRS, situations where it is probable an obligation exists and the amount can be reasonably estimated are treated as estimated liabilities. Contingent liabilities are possible obligations that the company probably will not have to settle, or obligations for which the amount cannot be reliably measured. 13. Under ASPE, a contingent liability is defined as a possible obligation that will be confirmed by the occurrence or non-occurrence of an uncertain future event. An estimated liability is an obligation that exists but whose amount and timing are uncertain. A contingent liability may be recognized as an estimated liability if it is likely that a present obligation exists and the amount can be reliably estimated. Under IFRS, a contingent liability is a possible obligation that does not meet the criteria for recognition and does not meet the definition of a liability. Under IFRS, situations where it is probable an obligation exists and the amount can be reasonably estimated are treated as estimated liabilities. 14.

Under ASPE, if a contingent liability is both likely to occur and reasonably estimable, it is recorded in the accounts. If its likelihood is not determinable, or if it is not reasonably estimable, it is not recorded in the accounts but disclosed in a note. If it is unlikely to occur, but could have a substantial negative effect on the company’s financial position, it should be disclosed. Otherwise, contingent liabilities are neither recorded nor disclosed.

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QUESTIONS (Continued) 15.

Under IFRS, a contingent liability is never recorded because it is a possible liability that does not meet the criteria for recognition, either because it is not probable or the amount cannot be reliably measured. The criteria for recognition of an estimated liability are that it is probable a present obligation exists and that the amount can be reliably estimated. Under IFRS, the threshold for recognizing liabilities is “probable” rather than “likely” as used under ASPE. This threshold is generally considered lower.

16.

If the chance of a contingency occurring is considered small, it should still be disclosed if the occurrence could have a substantial effect on the company’s financial position.

17.

Gross pay is the amount an employee actually earns. Net pay, the amount an employee is paid, is gross pay reduced by both mandatory and voluntary deductions, such as income tax, union dues, etc. Gross pay should be recorded as wages or salaries expense.

18.

Employee payroll deductions are the amounts subtracted from an employee’s gross pay in determining net pay. Mandatory employee payroll deductions include federal and provincial income taxes, Canada Pension Plan and Employment Insurance. When an employer withholds these amounts from an employee pay cheque, the employer is merely acting as a collection agent for the taxing body. Since the employer holds employees' funds, these withholdings are a liability for the employer until they are remitted to the government. Employee payroll deductions also include voluntary deductions for things such as insurance, pensions, union dues and donations to charities. Employer payroll deductions are amounts the employer is expected to pay that are charged on certain payroll deductions. These include CPP where the employer is expected to pay the same amount as the employee and EI where the employer is expected to pay 1.4 times the amount the employee has paid. These are expenses for the employer over and above gross pay.

19.

The employee earnings record is used in (1) determining when an employee has earned the maximum earnings subject to CPP and EI deductions, (2) filing information returns with the CRA, and (3) providing each employee with a statement of gross earnings and tax withholdings for the year on the T4 form. The payroll register accumulates gross earnings, deductions, and net pay for all employees for each pay period. It provides the documentation to support the preparation of the paycheque for each employee.

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QUESTIONS (Continued) 20.

Income tax, CPP and EI deductions are remitted to the CRA, usually on a monthly basis. Workplace, Health, Safety, and Compensation is remitted quarterly (or monthly depending on the province) to the Workplace, Health, Safety and Compensation Commission (or similar body depending on the province). Other deductions are paid to different organizations, such as the United Way, and would normally be made on a monthly basis.

21.

Paid absences refer to compensation paid by employers to employees for vacations, sickness, and holidays. When the payment of such compensation is probable and the amount can be reasonably estimated, a liability should be accrued for paid future absences, which employees have earned. When this amount cannot be reasonably estimated, the potential liability should be disclosed. Other employee benefits include workplace health, safety and compensation, as well as health and dental insurance which are expensed on a monthly basis. Employers also occasionally pay for post-employment benefits such as pensions and supplemental health and dental care and life insurance. These post-employment benefits are accounted for using the accrual basis.

22.

Current liabilities are usually listed in order of their liquidity, by maturity date. It may not be possible to list current liabilities in order of liquidity because of the varying maturity dates that may exist for certain specific obligations. They are also often listed in order of magnitude with the largest items listed first.

23.

If companies have used their line of credit and are overdrawn or show a negative cash balance, the amount is included in current liabilities and called bank indebtedness, bank overdraft or bank advances. Note disclosure will include security or collateral that was required by the bank, the maximum amount that can be withdrawn, as well as the interest rate charged on the bank overdraft. Terms associated with notes payable are also disclosed.

24.

A company can determine if its current liabilities are too high by monitoring the relationship of current assets to current liabilities and calculating the current ratio (current assets ÷ current liabilities). This relationship is critical in evaluating a company’s short term ability to pay debt.

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QUESTIONS (Continued) *25. Contribution rates for CPP are set by the federal government and are adjusted every January if there are increases in the cost of living. Employee contributions under the Canada Pension Plan Act are set at a percentage of pensionable earnings (currently 4.95%). Pensionable earnings are gross earnings less a basic yearly exemption (currently $3,500). A maximum ceiling or limit is imposed on pensionable earnings ($50,100 for 2012). The exemption and ceiling are prorated to the relevant pay period (e.g., weekly, biweekly, semimonthly, monthly). Contribution rates for EI are currently based upon a percentage (currently 1.83%) of insurable earnings, to a maximum earnings ceiling ($45,900 for 2012). In most cases, insured earnings are gross earnings plus any taxable benefits. *26. The amount deducted from an employee’s salary for income tax is determined by using payroll accounting programs, CRA payroll deduction tables, tables on diskette, or payroll deductions online calculator. The income tax that should be withheld from gross salary is based on the number of personal tax credits claimed by an employee.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) 2014 May 1 Cash ............................................... Notes Payable ........................... (b) June 1 Interest Expense ($10,500 × 4% × 1/12)..................... Cash........................................... (c) Aug. 31 Interest Expense ($10,500 × 4% × 1/12)..................... Interest Payable ........................ (d) 2015 Mar. 1 Interest Expense ($10,500 × 4% × 1/12)..................... Notes Payable................................ Cash...........................................

10,500 10,500

35 35

35 10,500 10,535

BRIEF EXERCISE 10-2 (a) Calculation of sales tax payable – Ontario store: HST payable = $7,200 × 13% = $936 Calculation of sales tax payable – Quebec store: GST payable = $8,400 × 5% = $420 QST payable = $8,400 × 9.975% = $838

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BRIEF EXERCISE 10-2 (Continued) (b) Ontario store: Mar. 12 Cash .................................................... Sales ............................................... HST Payable ................................... Quebec store: Mar. 12 Cash .................................................... Sales ............................................... GST Payable................................... QST Payable...................................

8,136 7,200 936

9,658 8,400 420 838

BRIEF EXERCISE 10-3 (a) May 10, 2014: Calculation of sales tax collected: HST: $1,500 × 13% × 10 =

$1,950

May 17, 2014: Calculation of sales: Sales = ($1,500 × 20) ÷ 1.13 = $26,549 Calculation of sales tax payable: HST payable = $26,549 × 13% = (b) Mar. 10

$3,451

Cash .................................................... 16,950 Sales ($1,500 × 10) ......................... HST Payable ...................................

15,000 1,950

Mar. 17 Cash ($1,500 × 20) .............................. 30,000 Sales ............................................... HST Payable ...................................

26,549 3,451

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-4 Mar. 31

Property Tax Expense ($7,860 × 3/12) Property Tax Payable.....................

1,965

June 30 Property Tax Payable ......................... Property Tax Expense ($7,860 × 3/12) Prepaid Property Tax ($7,860 × 6/12) Cash................................................

1,965 1,965 3,930

Dec. 31 Property Tax Expense ........................ Prepaid Property Tax .....................

3,930

1,965

7,860

3,930

BRIEF EXERCISE 10-5 (a)

Dec. 31 Warranty Expense ....................... 10,625 Warranty Liability.................. [(2,500 units × 5%) × $85/unit]

(b) Dec. 31 Warranty Liability .......................... 2,125 Repair Parts Inventory.......... (c)

Sales (2,500 units × $400) ......................... Less: Cost of goods sold (2,500 units × $175) Warranty expense.......................... Profit .........................................................

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10-13

10,625

2,125 $1,000,000 437,500 10,625 $551,875

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-6 July 3 Redemption Rewards Liability .......... Cash ($150 – $20) ............................... Sales ............................................... July 3 Sales Discounts for Redemption Rewards Issued ($150 × 2%).............. Redemption Rewards Liability......

20 130 150

3 3

Note: Each time One-Stop has a cash sale it debits Sales Discounts for Redemption Rewards Issued and credits Redemption Rewards Liability. This would have happened when Judy collected the $20 of One-Stop money used in this transaction.

BRIEF EXERCISE 10-7 (a) Sales (50,000 novels × $8) .......................... Less: Sales Discount for Redemption Rewards Issued (50,000 novels × 10% × $2) .............. Net Sales......................................................

$400,000

(10,000) $390,000

(b) July 31 Sales Discount for Redemption Rewards Issued .................................... 10,000 Redemption Rewards Liability ......

10,000

As redeemed in August: Redemption Rewards Liability .............. 2,000 Cash (1,000 × $2) ...........................

2,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-8 Dec. 2014 Cash .................................................. Unearned Revenue......................

4,750

Jan. 2015 Unearned Revenue........................... Sales ............................................

2,425

Cost of Goods Sold.......................... Merchandise Inventory ...............

1,070

4,750

2,425 1,070

BRIEF EXERCISE 10-9 (a)

(2) Disclosed: This liability should be disclosed. The outcome is neither likely nor unlikely (not determinable). The treatment would be the same under both IFRS and ASPE.

(b)

(1) Recorded: This liability is likely and can be reasonably estimated. The treatment would be the same under both IFRS and ASPE.

(c)

(1) Recorded under IFRS: This liability is “probable” and can be reasonably estimated. (2) Disclosed under ASPE: The outcome is not “likely”; the chance of occurrence is not considered sufficiently high.

(d)

(3) Neither recorded or disclosed: This contingency is considered unlikely. The treatment would be the same under both IFRS and ASPE.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-10 The arguments for recording this liability are that the outcome is probable and the amount can be estimated. Since the company is public, IFRS applies. In this case, the lawsuit is considered an estimated liability and is recorded since the loss is considered probable. Management may be reluctant to disclose this information separately on the financial statements for fear it will be taken as an admission of guilt.

BRIEF EXERCISE 10-11 (a) Gross earnings: Regular pay (40 × $18) ....................................... $720.00 Overtime pay (5 × $27) ....................................... 135.00

$855.00

Less: CPP contributions..................................... $38.99 EI premiums ................................................ 15.65 Income tax withheld................................. 132.00 Net pay .............................................................................

186.64 $668.36

(b) Employer costs: CPP contributions ................................................ $38.99 EI premiums ($15.65 × 1.4) ................................... 21.91

$60.90

The employer does not bear any costs for employee income taxes.

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BRIEF EXERCISE 10-12 (a) Aug. 22 Salaries Expense .................................. 70,000 CPP Payable................................... 3,330 EI Payable....................................... 1,281 Income Tax Payable....................... 19,360 Salaries Payable ............................ 46,029 ($70,000 – $3,330 – $1,281 – $19,360 = $46,029) 22 Salaries Payable ................................... 46,029 Cash................................................

46,029

22 Employee Benefits Expense .................. 5,123 CPP Payable................................... EI Payable ($1,281 × 1.4) ...............

3,330 1,793

(b)

BRIEF EXERCISE 10-13 (a) (b) (c) (d) (e) (f) (g)

Current liability Current liability Current liability Current liability Current liability Current asset Disclosed in the notes to the financial statements as a contingent liability (h) Current liability (i) Current asset (j) Current liability ($5,000) and long-term liability ($70,000)

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-14 (a)

Current liability: $12,000 Non-current liability: $48,000 Only the portion of principal to be repaid in 2015 would be shown as a current liability.

(b) Current liability: $24,000 ($2,000 per month × 12 months) Non-current liability: $66,000 ($96,000 – [$2,000 × 3] – $24,000) The principal repayments of $2,000 per month to be repaid in 2015 would be shown as a current liability.

BRIEF EXERCISE 10-15 (a) SUNCOR ENERGY INC. (Partial) Balance Sheet December 31, 2011 (in millions)

Liabilities Current liabilities Accounts payable and accrued liabilities ................. Income taxes payable................................................. Current portion of provisions .................................... Short term debt ........................................................... Current portion of long-term debt ............................. Total current liabilities...........................................

$ 7,755 969 811 763 12 $10,310

Note: This presentation lists the accounts in order of in order of size, with the largest one (accounts payable and accrued liabilities) listed first. Other alternatives are also possible, such as listing the accounts in order of liquidity, by estimated maturity date.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 10-15 (Continued) (b) Current Ratio = Current Assets ÷ Current Liabilities $14,124* ÷ $10,310 = 1.37 to 1 * $5,412 + $3,803 + $704 + $4,205 = $14,124 Acid-Test Ratio = (Cash + AR + Income Tax Recoverable) ÷ Current Liabilities ($5,412 + $3,803 + $704) ÷ $10,310 = 0.96 to 1

*BRIEF EXERCISE 10-16 Monthly Pay = ($60,100/year ÷ 12 months) = $5,008 (a)

January 2012: CPP deduction = ($5,008 – [$3,500 ÷ 12]) × 4.95% = $233.46 EI deduction = $5,008 × 1.83% = $91.65

(b) December 2012: No deductions for CPP or EI. The cumulative salary up to November 30, 2012 is $55,092 ($60,100 × 11 ÷ 12). The cumulative salary exceeds the annual maximum pensionable earnings of $50,100 and maximum insurable earnings of $45,900.

*BRIEF EXERCISE 10-17 Gross salary for the week = $1,075 (a) CPP [($1,075.00 − $67.30) × 4.95%] EI ($1,075 × 1.83%) (b) Federal income tax (claim code 1) Ontario income tax (claim code 1) Total deductions

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$49.88 19.67 136.00 67.20 $272.75

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Accounting Principles, Sixth Canadian Edition

*BRIEF EXERCISE 10-18 (a) Gross earnings: Regular pay......................................................... $860.00 Overtime pay ([$860 ÷ 40] × 1.5 × 8 hours) ....... 258.00 $1,118.00 (b) CPP ($1,118 – [$3,500 ÷ 52]) × 4.95% ........... $52.01 EI (1.83% × $1,118) .......................................... 20.46 (c) Federal income tax (claim code 2) ............... 140.95 Ontario income tax (claim code 2) .............. 69.55 Total deductions ..................................... $282.97 (d) Net pay............................................................................ $835.03

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 10-1 (a)

Novack Company 2014 June 1 Equipment.................................. 50,000 Accounts Payable ................. July

Aug.

1 Accounts Payable...................... 50,000 Notes Payable ....................... 1 Interest Expense ....................... Cash....................................... ($50,000 × 7% × 1/12)

292

Aug. 31 Interest Expense ....................... Interest Payable ....................

292

Sep.

292

Oct.

1 Interest Payable......................... Cash.......................................

50,000

292

1 Interest Expense ....................... 292 Notes Payable............................ 50,000 Cash.......................................

50,292

(b) Moleski Manufacturers 2014 June 1 Accounts Receivable ................ 50,000 Sales ......................................

50,000

1 Cost of Goods Sold................... 30,000 Merchandise Inventory.........

30,000

1 Notes Receivable ...................... 50,000 Accounts Receivable ............

50,000

10-21

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July

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EXERCISE 10-1 (Continued) (b) (Continued) Aug.

Sep.

Oct.

Solutions Manual .

1 Cash ........................................... Interest Revenue................... ($50,000 × 7% × 1/12)

292

1 Cash ........................................... Interest Revenue...................

292

1 Cash ........................................... 50,292 Interest Revenue................... Notes Receivable ..................

292 50,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-2 (a)

Tundra Trees Mar. 1 Equipment.................................. 30,000 Notes Payable ....................... July 31 Interest Expense ....................... Interest Payable .................... ($30,000 × 8% × 5/12) Oct.

30,000

1,000 1,000

1 Interest Expense* ...................... 400 Interest Payable......................... 1,000 Notes Payable............................ 30,000 Cash....................................... * ($30,000 × 8% × 2/12)

31,400

(b) Edworthy Equipment Mar. 1 Notes Receivable ...................... 30,000 Sales ......................................

30,000

1 Cost of Goods Sold................... 18,000 Merchandise Inventory.........

18,000

May 31 Interest Receivable ................... Interest Revenue................... ($30,000 × 8% × 3/12) Oct.

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600 600

1 Cash ........................................... 31,400 Interest Receivable ............... Interest Revenue* ................. Notes Receivable .................. * ($30,000 × 8% × 4/12)

600 800 30,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-3 1.

Sainsbury Company

April 10

Cash ........................................... 35,595 Sales ($35,595 ÷ 1.13) ........... HST Payable ($31,500 × 13%)

31,500 4,095

Montgomery Company

April 21

13,200 1,716

Hockenstein Company

April 15

Cash ........................................... 14,916 Sales ...................................... HST Payable ($13,200 × 13%)

Cash ........................................... 31,500 Sales ...................................... GST Payable ($30,000 × 5%)

30,000 1,500

Winslow Co.

April 27

Solutions Manual .

Cash ........................................... 28,112 Sales ...................................... GST Payable ($25,100 × 5%) PST Payable ($25,100 × 7%) .

10-24

25,100 1,255 1,757

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EXERCISE 10-4 2014 (a) Oct. 31 Cash.................................................... 31,500 Unearned Revenue ....................... (150 × $210) (b) 1. Nov. 30 Unearned Revenue ............................ Admission Revenue ..................... ($31,500 × 1/6)

31,500

5,250

2015 2. Mar. 31 Unearned Revenue .................................5,250 Admission Revenue ..................... ($31,500 × 1/6)* 3. Apr. 30 Unearned Revenue.................................5,250 Admission Revenue ..................... ($31,500 × 1/6)*

5,250

* Charleswood adjusts its accounts on a monthly basis. There would be a similar entry at December 31, 2014, January 31, 2015 and February 28, 2015. (c) Parts 1, 2 and 3.

Date 2014 Oct. 31 Nov. 30 Dec. 31 2015 Jan. 31 Feb. 28 Mar. 31 Apr. 30

Solutions Manual .

Unearned Revenue Explanation Ref. Debit

Credit Balance 31,500

Adjusting entry Adjusting entry

5,250 5,250

31,500 26,250 21,000

Adjusting entry Adjusting entry Adjusting entry Adjusting entry

5,250 5,250 5,250 5,250

15,750 10,500 5,250 0

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-5 (a)

May 31 Property Tax Expense ($18,660 × 1/12).......................... Property Tax Payable ...........

1,555 1,555

The company would have accrued property tax expense on a monthly basis using the 2013 monthly expense of $1,475 per month. An adjustment would be required when the property tax bill is received: May 31 Property Tax Expense............... 320 Property Tax Payable ........... 320 [($18,660 × 1/12) – $1,475] × 4 months The company accrues property tax expense on June 30, 2014 for one month. July 31 Property Tax Payable ($18,660 × 6/12).......................... Property Tax Expense ($18,660 × 1/12) ......................... Prepaid Property Tax ($18,660 × 5/12).......................... Cash.......................................

9,330 1,555 7,775 18,660

The company makes monthly adjusting entries for property tax expense on from August to December, as follows: Property Tax Expense ................... 1,555 Prepaid Property Tax............ 1,555 (b) Since the company’s fiscal year matches the annual property tax bill, there are no prepaid property taxes or property taxes payable. Income Statement, Year Ended December 31, 2014 (Partial) Operating expenses Property tax expense .................................................. $18,660

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-5 (Continued) (b) (Continued) Prepaid Property Tax Date Explanation Ref. Debit Credit Balance Jul. 31 7,775 7,775 Aug. 31 1,555 6,220 Sep. 30 1,555 4,665 Oct. 31 1,555 3,110 Nov. 30 1,555 1,555 Dec. 31 1,555 0

Date Jan. 31 Feb. 28 Mar. 31 Apr. 30 May 31 May 31 June 30 July 31 Aug. 31 Sep. 30 Oct. 31 Nov. 30 Dec. 31

Solutions Manual .

Property Tax Expense Explanation Ref. Debit Credit Balance 1,475 1,475 1,475 2,950 1,475 4,425 1,475 5,900 320 6,220 1,555 7,775 1,555 9,330 1,555 10,885 1,555 12,440 1,555 13,995 1,555 15,550 1,555 17,105 1,555 18,660

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-6 (a)

Estimated warranty costs for November and December sales: Number of units sold (30,000 + 32,000) Estimated rate of defective units Total estimated defective units Average warranty repair cost Estimated warranty costs for Nov. and Dec.

62,000 × 2.5% 1,550 × $20 $31,000

Dec. 31 Warranty Expense............................ 31,000 Warranty Liability....................

31,000

(b) Dec. 31 Warranty Liability............................. 21,600 Repair Parts Inventory, Salaries Payable, Cash, etc.... ([450 + 630] × $20)

21,600

(c) Income Statement, Year Ended December 31, 2014 (Partial) Operating expenses Warranty expense ....................................................... $31,000 Balance Sheet, at December 31, 2014 (Partial) Current Liabilities Warranty liability ($31,000 – $21,600) ....................

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EXERCISE 10-7 (a)

Warranty expense: 2012: ($2,000 × 500 units sold × 5%) = 2013: ($2,000 × 600 units sold × 5%) = 2014: ($2,000 × 525 units sold × 5%) =

$50,000 $60,000 $52,500

(b) Warranty liability at the end of the year: Estimated warranty expense for 2012: Less: Cost incurred in 2012 Warranty liability at end of 2012:

$50,000 (30,000) 20,000

Add: Estimated warranty expense for 2013: Less: Cost incurred 2013 Warranty liability at end of 2013:

60,000 (46,000) 34,000

Add: Estimated warranty expense for 2014: Less: Cost incurred 2014 Warranty liability at end of 2014:

52,500 (53,500) $33,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-8 (a)

2014: 900,000 × 35% × $0.01 = $3,150 2015: 1,200,000 × 35% × $0.01 = $4,200

(b) 2014: 225,000 × $0.01 = $2,250 2015: 336,000 × $0.01 = $3,360 (c)

2014: $3,150 – $2,250 = $900 2015: $900 + $4,200 – $3,360 = $1,740

(d) When the points are redeemed, the following entry would be done: Redemption Rewards Liability Cash Sales

XXX XXX

Cost of Goods Sold Inventory

XXX

The points reduce the amount of cash required to complete the sales transaction. The sale also triggers the issuance of new points: Sales Discount for Redemptions Rewards Issued XXX Redemption Rewards Liability

XXX

Points redemption reduces the amount of outstanding redemption rewards liability. The reduction of profit occurs when the original sale that triggered the points took place. However, since points are redeemed as part of a new sale transaction, there is a reduction of profit for the new points issued.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-9 (1)

(a) Estimable. The amount and timing with respect to brake replacement is uncertain. The existence of the liability to replace the brakes is certain and the amount can be reasonably estimated. The liability should be recorded in the financial statements. (b)

(2)

Not required.

(a) Estimable. The amount and timing with respect to “money back, no questions asked” guarantee is uncertain. The existence of the money back guarantee is certain. (b)

Not required.

(3)

Same as (2) above.

(4)

(a) Determinable. The timing with respect to the prizes to be distributed is uncertain. The existence of the liability and the cost of the trip are certain. The liability should be recorded in the financial statements. (b)

(5)

Not required.

(a) Contingent Liability under both IFRS and ASPE. The contingent liability is neither likely nor unlikely and the amount cannot be reasonably estimated. (b) Under both IFRS and ASPE, the contingent liability would be disclosed in the notes to the financial statements because the outcome and the amount are both unknown.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-10 (a)

The company should record an estimate of the cost of replacing the cribs in its financial statements. This liability is probable and can be reasonably estimated. The company also has a contingent liability with respect to the lawsuit. If the probability of loss of the lawsuit is remote, the company does not have to report or disclose anything else. If it is either possible (and the loss cannot be estimated) or if it cannot be determined if the lawsuit will be successful, the lawsuit should be disclosed in the notes as a contingent liability. If it is probable the lawsuit will be successful and the $1,500,000 is a reasonable estimate, it should be accrued as an estimated liability.

(b)

If Sleep-a-Bye Baby Company’s lawyers advise that it is likely that the company will have to pay damages of $100,000 then a journal entry should be recorded. The liability is likely and the amount can be reasonably estimated. The journal entry would be as follows: Loss due to Damages .................................... 100,000 Liability for Damages Due to Unsafe Cribs

(c)

100,000

If Sleep-a-Bye Baby Company is a private company, the answer to part (a) will be changed to assess the likelihood of loss from the lawsuit as “likely” rather than “probable”. If the likelihood of loss of the lawsuit is remote, the company does not have to report or disclose anything else. If it is either “likely” (and the loss cannot be estimated) or if it cannot be determined if the lawsuit will be successful, the lawsuit should be disclosed in the notes as a contingent liability. If it is “likely” the lawsuit will be successful and the $1,500,000 is a reasonable estimate, it should be recorded. Part (b) stays the same, since the higher threshold of “likely” was applied.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-11 (a) Apr. 30 Salaries Expense .................................. 45,500 CPP Payable................................... EI Payable....................................... Income Tax Payable....................... Cash................................................ (b) Apr. 30 Employee Benefits Expense .................. 5,549 CPP Payable................................... EI Payable ($833 × 1.4) .................. Workers’ Compensation Payable ($45,500 × 1%).......................... Vacation Pay Payable ($45,500 × 4%) (c) May 15 CPP Payable ($2,108 + $2,108) .............. 4,216 EI Payable ($833 + $1,166) ..................... 1,999 Income Tax Payable ............................... 8,798 Cash...............................................

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2,108 833 8,798 33,761

2,108 1,166 455 1,820

15,013

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-12 (a)

AHMAD COMPANY Payroll Register Week Ending May 31 Gross Earnings

Total Employee Hours Regular Overtime A. Kassam H. Faas G. Labute Totals

47 45 46

$ 520.00 560.00 600.00 $1,680.00

Gross Pay

$136.50 $ 656.50 665.00 105.00 135.00 735.00 $376.50 $2,056.50

Deductions CPP

Income Health Tax Insurance

$29.17 $12.01 $ 85.55 87.10 29.59 12.17 33.05 13.45 102.55 $91.81 $37.63 $275.20

Total

$10.00 $136.73 $ 519.77 521.14 15.00 143.86 15.00 164.05 570.95 $40.00 $444.64 $1,611.86

(b) May 31 Salaries Expense......................................................... 2,056.50 CPP Payable............................................................ EI Payable................................................................ Income Tax Payable ............................................... Health Insurance Payable ...................................... Salaries Payable .....................................................

91.81 37.63 275.20 40.00 1,611.86

31 Employee Benefits Expense....................................... CPP Payable ($91.81 × 1) ....................................... EI Payable ($37.63 × 1.4) ........................................ Workers’ Compensation Payable ($2,056.50 × 2%) Vacation Pay Payable ($2,056.50 × 4%) ................. Health Insurance Payable ......................................

91.81 52.69 41.13 82.26 40.00

10-34

Net Pay

307.89

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Accounting Principles, Sixth Canadian Edition

EXERCISE 10-13 Date Issued

Rate

Term

Current Portion

$60,000 3/31/14 $30,000 7/1/14 $120,000 9/1/14

6% 4% 5%

6 yrs. 7 mo. 30 mo.

$10,000 $30,000 $48,000

Principal 1. 2. 3.

NonCurrent Portion $50,000 $0 $60,000

Interest Payable $2,700 $600 $450

Current Portion: Note 1: One payment of $10,000 will be made in the coming year. Note 3: $48,000 = 12 monthly payments × $4,000 Non-Current Portion: Note 1: $50,000 = $60,000 – $10,000 Note 3: $60,000 = $120,000 – (3 payments in 2014 × $4,000) – $48,000 Interest Payable: Note 1: $2,700 = $60,000 × 6% × 9/12 Note 2: $600 = $30,000 × 4% × 6/12 Note 3: $450 = [$120,000 – (3 payments in 2014 × $4,000)] × 5% × 1/12

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EXERCISE 10-14 (a) LIGHTHOUSE DISTRIBUTORS (Partial) Balance Sheet September 30, 2014 Current liabilities Accounts payable ....................................................... $ 90,000 Bank indebtedness..................................................... 62,500 Income tax payable..................................................... 35,000 Unearned revenue ...................................................... 30,000 Warranty liability......................................................... 22,500 HST payable ................................................................ 15,000 Vacation pay payable ................................................. 13,500 Note payable—current portion .................................. 12,000 Mortgage payable—current portion .......................... 10,000 Interest payable .......................................................... 10,000 Property taxes payable............................................... 10,000 CPP payable ................................................................ 7,500 Redemption rewards liability..................................... 5,000 EI payable.................................................................... 3,750 Workers’ compensation payable ............................... 1,250 Total current liabilities........................................... $328,000 (b) Current ratio = ($182,000 + $275,000 + $12,500) ÷ $328,000 = 1.4:1 Acid-test ratio = $182,000 ÷ $328,000 = 0.6:1 (c)

The company has a negative cash balance in the form of bank indebtedness.

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*EXERCISE 10-15 (a)

Gross Pay = (40 hours × $22.60) + (4 hours × [$22.60 × 1.5]) = $904.00 + $135.60 = $1,039.60 Deductions (using Illustration 10A-3): CPP [$1,039.60 – ($3,500 ÷ 52) × 4.95%] EI ($1,039.60 × 1.83%) Federal income tax (claim code 1) Ontario income tax (claim code 1) Total deductions

$48.13 19.02 128.10 65.35 $260.60

(b) June 15 Salaries Expense .......................1,039.60 CPP Payable.......................... 48.13 EI Payable.............................. 19.02 Income Tax Payable ($128.10 + $65.35) 193.45 Cash....................................... 779.00 (c)

June 15 Employee Benefits Expense ......... 74.76 CPP Payable.......................... EI Payable ($19.02 × 1.4) ......

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*EXERCISE 10-16

Month

Gross Salary

Jan. – Aug. September October November December Totals

$38,000.00 4,750.00 4,750.00 4,750.00 4,750.00 $57,000.00

Cumulative Salary

CPP 4.95%

$38,000.00 $ 1,765.52 2 220.69 1 42,750.00 47,500.00 220.69 52,250.00 99.80 3 57,000.00 0 $2,306.70

EI 1.83% $695.40 5 86.93 4 57.64 6 0 0 $839.97

1. CPP = ($4,750 – [$3,500 ÷ 12]) × 4.95% = $220.69 2. CPP = $220.69/month × 8 months = $1,765.52 3. CPP = $99.80 (annual CPP maximum – CPP to end of October = maximum to be deducted in November [$2,306.70 – ($220.69 × 10) 4. EI = $4,750 × 1.83% = $86.93 5. EI = $86.93/month × 8 months = $695.40 6. EI = ($45,900 maximum insurable earnings – $42,750) × 1.83% = $57.65 (round to $57.64 so total EI equals annual maximum)

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 10-1A

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

Original Principal $ 35,000 $ 15,000 $ 26,000 $ 60,000 $ 100,000 $ 40,000

Date issued Rate Aug. 1/14 5.0% Sept. 1/14 4.0% Nov. 1/14 4.5% Mar. 31/14 3.5% Oct. 1/14 5.0% Jan. 31/13 5.0%

Term 10 months 4 months 6 months 5 years 6 years 4 years

$145.83 = $35,000 × 5.0% × 1/12 $200.00 = $15,000 × 4.0% × 4/12 $195.00 = $26,000 × 4.5% × 2/12 $1,575.00 = $60,000 × 3.5% × 9/12 $400.00 = $96,000 × 5.0% × 1/12 Interest was paid on December 31, 2014

(a)

(b)

(c)

Current Portion $ 35,000 $ 15,000 $ 26,000 $ 12,000 $ 24,000 $ 10,000

Noncurrent Portion $ $ $ $ 48,000 $ 72,000 $ 20,000

Interest Payable $ 145.83 $ 200.00 $ 195.00 $1,575.00 $ 400.00 $ -

8 9

1 2 3 4 5 6

current: $24,000 = $2,000 × 12 months non-current: $72,000 = $100,000 – $24,000

non-current: $20,000 = $40,000 – ($10,000 × 2)

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PROBLEM 10-1A (Continued) Taking It Further: For the maker, a note payable bears interest which is an additional cost. Some liabilities, such as accounts payable to suppliers are usually non-interest bearing as long as they are paid within the credit period. In addition, the term of the note may call for periodic payments of interest. This adds to the administrative burden of managing the note. The benefit to the maker is that the terms of the note are usually negotiated with the payee and the interest rate is more favourable than financing obtained through a bank. If the note is used to pay a supplier, the term of the note gives the maker additional time to repay the principal. For the payee, the note provides a stream of interest revenue. Because it is a signed document, it also provides additional security of collection. The cost to the payee is that cash is not received until the note reaches maturity.

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PROBLEM 10-2A (a)

Jan. 12 Merchandise Inventory ............. 20,000 Accounts Payable .................

20,000

31 Accounts Payable...................... 20,000 Notes Payable .......................

20,000

Feb. 28 Interest Expense ....................... ($20,000 × 5% × 1/12) Cash....................................... Mar. 31

83 83

Notes Payable............................ 14,000 Interest Payable......................... 490 Interest Expense ($14,000 × 7% × 3/12)................. 245 Cash.......................................

Mar. 31 Interest Expense ....................... ($20,000 × 5% × 1/12) Cash.......................................

83 83

Apr. 30 Notes Payable............................ 20,000 Interest Expense 83 ($20,000 × 5% × 1/12)................. Cash....................................... Aug.

14,735

20,083

1 Equipment.................................. 41,000 Cash....................................... Notes Payable .......................

11,000 30,000

Sept. 30 Cash ........................................... 100,000 Notes Payable .......................

100,000

Dec. 31

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Interest Expense ....................... ($100,000 × 5% × 3/12) Cash.......................................

10-41

1,250 1,250

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PROBLEM 10-2A (Continued) (a) (Continued) Dec. 31

Interest Expense ....................... ($30,000 × 6% × 5/12) Interest Payable ....................

750 750

(b) LEARNSTREAM COMPANY (Partial) Balance Sheet December 31, 2014

Current liabilities Notes payable ............................................................. Current portion of long-term notes payable ............. Interest payable .......................................................... Long-term liabilities Notes payable ............................................. $100,000 Less current portion .................................. (10,000)

$30,000 10,000 750 $40,750

$90,000

(c) LEARNSTREAM COMPANY (Partial) Income Statement Year Ended December 31, 2014 Other expense Interest expense .........................................................

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PROBLEM 10-2A (Continued) (b) (Continued) Date

Explanation

Dec. 31 Jan. 31 Mar. 31 Apr. 30 Aug. 1 Sep. 30

Notes Payable Ref. Debit

Credit Balance

 20,000 14,000 20,000 30,000 100,000

14,000 34,000 20,000 0 30,000 130,000

Interest Expense Date Explanation Ref. Debit Credit Balance Feb. 28 83 83 Mar. 31 245 328 Mar. 31 83 411 Apr. 30 83 494 Dec. 31 1,250 1,744 Dec. 31 750 2,494 Taking It Further: Notes payable are classified according to their maturity dates as being either current or non-current. This classification is also extended to the portion of long-term debt that is repayable in the current term. This classification is important because it represents amounts that must be settled within the next year and is an important factor in assessing the company’s liquidity.

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PROBLEM 10-3A (a) Jan. 2 Cash................................................ 50,000 Notes Payable...........................

50,000

5 Cash................................................ Sales ......................................... HST Payable ($8,800 × 13%) ....

9,944 8,800 1,144

Cost of Goods Sold ....................... Merchandise Inventory ............

4,600 4,600

12 Unearned Revenue ........................ 8,500 Service Revenue ($8,500 ÷ 1.13) HST Payable ($7,522 × 13%) ....

7,522 978

14 HST Payable ................................... Cash ..........................................

9,230 9,230

1,580 730 3,367

CPP Payable................................... EI Payable....................................... Income Tax Payable....................... Cash ..........................................

5,677

17 Accounts Payable .......................... 15,000 Cash ..........................................

15,000

20 Accounts Receivable ..................... 31,075 Sales (500 × $55) ...................... HST Payable ($27,500 × 13%) ..

27,500 3,575

Cost of Goods Sold (500 × $25) .... 12,500 Merchandise Inventory ............

12,500

29 Redemption Rewards Liability...... 2,300 HST Payable ($2,300 × 13/113) Service Revenue ($2,300 − $265)

265 2,035

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PROBLEM 10-3A (Continued) (a) (Continued) Jan. 30 Sales Discount for Redemption Rewards Issued (30,000 × $1 × 20%) 6,000 Redemption Rewards Liability

6,000

31 Salaries Expense ............................. 17,500 CPP Payable ............................. EI Payable ................................. Income Tax Payable ................. Salaries Payable.......................

809 320 3,544 12,827

31 Salaries Payable .............................. 12,827 Cash ..........................................

12,827

(b) (1) Jan. 31 Interest Expense ............................ Interest Payable........................ ($50,000 × 7% × 1/12) (2) Jan. 31 Warranty Expense (500 × 9% × $10) ............................. Warranty Liability ..................... (3) Jan. 31 Employee Benefits Expense ......... CPP Payable ............................. EI Payable ($320 × 1.4)............. Vacation Pay Payable .............. (4) Jan. 31 Property Tax Expense ($8,940 ÷ 12) ................................... Property Tax Payable ...............

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292 292

450 450 1,957 809 448 700

745 745

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PROBLEM 10-3A (Continued) (c) SHUMWAY SOFTWARE COMPANY (Partial) Balance Sheet January 31, 2014

Current liabilities Notes payable ............................................................. $ 50,000 Accounts payable ($37,900 – $15,000) ...................... 22,900 Unearned revenue ($15,000 – $8,500) ....................... 6,500 HST payable ($9,230 + $1,144 + $978 – $9,230 + $3,575 + $265) 5,962 Income tax payable ($3,367 – $3,367 + $3,544)......... 3,544 Redemption rewards liability ($4,500 – $2,300 + $6,000) 8,200 CPP payable ($1,580 – $1,580 + $809 + $809) ........... 1,618 EI payable ($730 – $730 + $320 + $448) ..................... 768 Vacation pay payable ($9,035 + $700) ....................... 9,735 Property tax payable................................................... 745 Warranty liability......................................................... 450 Interest payable ........................................................... 292 Total current liabilities ............................................. $110,714

Taking It Further: Most companies require employees to take their vacation as soon as possible after it is earned, usually after a year of work when the full annual entitlement is earned. This prevents the accumulation of vacation pay liability for the company, and ensures staff is rotated and cross-trained for other functions. Ensuring staff take vacation on a regular basis also results in stronger internal controls and reduces the likelihood of fraud and theft by ensuring one staff member’s work is performed by another staff member. When employees take their vacation, the Vacation Pay Payable account is debited. The credit side of the entry is the same as for regular payroll: CPP Payable, EI Payable, Income Taxes Payable and Salaries payable are credited. Solutions Manual .

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PROBLEM 10-4A (a)

Warranty expense 2012 – (1,500 × 5% × $30) = $2,250 2013 – (1,700 × 5% × $30) = $2,550 2014 – (1,800 × 5% × $30) = $2,700 Warranty liability at year end 2012 – ($0 – $2,250 + $2,250) = $0 2013 – ($0 – $2,400 + $2,550) = $150 2014 – ($150 – $2,640 + $2,700) = $210

Note: See analysis of warranty liability account in (b) below. (b) 2012

2013

2014

Warranty Liability.................................. Repair Parts Inventory .....................

2,250

Warranty Expense (1,500 × 5% × $30) . Warranty Liability .............................

2,250

Warranty Liability.................................. Repair Parts Inventory .....................

2,400

Warranty Expense (1,700 × 5% × $30) . Warranty Liability .............................

2,550

Warranty Liability.................................. Repair Parts Inventory .....................

2,640

Warranty Expense (1,800 × 5% × $30) . Warranty Liability .............................

2,700

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2,250

2,400

2,550

2,640

2,700

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PROBLEM 10-4A (Continued) (b) (Continued)

Date 2012 During Dec. 31 2013 During Dec. 31 2014 During Dec. 31 (c)

Warranty Liability Explanation Ref. Debit

Credit Balance

2,250

2,250 Dr 2,250 0

2,400

2,400 Dr 2,550 150

2,640

2,490 Dr 2,700 210

Percentage of units returned for repair = Number of units returned ÷ Number of units sold Returned 2012 75 2013 90 2014 105 270

Sold 1,500 1,700 1,800 5,000

Percentage returned = 270 ÷ 5,000 = 5.4% Average actual warranty cost per unit = Total actual warranty costs ÷ Total units returned Actual costs 2012 $2,250 2013 2,400 2014 2,640 $7,290 Average warranty cost over the three-year period: $7,290 ÷ 270 = $27

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PROBLEM 10-4A (Continued) Taking It Further: Revisions of estimates are applied prospectively. This means that the changes in estimates will be applied to 2014 only. The January 1, 2014 opening balance in the Warranty Liability account remains at $150. The revised warranty expense for 2014 is calculated as follows: Warranty expense 2014: 1,800 × 7% × $27 = $3,402 Warranty liability at December 31, 2014: $150 – $2,640 + $3,402 = $912

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PROBLEM 10-5A (a)

1. Reduces revenues and profit* 2. No effect on revenues, expenses and profit 3. No effect on revenues, expenses and profit 4. Increases revenues, expenses (cost of good sold) and profit *Instructors note: coupons are issued under the assumption that sales revenues and therefore profits will rise in the future. But the act of issuing the coupon will reduce both net revenues and profits as it creates an obligation.

(b) 2013: 1 Sales Discount for Redemption Rewards Issued (3,500,000 × $0.035) 122,500 Redemption Rewards Liability..... 122,500 2

Cash ....................................................... 1,755,000 Redemption Rewards Liability ............ 45,000 Sales .............................................. 1,800,000 2014: 3 Sales Discount for Redemption Rewards Issued (4,250,000 × $0.035) 148,750 Redemption Rewards Liability..... 148,750 4

Cash ....................................................... 2,177,500 Redemption Rewards Liability ............ 52,500 Sales .............................................. 2,230,000

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

75,000

Unearned Revenue .............................. Sales ..............................................

45,400

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75,000

45,400

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Accounting Principles, Sixth Canadian Edition

PROBLEM 10-5A (Continued) (c) Date 2013 During Dec. 31 2014 During Dec. 31

Date 2014 During Dec. 31

Redemption Rewards Liability Explanation Ref. Debit Credit Balance 122,500

122,500 77,500

148,750 52,500

226,250 173,750

Unearned Revenue Explanation Ref. Debit

Credit Balance

45,000

75,000 45,400

75,000 29,600

Taking It Further: Management should consider the following factors:  The historical rate of redemption on the grocery coupons. Some coupons will never be redeemed and management needs to determine over time, if some of the amounts allocated to the liability account can be recognized as revenues if the coupons become unlikely to be redeemed.  Factors to consider for the gift cards include long periods of inactivity by customers, or low residual balances. These factors increase the likelihood that the cards will not be used. Unearned revenue linked to gift cards that are unlikely to be used should be transferred to a revenue account.

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PROBLEM 10-6A 1.

Note disclosure: It does not appear that it is probable that the company will lose the lawsuit. If the possibility of loss is considered remote, Mega Company would not need to disclose the lawsuit.

Note disclosure: Since it is likely that the company will lose the lawsuit, but the amount of the liability cannot be reliably measured, the lawsuit should be disclosed.

Since it is now January 31, 2015, Mega can determine if the loan has been repaid by the supplier. If the loan has not been repaid, Mega should make an accrual in its December 31, 2014 financial statements since a probable present obligation exists and it is measurable. If the loan has been repaid, then no obligation or contingency exists and no note disclosure is required.

Accrue in the financial statements: Because Mega has negotiated a settlement, it now has a liability and the amount is measurable.

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PROBLEM 10-6A (Continued) Taking It Further: Making an accrual for a contingency reflects the impact of the loss on the current year’s profit. If the contingency is only reflected in the notes and not accrued, its impact on the financial results is not as readily visible. Thus a benefit of recording the accrual is that it allows users of financial statements to make better informed decisions. Also, by reflecting the amounts in the financial statements, this improves the ability of users to generate meaningful ratios. The cost of accruing a contingency is that companies must be very careful in wording the information in order to avoid the appearance of admitting culpability in matters that are not fully resolved. In addition, until the loss and liability are probable and measurable, the company risks damaging its ability to attract investors or obtain credit by portraying weaker financial results if the loss and liability are not realized in a later period.

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PROBLEM 10-7A (a) SURE VALUE HARDWARE Payroll Register Week Ending March 14, 2011 Gross Earnings

Employee Hours Regular I. Dahl F. Gualtieri G. Ho A. Israeli Totals

37.5 42 44 46

Overtime

637.50 0 640.00 48.00 620.00 93.00 620.00 139.50 2,517.50 280.50

Gross Pay

Deductions

CPP

637.50 29.22 11.67 688.00 30.72 12.59 713.00 31.96 13.05 759.50 34.26 13.90 2,798.00 126.16 51.21

10-54

Income United Tax Way 82.25 91.20 97.50 107.75 378.70

7.50 8.00 5.00 10.00 30.50

Total

Net Pay

130.64 506.86 142.51 545.49 147.51 565.49 165.91 593.59 586.57 2,211.43

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PROBLEM 10-7A (Continued) (b) Mar.14

Salaries Expense ......................... 2,798.00 CPP Payable ......................... 126.16 EI Payable ............................. 51.21 Income Tax Payable............. 378.70 United Way Contributions Payable 30.50 Salaries Payable................... 2,211.43

14 Employee Benefits Expense ..... 309.77 CPP Payable ($126.16 × 1)... EI Payable ($51.21 × 1.4)...... Vacation Pay Liability .......... Vacation pay liability = $2,798.00 × 4% (c) Mar.14

Salaries Payable .......................... 2,211.43 Cash ...................................... 2,211.43

(d) Apr. 15 CPP Payable ($126.16 + $126.16) .................... EI Payable ($51.21 + $71.69) ..... Income Tax Payable .................. Cash ......................................

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126.16 71.69 111.92

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252.32 122.90 378.70 753.92

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PROBLEM 10-7A (Continued) Taking It Further: The owner of a proprietorship is not considered an employee for income tax purposes. Since the business is not a separate legal entity, the owner is considered to own all of the profit of the business and is taxed on his/her personal income tax return for the profit of the business and not on the drawings. Income tax payments are usually made through the payment of instalments rather than through monthly remittances with the employees’ payroll. A proprietor is not required, nor able, to pay EI on business profit for purposes of collecting employment insurance if he or she is not working. However, a proprietor can choose to pay EI for special benefits such as sickness or maternity benefits. Business profit is considered pensionable earnings for CPP and the owner must make CPP remittances on the business profit. This is accomplished through the owner’s personal income tax return and is not calculated or remitted as part of the payroll function.

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PROBLEM 10-8A (a) Feb. 4

Union Dues Payable ........................... Cash................................................

1,450

Disability Insurance Payable ............. Life Insurance Payable ...................... Cash................................................

1,280 855

1,450

2,135

CPP Payable ....................................... 7,887 EI Payable ........................................... 3,755 Income Tax Payable ........................... 16,252 Cash................................................

20 Workers’ Compensation Payable ...... Cash................................................

27,894

4,275 4,275

28 Salaries Expense................................ 92,600 CPP Payable................................... EI Payable....................................... Income Tax Payable ...................... Union Dues Payable ...................... Disability Insurance Payable......... Salaries Payable ............................

4,281 1,695 17,595 1,574 1,380 66,075

28 Salaries Payable ................................. 66,075 Cash................................................

66,075

28 Employee Benefits Expense.............. 15,914 CPP Payable................................... EI Payable ($1,695 × 1.4) ............... Workers’ Compensation Payable ($92,600 × 5%) ................................ Vacation Pay Payable ($92,600 × 4%) Life Insurance Payable ($92,600 × 1%)

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4,281 2,373 4,630 3,704 926

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PROBLEM 10-8A (Continued) (b)

Date Feb. 1 15 28 28

Date Feb. 1 15 28

Date Feb. 1 20 28

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Canada Pension Plan Payable Explanation Ref. Debit Credit Balance Balance

 7,887 4,281 4,281

7,887 0 4,281 8,562

Employment Insurance Payable Explanation Ref. Debit Credit Balance Balance

 3,755 1,695 2,373

Income Tax Payable Explanation Ref. Debit Balance

3,755 0 1,695 4,068

Credit Balance

 16,252 17,595

16,252 0 17,595

Workers’ Compensation Payable Explanation Ref. Debit Credit Balance Balance

 4,275 4,630

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4,275 0 4,630

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PROBLEM 10-8A (Continued) (b) (Continued)

Date Feb. 1 14 28

Date Feb. 1 7 28

Date Feb. 1 28

Date Feb. 1 7 28

Date Feb. 28 28

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Union Dues Payable Explanation Ref. Debit Balance

Credit Balance

 1,450 1,574

Life Insurance Payable Explanation Ref. Debit Balance

Credit Balance

 855 926

Vacation Pay Payable Explanation Ref. Debit Balance

1,450 0 1,574

855 0 926

Credit Balance

 3,704

20,520 24,224

Disability Insurance Payable Explanation Ref. Debit Credit Balance Balance

 1,280 1,380

Salaries Payable Explanation Ref. Debit 

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Credit Balance 66,075

66,075

1,280 0 1,380

66,075 0

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PROBLEM 10-8A (Continued) Taking It Further: The employee earning record is required to determine the employee’s total earnings for the year and total deductions. This document is used to prepare the annual T4 slip that is required for the employee’s income tax filing requirement. This information is also filed with CRA by the employer. The employee earning record also helps the employer determine when the employee has reached maximum pensionable and insurable earnings for CPP and EI purposes. The earning record is also used for other requirements such as the statement of earnings for EI benefits. The payroll register contains the current pay information for all employees for a particular pay period. It allows the company to accumulate gross pay, CPP, EI, Income tax and other amounts withheld from the employees’ pay. The summary information can then be used to prepare the journal entry and paycheques for each employee.

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PROBLEM 10-9A (a) MAPLE LEAF FOODS INC. (Partial) Balance Sheet December 31, 2011 (in thousands)

Current liabilities Accounts payable and accruals................................... $482,059 Bank indebtedness................................................... 36,404 Current portion of long-term debt ........................... 5,618 Other current liabilities ............................................ 20,409 Provisions ..................................................................... 44,255 Total current liabilities ............................................. $588,745 (b) Current ratio: $643,022 ÷ $588,745 = 1.09:1 Current assets = $133,504 + $49,265 + $43,789 + $293,231 + $98,545 + $24,688 = $643,022 Acid-test ratio: ($133,504 + $43,789 + $98,545) ÷ $588,745 = 0.47:1 (c)

Current ratio Dec. 31, 2010: $583,557 ÷ $1,091,960 = 0.53:1 Acid-test ratio Dec. 31, 2010: $217,751 ÷ $1,091,960 = 0.20:1 Both the current and acid-test ratios improved during 2011.

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PROBLEM 10-9A (Continued) Taking It Further: In assessing liquidity, we should also look at the receivables and inventory turnover ratios to ensure that the current assets are liquid. A slow-down in the turnover ratios of receivables and inventory would trigger an increase in current assets and in the current ratio, but would signal a decrease in the liquidity of receivables and inventory. We should also look at the difference between the acid-test ratio and the current ratio. The acid-test ratio uses only the liquid current assets (those that can be converted to cash readily). A significant difference between the current ratio and the acid-test ratio may indicate that the company has less short-term liquidity. In the case of Maple Leaf Foods Inc. the acid-test ratio is less than half of the current ratio indicating that the company has a high proportion of less liquid current assets. Other factors to consider include general economic and industry conditions, as well as comparisons with ratios from other companies in the same or related industries.

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*PROBLEM 10-10A (a) WESTERN ELECTRIC COMPANY Payroll Register Week Ending June 5, 2012

Employee C. Tam T. Ng O. Stavtech A. Mandell Totals

Gross Pay 945.00 1,130.00 1,130.00 1,067.00 4,272.00

CPP 43.45 52.60 52.60 49.48 198.13

1 2 2 3

Deductions Federal Ontario Total EI Income Tax Income Tax Deductions 4 103.70 54.40 218.84 17.29 5 131.65 66.70 271.63 20.68 5 146.55 71.60 291.43 20.68 6 133.35 66.10 268.46 19.53 78.18 515.25 258.80 1,050.36

1. CPP = ($945.00 – [$3,500 ÷ 52]) × 4.95% = $43.45 2. CPP = ($1,130.00 – [$3,500 ÷ 52]) × 4.95% = $52.60 3. CPP = ($1,067.00 – [$3,500 ÷ 52]) × 4.95% = $49.48 4. EI = $945.00 × 1.83% = $17.29 5. EI = $1,130.00 × 1.83% = $20.68 6. EI = $1,067.00 × 1.83% = $19.53

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Net Pay 726.16 858.37 838.57 798.54 3,221.64

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*PROBLEM 10-10A (Continued) (b) Semi-monthly Payroll Ending June 15, 2012:

Employee

Gross Salary

Gross Pay

CPP 4.95%

EI 1.83%

S. Goodspeed M. Giancarlo H. Radley

$43,440 64,770 76,880

$1,810.00 2,698.75 3,203.33

$ 82.38 1 126.37 2 151.35 3

$33.12 4 49.39 5 58.62 6

1. CPP = ($1,810.00 – [$3,500 ÷ 24]) × 4.95% = $82.38 2. CPP = ($2,698.75 – [$3,500 ÷ 24]) × 4.95% = $126.37 3. CPP = ($3,203.33 – [$3,500 ÷ 24]) × 4.95% = $151.35 4. EI = $1,810.00 × 1.83% = $33.12 5. EI = $2,698.75 × 1.83% = $49.39 6. EI = $3,203.33 × 1.83% = $58.62 (c) Pay period in which CPP maximum is reached = Maximum annual employee CPP contribution ÷ semi-monthly contribution for the employee (the answer is rounded up since the maximum is reached in the next pay period). Pay period in which EI maximum is reached = Maximum annual employee EI premium ÷ semi-monthly premium for the employee (the answer is rounded up since the maximum is reached in the next pay period). S. Goodspeed: His annual salary is less than the maximum pensionable earnings and the maximum insurance earnings. He will not reach the maximum CPP and EI payments for 2012. M. Giancarlo: Pay period in which CPP maximum is reached = $2,306.70 ÷ $126.37 = 18.25; rounded up to pay period 19 (October 15).

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*PROBLEM 10-10A (Continued) (c) (Continued) Pay period in which EI maximum is reached = $839.97 ÷ $49.39 = 17.01; rounded up to pay period 18 (September 30). H. Radley: Pay period in which CPP maximum is reached = $2,306.70 ÷ $151.35 = 15.24; rounded up to pay period 16 (August 31). Pay period in which EI maximum is reached = $839.97 ÷ $58.62 = 14.33; rounded up to pay period 15 (August 15). Taking It Further: The payroll tables are prepared for various pay periods used by different companies, or for different groups of employees of the same company. The amounts of CPP, EI and income tax to be deducted are all dependent upon the length of the pay period, thus different tables are required.

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PROBLEM 10-1B

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

Principal $ 25,000 $ 10,000 $ 40,000 $ 80,000 $ 126,000 $ 50,000

Date issued July 1/14 Sept. 1/14 Nov. 1/14 May 31/14 Oct. 1/14 Mar. 31/13

Rate 5.00% 4.00% 4.50% 3.75% 4.25% 5.00%

Term 9 months 6 months 7 months 5 years 3 years 4 years

(a)

(b)

(c)

Current Portion $ 25,000 $ 10,000 $ 40,000 $ 16,000 $ 42,000 $ 12,500

Noncurrent Portion $ $ $ $ 64,000 $ 77,000 $ 25,000

Interest Payable $ 104.17 $ 133.33 $ 300.00 $1,750.00 $ 421.46 $ -

8 9

1 2 3 4 5 6

7 $104.17 = $25,000 × 5.0% × 1/12 current: $42,000 = $3,500 × 12 months 8 $133.33 = $10,000 × 4.0% × 4/12 non-current: $77,000 = $126,000 – ($3,500 × 2) $300.00 = $40,000 × 4.5% × 2/12 – $42,000 9 $1,750.00 = $80,000 × 3.75% × 7/12 non-current: $25,000 = $50,000 – ($12,500 × 2) $421.46 = ($126,000 – [2 × $3,500]) × 4.25% × 1/12 Interest was paid on December 31, 2014

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PROBLEM 10-1B (Continued) Taking It Further: For the maker, a note payable bears interest, which is an additional cost. Some liabilities, such as accounts payable to suppliers, are usually non-interest bearing as long as they are paid within the credit period. In addition, the term of the note may call for periodic payments of interest. This adds to the administrative burden of managing the note. The benefit to the maker is that the terms of the note are usually negotiated with the payee and the interest rate is more favourable than financing obtained through a bank. If the note is used to pay a supplier, the term of the note gives the maker additional time to repay the principal. For the payee, the note provides a stream of interest revenue. Because it is a signed document, it also provides additional security of collection. The cost to the payee is that cash is not received until the note reaches maturity.

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PROBLEM 10-2B (a)

2013: Dec. 1 Interest Expense ($15,000 × 6% × 1/12)................. 75 Interest Payable......................... 375 Note Payable.............................. 15,000 Cash....................................... 2014: Apr. 1 Land ........................................... 75,000 Notes Payable ....................... Apr. 30 Equipment.................................. Accounts Payable .................

8,000

May 31 Accounts Payable...................... Notes Payable .......................

8,000

July

1,313

1 Interest Expense ....................... ($75,000 × 7% × 3/12) Cash.......................................

Aug. 31 Interest Expense ($8,000 × 8% × 3/12)................... Note Payable.............................. Cash....................................... Oct.

Oct.

1 Interest Expense ($75,000 × 7% × 3/12)................ Cash....................................... 1 31

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15,450

75,000 8,000 8,000

1,313 160 8,000 8,160

1,313 1,313

Cash ........................................... 90,000 Notes Payable .......................

90,000

Interest Expense ....................... 888 [($90,000 × 6% × 1/12) + ($1,313 × ⅓)] Interest Payable ....................

888

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PROBLM 10-2B (Continued) (b) MILEHI MOUNTAIN BIKES (Partial) Balance Sheet October 31, 2014 Current liabilities Notes payable ............................................................. Current portion of long-term notes payable ............. Interest payable .......................................................... Total current liabilities...........................................

$75,000 18,000 888 $93,888

Long-term liabilities Notes payable .......................................... Less current portion ................................

$72,000

$90,000 (18,000 )

(c) MILEHI MOUNTAIN BIKES (Partial) Income Statement Year ended October 31, 2014 Other expenses Interest expense .........................................................

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PROBLM 10-2B (Continued) (c) (Continued)

Date Dec. 1 July 31 Aug. 31 Oct. 1 Oct. 31

Date

Interest Expense Explanation Ref. Debit Credit Balance 75 75 1,313 1,388 160 1,548 1,313 2,861 888 3,749

Explanation

Nov. 1 Dec. 1 Apr. 1 May 31 Aug. 31 Oct. 1

Notes Payable Ref. Debit

Credit Balance

 15,000 75,000 8,000 8,000 90,000

15,000 0 75,000 83,000 75,000 165,000

Taking It Further: Notes payable are classified according to their maturity dates as being either current or non-current. This classification is also extended to the current maturity of the portion of long-term debt that is repayable in the current term. This classification is important because it shows the amount that must be settled within one year, which is an important factor in evaluating the company’s liquidity.

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PROBLEM 10-3B (a) Jan. 5 Cash................................................. 17,854 Sales ....................................... HST Payable ($15,800 × 13%) .

15,800 2,054

12 Unearned Revenue ........................... 7,000 HST Payable ($6,195 × 13%) ... Service Revenue ($7,000 ÷ 1.13)

805 6,195

14 HST Payable .................................. 11,390 Cash .........................................

11,390

CPP Payable.................................. EI Payable...................................... Income Tax Payable ..................... Cash .........................................

2,152 1,019 4,563 7,734

16 Cash............................................... 18,000 Notes Payable ......................... 17

18,000

Accounts Payable ......................... 35,000 Cash .........................................

35,000

20 Accounts Receivable.................... 33,900 Sales (500 × $60) ..................... HST Payable ($30,000 × 13%) .

30,000 3,900

30 Redemption Rewards Liability..... 1,750 HST Payable ($1,549 × 13%) ... Service Revenue ($1,750 ÷ 1.13)

201 1,549

31 Sales Discount for Redemptions Reward Issued .............................. Redemption Rewards Liability (50,000 × 10% × $1)

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PROBLEM 10-3B (Continued) (a) (Continued) Jan. 31 Warranty Liability ...................... Repair Parts Inventory .........

875 875

31 Salaries Expense....................... 25,350 CPP Payable.......................... EI Payable.............................. Income Tax Payable ............. Salaries Payable ................... 31

Salaries Payable ........................ 19,140 Cash.......................................

(b) Jan. 31 Interest Expense ....................... Interest Payable .................... [($18,000 × 6% × 1/12) × 1/2]

31 Warranty Expense ..................... Warranty Liability.................. (500 × 6% × $10)

300

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19,140

Employee Benefits Expense..... 2,847 CPP Payable.......................... EI Payable ($464 × 1.4) ......... Vacation Pay Payable ($25,350 × 4%)

10-72

1,183 464 4,563 19,140

300

1,183 650 1,014

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PROBLEM 10-3B (Continued) (c) ZAUR COMPANY (Partial) Balance Sheet January 31, 2014 Liabilities Current liabilities Accounts payable ($63,700 – $35,000) ...................... Notes payable ............................................................. Vacation pay liability ($9,120 + $1,014) ..................... Unearned revenue ($16,000 – $7,000) ....................... HST payable ($11,390 + $2,054 + $805 – $11,390 + $3,900 + $201)...................................................... Redemption rewards liability ($2,150 – $1,750 + $5,000).................................................................. Warranty liability ($5,750 – $875 + $300) ................... Income taxes payable ($4,563 – $4,563 + $4,563) ..... CPP payable ($2,152 – $2,152 + $1,183 + $1,183) ..... EI payable ($1,019 – $1,019 + $464 + $650) ............... Interest payable .......................................................... Total current liabilities...........................................

$28,700 18,000 10,134 9,000 6,960 5,400 5,175 4,563 2,366 1,114 45 $91,457

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PROBLEM 10-4B (a)

Warranty expense 2012 – (1,200 × 5% × $25) = $1,500 2013 – (1,320 × 5% × $25) = $1,650 2014 – (1,420 × 5% × $25) = $1,775 Warranty liability at year end 2012 – ($0 – $1,275 + $1,500) = $225 2013 – ($225 – $1,600 + $1,650) = $275 2014 – ($275 – $1,960 + $1,775) = $90

Note: See analysis of warranty liability account in (b) below. (b) 2012 Warranty Liability ................................ Repair Parts Inventory...................

1,275

Dec. 31 Warranty Expense (1,200 × 5% × $25) Warranty Liability...........................

1,500

1,275

1,500

2013 Warranty Liability ................................ Repair Parts Inventory...................

1,600

Dec. 31 Warranty Expense (1,320 × 5% × $25) Warranty Liability...........................

1,650

1,600

1,650

2014 Warranty Liability ................................ Repair Parts Inventory...................

1,960

Dec. 31 Warranty Expense (1,420 × 5% × $25) Warranty Liability...........................

1,775

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PROBLEM 10-4B (Continued) (b) (Continued)

Date 2012 During Dec. 31 2013 During Dec. 31 2014 During Dec. 31 (c)

Warranty Liability Explanation Ref. Debit

Credit

Balance

1,275 1,500

1,275 Dr 225

1,650

1,375 Dr 275

1,775

1,685 Dr 90

1,600

1,960

Percentage of units returned for repair = Number of units returned ÷ Number of units sold Returned 2012 60 2013 70 2014 80 210

Sold 1,200 1,320 1,420 3,940

Percentage returned = 210 ÷ 3,940 = 5.3% Average actual warranty cost per unit = Total actual warranty costs ÷ Total units returned

2012 2013 2014

Actual costs $1,275 1,600 1,960 $4,835

Average warranty cost over the three-year period: $4,835 ÷ 210 = $23

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PROBLEM 10-4B (Continued) Taking It Further: Revisions of estimates are applied prospectively. This means that the changes in estimates will be applied to 2014 only. The January 1, 2014 opening balance in the Warranty Liability account remains at $275. The revised warranty expense for 2014 is calculated as follows: Warranty expense 2014: 1,420 × 7% × $25 = $2,485 Warranty liability at December 31, 2014: $275 – $1,960 + $2,485 = $800

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PROBLEM 10-5B (a)

1. Reduces revenues and profit* 2. No effect on revenues, expenses and profit 3. No effect on revenues, expenses and profit 4. Increases revenues, expenses (cost of goods sold) and profit *Instructors note: coupons are issued under the assumption that sales revenues and therefore profits will rise in the future. But the act of issuing the coupon will reduce both net revenues and profits as it creates an obligation.

(b) 2013: 1 Sales Discount for Redemption Rewards Issued (750,000 × $0.025). Redemption Rewards Liability..... 2

18,750 18,750

Cash...................................................... Redemption Rewards Liability ............ Service Revenue ........................... 2014: 3 Sales Discount for Redemption Rewards Issued (810,000 × $0.025). Redemption Rewards Liability.....

17,850 5,950

Cash...................................................... Redemption Rewards Liability ............ Sales ..............................................

20,730 9,500

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

3,950

Unearned Revenue .............................. Sales ..............................................

1,500

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23,800

20,250 20,250

30,230

3,950

1,500

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PROBLEM 10-5B (Continued) (c) Date 2013 During Dec. 31 2014 During Dec. 31

Date 2014 During Dec. 31

Redemption Rewards Liability Explanation Ref. Debit Credit Balance 18,750

18,750 12,800

20,250 9,500

33,050 23,550

Unearned Revenue Explanation Ref. Debit

Credit Balance

5,950

3,950 1,500

3,950 2,450

Taking It Further: Management should consider the following factors:  The historical rate of redemption on the service coupons. Some coupons will never be redeemed and management needs to determine over time, if some of the amounts allocated to the liability account can be recognized as revenues if the coupons become unlikely to be redeemed.  The likelihood of redemption of the gift cards. Factors such as long periods of inactivity by customers, or low residual balances increase the likelihood that the cards will not be used. Unearned revenue linked to gift cards that are unlikely to be used should be transferred to a revenue account.

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PROBLEM 10-6B 1.

Note disclosure: It does not appear that it is likely that the company will have an obligation for its customer’s bank loan.

Note disclosure: Since the amount of the liability cannot be reliably measured, the lawsuit cannot be recorded, but it should be disclosed.

It appears that it is unlikely that Big Fork will lose the lawsuit; therefore the company does not need to record or report it in the notes to the financial statements. If the loss from the lawsuit could have a substantial negative effect on the company’s financial position, then note disclosure is still desirable.

Accrue in the financial statements: It appears likely that the company will lose this claim as it was at fault and the claim of $250,000 appears to be a reasonable estimate.

Taking It Further: Making an accrual for a contingency reflects the impact of the loss on the current year’s profit. This allows users of financial statements to make better informed decisions. If the contingency is only reflected in the notes and not accrued, its impact on the financial results is not as readily visible. Also, by reflecting the amounts in the financial statements, this improves the ability of users to generate meaningful ratios. The costs of accruing a contingency is that companies must be very careful in wording the information in order to avoid the appearance of admitting culpability in matters that are not fully resolved. In addition, until the loss and liability are likely and measurable, the company risks damaging its ability to attract investors or obtain credit by portraying weaker financial results if the loss and liability are not realized in a later period.

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PROBLEM 10-7B (a) SCOOT SCOOTERS Payroll Register Week Ending February 17, 2012

Earnings

Deductions Gross Income United Employee Hours Regular Overtime EI Pay CPP Tax Way P. Kilchyk 40 610.00 0 610.00 26.86 11.16 76.60 5.00 B. Quon 42 600.00 45.00 645.00 28.60 11.80 83.70 7.25 C. Pospisil 40 650.00 0 650.00 28.84 11.90 84.00 5.50 B. Verwey 44 580.00 87.00 667.00 29.6812.21 87.10 8.25 Totals 2,440.00 132.00 2,572.00 113.98 47.07 331.40 26.00

10-80

Total Net Pay 119.62 490.38 131.35 513.65 130.24 519.76 137.24 529.76 518.45 2,053.55

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PROBLEM 10-7B (Continued) (b) Feb.15

Salaries Expense ......................... 2,572.00 CPP Payable.......................... 113.98 EI Payable.............................. 47.07 Income Tax Payable ............. 331.40 United Way Contributions Payable 26.00 Salaries Payable ................... 2,053.55

15 Employee Benefits Expense ........ 282.76 CPP Payable.......................... EI Payable ($47.07 × 1.4) ...... Vacation Pay Payable ........... ($2,572.00 × 4%) (c) Feb.17

Salaries Payable .......................... 2,053.55 Cash....................................... 2,053.55

(d) Mar.15 CPP Payable ($113.98 + $113.98). 227.96 EI Payable ($47.07 + $65.90) .......... 112.97 Income Tax Payable ....................... 331.40 Cash.......................................

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113.98 65.90 102.88

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PROBLEM 10-7B (Continued) Taking It Further: The owner of a proprietorship is not considered an employee for income tax purposes. Since the business is not a separate legal entity, the owner is considered to own all of the profit of the business and is taxed on his/her personal income tax return for the profit of the business and not on the drawings. Income tax payments are usually made through the payment of instalments rather than through monthly remittances with the employees’ payroll. Business profit is not considered insurable profit for EI purposes, so no EI is deducted from business profit or drawings. Business profit is considered pensionable profit for CPP and the owner must make CPP remittances on the business profit. This is accomplished through the owner’s personal income tax return and is not calculated or remitted as part of the payroll function.

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PROBLEM 10-8B (a) Apr. 4

Union Dues Payable ........................... Cash................................................

1,285

Disability Insurance Payable ............. Life Insurance Payable ...................... Cash................................................

1,134 756

1,285

1,890

CPP Payable ....................................... 6,907 EI Payable ........................................... 3,320 Income Tax Payable ........................... 14,364 Cash................................................

20 Workers’ Compensation Payable ...... Cash................................................

24,591

3,780 3,780

28 Salaries Expense................................ 83,160 CPP Payable................................... EI Payable....................................... Income Tax Payable ...................... Union Dues Payable ...................... Disability Insurance Payable......... Salaries Payable ............................

3,799 1,522 15,800 1,414 1,257 59,368

28 Salaries Payable ................................. 59,368 Cash................................................

59,368

28 Employee Benefits Expense.............. 14,246 CPP Payable................................... EI Payable ($1,522 × 1.4) ............... Workers’ Compensation Payable ($83,160 × 5%) ................................ Vacation Pay Payable ($83,160 × 4%) Life Insurance Payable ($83,160 × 1%)

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3,799 2,131 4,158 3,326 832

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PROBLEM 10-8B (Continued) (b)

Date Apr. 1 13 28 28

Date Apr. 1 13 28

Date Apr. 1 13 28 28

Date Apr. 1 20 28

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Canada Pension Plan Payable Explanation Ref. Debit Credit Balance Balance

 6,907 3,799 3,799

Income Tax Payable Explanation Ref. Debit Balance

6,907 0 3,799 7,598

Credit Balance

 14,364 15,800

14,364 0 15,800

Employment Insurance Payable Explanation Ref. Debit Credit Balance Balance

 3,320 1,522 2,131

3,320 0 1,522 3,653

Workers’ Compensation Payable Explanation Ref. Debit Credit Balance Balance

 3,780 4,158

10-84

3,780 0 4,158

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PROBLEM 10-8B (Continued) (b) (Continued)

Date Apr. 1 4 28

Date Apr. 1 7 28

Date Apr. 1 28

Date Apr. 1 7 28

Date Apr. 1 28 28

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Union Dues Payable Explanation Ref. Debit Balance

Credit Balance

 1,285 1,414

1,285 0 1,414

Disability Insurance Payable Explanation Ref. Debit Credit Balance Balance

 1,134 1,257

Vacation Pay Payable Explanation Ref. Debit Balance

Credit Balance

 3,326

Life Insurance Payable Explanation Ref. Debit Balance

756 832

Balance

59,368

10-85

756 0 832

Credit Balance

 59,368

3,024 6,350

Credit Balance



Salaries Payable Explanation Ref. Debit

1,134 0 1,257

0 59,368 0

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PROBLEM 10-8B (Continued) Taking It Further: The employee earning record is required to determine the employee’s total earnings and total deductions for the year. This document is used to prepare the annual T4 slip that is required for the employee’s income tax filing requirement. This information is also filed with CRA by the employer. The employee earning record also helps the employer determine when the employee has reached maximum pensionable and insurable earnings for CPP and EI purposes. The earning record is also used for other requirements such as the statement of earnings for EI benefits purposes. The payroll register contains the current pay information for all employees for a particular pay period. It allows the company to accumulate gross pay, CPP, EI, Income tax and other amounts withheld from the employees’ pay. The summary information can then be used to prepare the journal entry and paycheques for each employee.

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PROBLEM 10-9B (a) BCE INC. (Partial) Balance Sheet December 31, 2011

Current liabilities Trade payables and other liabilities ..................... Current tax liabilities ............................................. Dividends payable ................................................. Interest payable ..................................................... Debt due within one year ...................................... Total current liabilities...................................... (b)

$4,056 47 415 134 2,106 $6,758

Current ratio: $4,178 ÷ $6,758 = 0.62:1 Current assets: $130 + $45 + $427 + $152 + $262 + $3,162 = $4,178 Acid-test ratio: ($130 + $45 + $152 + $3,162) ÷ $6,758 = 0.52:1

(c)

Current ratio Dec. 31, 2010: $4,655 ÷ $6,954 = 0.67:1 Acid-test ratio Dec. 31, 2010: $3,795 ÷ $6,954 = 0.55:1 Both the current and acid-test ratios weakened during 2011.

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PROBLEM 10-9B (Continued) Taking It Further: In assessing liquidity, we should also look at the receivables and inventory turnover ratios to ensure that the current assets are liquid. A slow-down in the turnover ratios of receivables and inventory would trigger an increase in current assets and in the current ratio, but would signal a decrease in the liquidity of receivables and inventory. We should also look at the difference between the acid-test ratio and the current ratio. The acid-test ratio uses only the liquid current assets (those than be converted to cash readily). A significant difference between the current ratio and the acid-test ratio may indicate that the company has less short-term liquidity. In the case of BCE Inc. the acid-test and current ratios are relatively close, indicating that the company has a high proportion of liquid current assets. Other factors to consider include general economic and industry conditions, as well as comparisons with ratios from other companies in the same or related industries.

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*PROBLEM 10-10B (a) SLOVAK PLUMBING COMPANY Payroll Register Week Ending May 11, 2012

Employee D. Quinn K. Holub A. Lowhorn I. Kostra Totals

Gross Pay 985.00 1,037.00 1,080.00 950.00 4,052.00

CPP 45.43 1 48.00 2 50.13 3 43.69 4 187.25

Deductions Ontario Total Federal EI Income Tax Income Tax Deductions 115.35 59.00 237.81 18.03 5 6 119.15 60.40 246.53 18.98 7 136.00 67.20 273.09 19.76 8 93.45 50.45 204.98 17.39 74.16 463.95 237.05 962.41

1. CPP = ($985.00 – [$3,500 ÷ 52]) × 4.95% = $45.43 2. CPP = ($1,037.00 – [$3,500 ÷ 52]) × 4.95% = $48.00 3. CPP = ($1,080.00 – [$3,500 ÷ 52]) × 4.95% = $50.13 4. CPP = ($950.00 – [$3,500 ÷ 52]) × 4.95% = $43.69 5. EI = $985.00 × 1.83% = $18.03 6. EI = $1,037.00 × 1.83% = $18.98 7. EI = $1,080.00 × 1.83% = $19.76 8. EI = $950.00 × 1.83% = $17.39

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Net Pay 747.19 790.47 806.91 745.02 3089.59

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*PROBLEM 10-10B (Continued) (b) Semi-monthly Payroll Ending May 15, 2012:

Employee B. Dolina H. Koleno A. Krneta

Gross Salary

Gross Pay

CPP 4.95%

$80,700 62,500 44,120

$3,362.50 $159.23 1 2,604.17 121.69 2 1,838.33 83.78 3

EI 1.83% $61.53 4 47.66 5 33.64 6

1. CPP = ($3,362.50 – [$3,500 ÷ 24]) × 4.95% = $159.23 2. CPP = ($2,604.17 – [$3,500 ÷ 24]) × 4.95% = $121.69 3. CPP = ($1,838.33 – [$3,500 ÷ 24]) × 4.95% = $83.78 4. EI = $3,362.50 × 1.83% = $61.53 5. EI = $2,604.17 × 1.83% = $47.66 6. EI = $1,838.33 × 1.83% = $33.64 (c) Pay period in which CPP maximum is reached = Maximum annual employee CPP contribution ÷ semi-monthly contribution for the employee (the answer is rounded up since the maximum is reached in the next pay period). Pay period in which EI maximum is reached = Maximum annual employee EI premium ÷ semi-monthly premium for the employee (the answer is rounded up since the maximum is reached in the next pay period). B. Dolina: Pay period in which CPP maximum is reached = $2,306.70 ÷ $159.23 = 14.49; rounded up to pay period 15 (August 15th). Pay period in which EI maximum is reached = $839.97 ÷ $61.53 = 13.65; rounded up to pay period 14 (July 31st).

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*PROBLEM 10-10B (Continued) (c) (Continued) H. Koleno: Pay period in which CPP maximum is reached = $2,306.70 ÷ $121.69 = 18.96; rounded up to pay period 19 (October 15). Pay period in which EI maximum is reached = $839.97 ÷ $47.66 = 17.62; rounded up to pay period 18 (September 30). A. Krneta: Her annual salary is less than the maximum pensionable earnings and the maximum insurance earnings. She will not reach the maximum CPP and EI payments for 2012. Taking It Further: The payroll tables are prepared for various pay periods used by different companies, or for different groups of employees of the same company. The amounts deducted for CPP, EI, and income taxes depends on the length of the pay period, thus different tables are necessary.

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CONTINUING COOKIE CHRONICLE 1.

The cash from the sale of gift certificates must be recorded as unearned revenue. Unearned revenue represents cash payments received in advance of earning the revenue because the service or goods has not been provided to the customer. With a gift certificate, Natalie’s business owes a service of cookie-making lessons and supplies to the customers who have prepaid. This is the same rationale as deposits received for cookie-making lessons.

If the sale of gift certificates is recorded as revenue, revenues on the income statement will be overstated and profit will also be overstated. The revenue is not earned until the cookie-making lessons are provided to customers. The gift certificate does not represent a good or service but rather an entitlement to receive services in the future when they are redeemed. If the gift certificates are never used, Natalie will need to use her past experience to determine what her liability is and the likelihood of the older gift cards being redeemed. She can then recognize revenue on gift cards unlikely to be redeemed.

There is not really a way to ensure that gift certificates get used. Some companies place a time limit on when the card can be used although this can be unpopular with customers and not permitted in some provinces. The longer a gift card remains unused, the more likely that it will not be redeemed and this results in additional revenue for the company. It may be to Natalie’s advantage to not limit the time over which the cards can be redeemed. To ensure that cards are not duplicated and used again, Natalie can use pre-numbered cards. She would then keep a

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CONTINUING COOKIE CHRONICLE (continued) 3 (continued) record of the numbers and values of cards issued and record the redemption of the card.

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CUMULATIVE COVERAGE: CHAPTERS 3 TO 10 (a) 1.

July 31 Operating Expenses.................. Accounts Receivable ................ Cash.......................................

50 650 700

31 Bad Debt Expense ......................... 1,850 Allowance for Doubtful Accounts ($3,850 − $2,000) ................... 31 Interest Receivable ................... Interest Revenue ($10,000 × 8% × 1/12 months)

1,850

67 67

31 Cost of Goods Sold ....................... 6,700 Merchandise Inventory ($45,900 − $39,200) ...............

6,700

31 Operating Expenses...................... 5,500 Prepaid Expenses.................

5,500

31 Depreciation Expense ($5,600 + $5,120)........................ 10,720 Amortization Expense ................. 15,000 Accumulated Depreciation 5,600 —Building.............................. Accumulated Depreciation —Equipment ......................... 5,120 Accumulated Amortization —Patent ................................. 15,000 Calculations Building ($155,000 − $15,000) ÷ 25 years = $5,600 Equipment ($25,000 − $12,200) × 40% (2 × 1 ÷ 5 years) = $5,120 Patent $75,000 ÷ 5 years = $15,000

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CUMULATIVE COVERAGE (Continued) (a) (Continued) 7.

July 31 Interest Expense ....................... Interest Payable ($124,200 × 6% × 1/12) ..........

621

31 Operating Expenses.................. Warranty Liability..................

1,975

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621

1,975

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CUMULATIVE COVERAGE (Continued) (b) LEBRUN COMPANY Adjusted Trial Balance July 31, 2014 Debit $ 15,850 200 39,150

Credit

Cash .......................................................... Petty cash ................................................. Accounts receivable ................................ Allowance for doubtful accounts ............ $ 3,850 Note receivable ........................................ 10,000 Interest receivable.................................... 67 Merchandise inventory ............................ 39,200 Prepaid expenses..................................... 10,500 Land .......................................................... 50,000 Building..................................................... 155,000 Accumulated depreciation—building ..... 16,400 Equipment................................................. 25,000 Accumulated depreciation—equipment . 17,320 Patent ........................................................ 75,000 Accumulated amortization—patent ........ 30,000 Accounts payable..................................... 78,900 Interest payable ........................................ 621 Warranty Liability ..................................... 7,975 Note payable ............................................. 124,200 S. LeBrun, capital..................................... 124,700 S. LeBrun, drawings ................................ 54,000 Sales.......................................................... 750,000 Cost of goods sold................................... 456,700 Bad debt expense..................................... 1,850 Operating expenses ................................. 188,745 Amortization expense .............................. 15,000 Depreciation expense .............................. 10,720 Interest revenue ....................................... 467 Interest expense ......................................... 7,451 Total ............................................................. $1,154,433 $1,154,433 See the following page for calculations.

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CUMULATIVE COVERAGE (Continued) (b) This format not required but is presented to show calculations. Account

Cash Petty cash Accounts receivable Allowance for doubtful accounts Note receivable Interest receivable Merchandise inventory Prepaid expenses Land Building Accumulated depreciation —building Equipment Accumulated depreciation —equipment Patent Accumulated amortization —patent Accounts payable

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Adjustments

Unadjusted Trial Balance Dr. Cr. 16,550 200

38,500

Cr. (1) 700

(1) 650

2,000

Adjusted Trial Balance Dr. Cr. 15,850 200 39,150

(2) 1,850

10,000

3,850 10,000

(3) 67

45,900

(4) 6,700

39,200

16,000 50,000 155,000

(5) 5,500

10,500 50,000 155,000

10,800

(6) 5,600

25,000

16,400 25,000

12,200

(6) 5,120

75,000

17,320 75,000

15,000

(6)15,000

30,000

78,900

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CUMULATIVE COVERAGE (Continued) (b) (Continued) Account Interest payable Warranty Liability Note payable S. LeBrun, capital S. LeBrun, drawings Sales Cost of goods sold Bad debt expense Operating expenses Amortization expense Depreciation expense Interest revenue Interest expense Total

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Unadjusted Trial Balance Dr. Cr.

Adjusted Trial Balance Dr. Cr.

Adjustments Dr. Cr.

6,000 124,200

(7) 621

621

(8) 1,975

7,975 124,200

124,700

54,000

54,000 750,000

450,000

181,220

750,000 (4) 6,700

456,700

(2) 1,850 (5) 5,500 (8) 1,975 (1) 50

1,850

188,745

(6)15,000

15,000

(6)10,720

10,720

400

(3)

467

6,830 (7) 621 1,124,200 1,124,200 43,133

10-98

7,451 43,133 1,154,433 1,154,433

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CUMULATIVE COVERAGE (Continued) (c) LEBRUN COMPANY Income Statement Year Ended July 31, 2014 Sales revenues Sales .............................................................................. $750,000 Cost of goods sold ....................................................... 456,700 Gross profit ..................................................................... 293,300 Operating and other expenses Operating expenses .................................... $188,745 Amortization expense................................. 15,000 Depreciation expense................................. 10,720 Bad debt expense ........................................ 1,850 Total expenses .......................................................... 216,315 Profit from operations..................................................... 76,985 Other revenues Interest revenue .......................................... $ 467 Other expenses Interest expense ......................................... 7,451 ... 6,984 Profit..................................................................................... $70,001

LEBRUN COMPANY Statement of Owner’s Equity Year Ended July 31, 2014 S. LeBrun, capital, August 1, 2013 ................................. $124,700 Add: Profit........................................................................ 70,001 194,701 Less: Drawings................................................................ 54,000 S. LeBrun, capital, July 31, 2014 .................................... $140,701

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CUMULATIVE COVERAGE (Continued) (c) (Continued) LEBRUN COMPANY Balance Sheet July 31, 2014 Assets Current assets Cash ($15,850 + $200) ................................................ $ 16,050 Accounts receivable ...................................... $39,150 Less: Allowance for doubtful accounts ...... 3,850 35,300 Note receivable ........................................................... 10,000 Interest receivable ...................................................... 67 Merchandise inventory............................................... 39,200 Prepaid expenses ....................................................... 10,500 Total current assets ............................................... 111,117 Property, plant, and equipment Land............................................................. $ 50,000 Building .........................................$155,000 Less: Accumulated depreciation 16,400 138,600 Equipment ................................. $25,000 Less: Accumulated depreciation 17,320 7,680

196,280

Intangible assets Patent ............................................................. $75,000 Less: Accumulated amortization............... 30,000

45,000

Total assets ....................................................................... $352,397

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CUMULATIVE COVERAGE (Continued) (c) (Continued) LEBRUN COMPANY Balance Sheet (Continued) July 31, 2014 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................... Interest payable .......................................................... Warranty Liability........................................................ Current portion of note payable ................................ Total current liabilities...........................................

$ 78,900 621 7,975 1,680 89,176

Long-term liabilities Note payable ($124,200 − $1,680) ................................. 122,520 Total liabilities ............................................................ 211,696 Owner’s equity S. LeBrun, capital ......................................................... 140,701 Total liabilities and owner’s equity ......................... $352,397

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BYP 10-1 FINANCIAL REPORTING PROBLEM (a)

Total current liabilities at January 28, 2012, were $89,132,000. There was a $2,177,000 decrease from the previous year ($91,309,000 – $89,132,000), which was equivalent to a 2% decrease ($2,177,000 ÷ $91,309,000).

(b) The components of total current liabilities on January 28, 2012 were trade and other payables, derivative financial liability, deferred revenue, income taxes payable and current portion of long-tem debt. (c)

Current ratio: 2012 $366,983,000 ÷ $89,132,000 = 4.12:1 Current ratio: 2011 $389,005,000 ÷ $91,309,000 = 4.26:1 Acid-test ratio: 2012 ($196,835,000 + $71,442,000 + $3,033,000) ÷ $89,132,000 = 3.04:1 Acid-test ratio: 2011 ($230,034,000 + $70,413,000 + $2,866,000) ÷ $91,309,000 = 3.32:1 Receivables turnover: 2012 $1,019,397,000 ÷ [($3,033,000 + $2,866,000) ÷ 2] = 345.62 Receivables turnover: 2011 $1,059,000,000 ÷ [($2,866,000 + $2,926,000) ÷ 2] = 365.68 Inventory turnover: 2012 $363,333,000 ÷ [($78,285,000 + $73,201,000) ÷ 2] = 4.80 Inventory turnover: 2011 $350,671,000 ÷ [($73,201,000 + $63,127,000) ÷ 2] = 5.14

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BYP 10-1 (Continued) Operating cycle: 2012 (365 ÷ 345.62) + (365 ÷ 4.80) = 77.1 days Operating cycle: 2011 (365 ÷ 365.68) + (365 ÷ 5.14) = 72.01 days

Ratio: Current ratio Acid-test ratio Receivables turnover Inventory turnover Operating cycle

Summary 2012 4.12:1 3.04:1 345.62 4.80 77.1 days

2011 4.26:1 3.32:1 365.68 5.14 72.01 days

Reitman’s overall liquidity has decreased slightly in 2012. All of the liquidity ratios have shown a slightly decline during 2012. The company however shows a very high level of liquidity. Its acid-test ratio is close to the current ratio indicating a high proportion of liquid current assets. (d)

Reitmans reports guarantees in note 24 to its financial statements. Contingencies include guarantees of third-party contractual obligations. The maximum potential liability was $5,083,000. In the opinion of management, the company does not expect to make any payments under these guarantees and has not recorded any liability.

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BYP 10-2 INTERPRETING FINANCIAL STATEMENTS (a)

Canadian Tire does not accrue legal proceedings, as they are not expected to have a material impact on the reported results. It also does not accrue the class action proceedings as the company does not consider it probable that a liability has been incurred. These class action proceedings however, if successful, would result in material losses for the company and it is desirable to disclose these items because they would have a substantial negative effect on the company’s financial position.

(b) The company may be required to incur significant legal costs of representation in order to defend itself regardless of the outcome of the legal proceedings. Since Canadian Tire is able to estimate these amounts, and it is probable that it will have pay these legal costs then Canadian Tire has a future obligation which must be recorded as a liability along with the related expense.

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BYP 10-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

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BYP 10-4 COMMUNICATION ACTIVITY

RE: TO: FROM: DATE:

Accounting for Gift Certificates Show_Time_Movie_Theatre@gmail.com Student@gmail.com

In response to your request, I wish to answer your questions regarding the accounting for gift certificates in your theatre. (a)

A liability is recorded when these certificates are sold because there is still a service to be provided by the theatre. The certificates sold are considered unearned revenue until they are redeemed and the service provided. At this point, the theatre's obligation is fulfilled and the amounts can be transferred from a liability account to a revenue account. The foregoing applies even though the gift certificates may, as you suggest, also generate additional revenues for the theatre.

(b) Since the gift certificates have no expiry date, the theatre will always have a liability for any gift certificates produced and redeemed. However, based upon the experience of your theatre and the theatre industry in general, estimates could be developed for the proportion of gift certificates that will never be redeemed. An entry would be made to reduce the liability related to unearned revenue, and to record the estimated amount which will never be redeemed as earned (or perhaps as a gain), rather than carrying an unlikely liability on your books in perpetuity.

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BYP 10-5 ETHICS CASE (a)

The stakeholders in this situation include: Shareholders Creditors Employees Government inspectors Public

(b) The alternative reporting options the company can use are: 1. Accrue the estimated cost in the financial statements. 2. Disclose the liability in the notes to the financial statements. 3. Do not accrue or disclose the liability in the financial statements. (c)

Accruing the estimate will result in increased liabilities, lower profit and lower shareholders’ equity on the financial statements. Disclosure of the liability will not directly affect the financial position, but users of the statements may adjust the financial position based on the information in the note. If the liability is not accrued or disclosed, it will not impact the financial position reported.

(d) It would be unethical not to disclose the liability. The company is responsible for the clean up and will incur some costs. Hiding this information from stakeholders would be dishonest. (e)

I recommend the company accrue the minimum amount of $50 million and disclose in the notes that the actual cost may be higher.

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BYP 10-6 “ALL ABOUT YOU” ACTIVITY (a)

Some of the factors to consider in determining if a worker is an employee or self-employed include:  the level of control the payer has over the worker;  whether or not the worker provides the tools and equipment;  whether the worker can subcontract the work or hire assistants;  the degree of financial risk taken by the worker;  the degree of responsibility for investment and management held by the worker;  the worker’s opportunity for profit; and  any other relevant factors, such as written contracts.

(b) The amount of cash received each month is the gross pay less the payroll deductions: Gross pay: Less: $134.06 CPP Contribution EI Contribution 54.90 Income taxes 407.95 Cash received (net pay)

$3,000.00

596.91 $2,403.09

The total amount of cash received in a year: Annual salary ($3,000 × 12) Less deductions: CPP Contribution ($134.06 × 12) EI Contribution ($54.90 × 12) Income tax ($407.95 × 12) Cash received (net pay)

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$36,000.00 1,608.72 658.80 4,895.40 $28,837.08

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BYP 10-6 (Continued) (c)

The total CPP paid in the year will be $134.06 × 12 = $1,608.72. Since the employee’s annual salary of $36,000 is less than the 2012 maximum pensionable earnings of $50,100, the employee will not reach the maximum annual contribution. The total EI paid in the year will be $54.90 × 12 = $658.80. The employee’s annual salary is less than the 2012 maximum insurable earnings of $45,900, so the maximum annual employee EI premium will not be reached.

(d) If you are self-employed, you will receive the full $3,000 each month. As a self-employed individual, you will be responsible for making periodic instalment payments to CRA for income tax. The amount paid in income taxes may differ depending on the expenses that you can claim as a self-employed individual. If no expenses are claimed, the amount of CPP paid in a year will include the employee and the employer portion as follows: $1,608.72 × 2 = $3,217.44 If no expenses are claimed, and the individual has chosen to pay EI, the amount of EI paid in a year will include only the employee’s contribution of $658.80.

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BYP 10-6 (Continued) (e)

(f)

Consulting revenue ($3,000 × 12) Less deductions: Income tax ($407.95 × 12) CPP Contribution ($134.06 × 12 × 2) Net pay

$36,000.00 4,895.40 3,217.44 $27,887.16

Based on the calculations in (c) and (e), it is preferable to be an employee because the net pay is higher.

(g) The answer to (f) may change if there is more than one client. It would be likely that additional expenses, such as travelling to the client’s location would be incurred. As a self-employed consultant, these costs would be deductible for income tax purposes and would decrease the amount of taxes paid.

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CHAPTER 11 Financial Reporting Concepts ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief Exercises

1. Explain the importance of having a conceptual framework of accounting, and list the key components.

2, 3, 4, 5, 2. Identify and apply 11 the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants.

Exercises

Proble ms Set A

Problems Set B

2, 3, 4, 6, 7

1, 2, 4, 5, 6

1, 2, 4, 5, 10

3. Describe the fundamental and enhancing qualitative characteristics of financial reporting.

6, 7, 8, 9, 10, 11, 12, 22

5, 6, 7

3, 4, 5

1, 2, 3, 4

4. Identify and apply the basic recognition and measurement concepts of accounting.

13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23

7, 8, 9, 10, 11, 12, 13, 14

5, 6, 7, 8, 9, 10, 11

3, 4, 5, 6, 7, 8, 9, 10,

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ASSIGNMENT CHARACTERISTICS TABLE

Comment on objective of financial reporting, and qualitative characteristics. Assumptions and concepts – going concern, full disclosure. Comment on objective of financial reporting, qualitative characteristics, and constraints.

Moderate

Time Allotted (min.) 15-20

Moderate

15-25

Moderate

15-20

Identify concept or assumption violated and prepare entries. Identify assumption or concepts and correct entries. Identify point of revenue recognition.

Moderate

20-30

Moderate

15-25

Moderate

15-20

Calculate revenue, cost of goods sold, and gross profit. Revenue recognition criteria – sale of goods.

Moderate

20-30

Moderate

20-30

Calculate revenue, expense, and gross profit – percentage-of-completion method.

Moderate

20-30

10A

Objective of financing reporting, identifying elements, and revenue and expense recognition.

Moderate

20-30

Comment on objective of financial reporting, and qualitative characteristics.

Moderate

15-20

Assumptions and concepts – going concern, full disclosure. Comment on objective of financial reporting, qualitative characteristics, and constraints.

Moderate

15-25

Moderate

15-20

Identify concept or assumption violated and prepare entries.

Moderate

20-30

Identify assumption or concepts and correct entries. Identify point of revenue recognition.

Moderate

15-25

Moderate

15-20

Calculate revenue, cost of goods sold, and gross profit. Revenue recognition criteria – sale of goods.

Moderate

20-30

Moderate

20-30

Calculate revenue, expense, and gross profit – percentage-of-completion method.

Moderate

20-30

10B

Objective of financing reporting, identifying elements, and revenue and expense recognition.

Moderate

20-30

Problem Number 1A 2A 3A

4A 5A 6A 7A 8A

6B 7B 8B

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Description

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objectives

Knowledge

1. Explain the importance of having a conceptual framework of accounting, and list the key components.

BE11-1

Q11-1 P11-3A P11-3B

2. Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants.

Q11-2 BE11-3

Q11-3 Q11-4 Q11-5 Q11-11 BE11-2 BE11-6 BE11-7 E11-2 E11-4 P11-1A P11-1B

BE11-4 E11-1 E11-5 P11-2A P11-10A P11-2B P11-10B

E11-6 P11-4A P11-5A P11-4B P11-5B

3. Describe the fundamental and enhancing qualitative characteristics of financial reporting.

Q11-6 Q11-8 Q11-9 BE11-5

E11-5 P11-2A P11-2B

P11-4A P11-4B

4. Identify and apply the basic recognition and measurement concepts of accounting.

Q11-14 Q11-15 Q11-18 Q11-19 Q11-21 Q11-23

Q11-7 Q11-10 Q11-11 Q11-12 BE11-6 BE11-7 E11-3 E11-4 P11-1A P11-3A P11-1B P11-3B Q11-13 Q11-22 BE11-7 E11-7 E11-8

Broadening Your Perspective

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Comprehension

P11-3A P11-6A P11-3B P11-6B

Application

BE11-20 BE11-8 BE11-9 BE11-10 BE11-11 BE11-12 BE11-13 E11-5 E11-9 E11-10 E11-11

P11-7A P11-8A P11-9A P11-10A P11-7B P11-8B P11-9B P11-10B

BYP11-4 Continuing Cookie Chronicle

BYP11-3

11-3

Analysis

Synthesis

Evaluation

BE11-16 BE11-17 E11-6 P11-4A P11-5A P11-4B

BYP11-1 BYP11-2 BYP11-6

BYP11-5

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ANSWERS TO QUESTIONS 1.

(a) The conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribe the nature, function, and limits of financial accounting statements. It guides choices about what to present in financial statements, decisions about alternative ways of reporting economic events, and the selection of appropriate ways of communicating such information. (b) The conceptual framework is applicable to companies reporting under IFRS and ASPE.

(a)

The main objective of financial reporting is to provide information that is useful for decision-making. More specifically, the conceptual framework states that the objective of general purpose financial reporting is to provide financial information that is useful to present and potential investors, lenders, and other creditors in making decisions about a business.

(b) The objective identifies the specific users to ensure that all possible points of view are included in fulfilling the needs of users. 3.

(a) Going Concern: The company will continue operating for the foreseeable future – long enough to achieve its goals and respect its commitments. The going concern assumption is necessary because many accounting principles require us to assume that a company is going to continue to operate in the future. For example, if a company was not going to continue to operate into the future, depreciation of long-lived assets would not be justifiable and appropriate. (b) The going concern assumption supports reporting the cost of an asset because if a company is not going to sell its assets, cost (the amount given up to acquire the asset) becomes more relevant than fair values. When a company is no longer a going concern, assets would be valued at fair or liquidation values rather than at historical cost. The timing of when the asset will be converted to cash or used in operations and when liabilities are to be paid determines their classification on the statement of financial position. Since the business is expected to remain in operation for the foreseeable future, these elements can continue to be reported in accordance with their respective current or non-current classifications.

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Questions (Continued) 4.

The cost constraint means that the costs of obtaining the accounting information should not exceed the benefits derived from it. For example, a small company could issue interim statements monthly instead of quarterly, but the benefits provided to users would probably be outweighed by the additional costs associated with preparing and presenting the extra information.

I disagree. The costs of applying IFRS to small or non-publicly traded companies exceed the benefits. As a result, a simplified version of GAAP has been developed and set in place for these companies, referred to as ASPE.

The fundamental qualitative characteristics are relevance and faithful representation. Accounting information has relevance if it makes a difference in a decision. Relevant information has predictive value or confirmatory value. Faithful representation shows the economic reality of events rather than just their legal form. Faithful representation is achieved if the information is complete, neutral and free from material error. Complete information includes all information necessary to show the economic reality of the transaction. Accounting information is neutral if it is free from bias intended to attain a predetermined result or encourage a particular behaviour. Accounting estimates must also be based on the best available information and be reasonably accurate to be considered free from material error.

(a) The concept of materiality means that an item may be so small that failure to follow generally accepted accounting principles will not influence the decision of a reasonably prudent investor or creditor. For example, the expensing of a $20 calculator would not be in accordance with GAAP since the calculator will probably have a useful life beyond one year. However, the cost is so insignificant that it will have no impact on users’ decisions and therefore, this GAAP deviation is not considered to be material. (b) In order to be relevant to a financial statement user, a transaction or amount must make a difference to the user when making a decision. If an omission or misstatement does not influence a user, it is said to be immaterial or not material. Materiality is not only a matter of size, but also has to do with the nature of the omission or misstatement (for instance, illegal acts).

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Accounting Principles, Sixth Canadian Edition

Questions (Continued) 8.

The four enhancing qualitative characteristics verifiability, timeliness and understandability.

are

comparability,

Accounting information about a company is most useful when it can be compared with accounting information about other companies. Comparability results when different companies use the same accounting principles. Comparability is easier when accounting policies are used consistently by a business from one accounting period to the next. Information is verifiable if two knowledgeable and independent people would agree that it faithfully represents the economic reality. The usefulness of accounting information is enhanced when it is provided on a timely basis, when it is still highly useful for decision-making. Information in financial statements must be capable of being understood by users. Understandability is enhanced by classified, clear, and concise presentation. It is assumed that the average user has a reasonable understanding of accounting concepts and procedures, and general business and economic conditions. 9.

The two fundamental qualitative characteristics should be applied first before the four enhancing characteristics. Relevance should be applied first, followed by faithful representation. Relevance is applied first to identify which information would impact a user’s decision. Faithful representation is applied second to ensure the relevant information represents its substance. Comparability, verifiability, timeliness and understandability enhance the communication of information that is relevant and representationally faithful.

10. While the conceptual framework for IFRS identifies two fundamental and four enhancing characteristics, the framework for ASPE identifies four principal qualitative characteristics: understandability, relevance, reliability, and comparability. ASPE also recognizes conservatism as a qualitative characteristic of financial information. 11. In general terms, in order for financial information to be useful, it must be complete. To achieve completeness, accountants could record or disclose every financial event that occurs and every uncertainty that exists. However, providing this information increases reporting costs. The benefits of providing more information, in some cases, may be less than the costs. 12.

Yes. Rounded figures provide enough information to be useful for decision-making and are less distracting to the reader than are too many digits in a number. In fact, including specific dollar figures can imply a false sense of accuracy that is simply not the case in financial statements where estimates and other judgements are made.

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Accounting Principles, Sixth Canadian Edition

Questions (Continued) 13. The revenue recognition criteria state that revenue is recognized when there is an increase in an asset or a decrease in a liability due to profitgenerating activities. The application of these criteria involves judgement. In addition, activities that generate revenues have become a lot more innovative and complex than in the past, making the point where revenues meet these guidelines much harder to determine. 14. The revenue recognition criteria state that revenue is recognized when there is an increase in an asset or a decrease in a liability due to profitgenerating activities. 15. The five conditions that must be met for revenue to be recognized include:  the risks and rewards of ownership must be transferred;  the seller does not have control over the goods;  the amount of revenue can be reliably measured;  collection must be reasonably assured; and  costs can be reliably measured. 16. I disagree. The risks and rewards of ownership did not get transferred to the buyer until the customer took possession of the shipment. This transfer did not legally occur in 2013 and so the sale should not have been included in the December 31, 2013 income statement. There exists an added risk to recording the sale in December which could bring about an error. Since the goods were not shipped as of the end of the fiscal year, they would be included in the physical count of inventory. Consequently, the inventory would be included on JRT’s balance sheet as well as the accounts receivable from the sale. This error has a significant effect on gross profit and profit for the year, making the results misleading to any reader. 17. (a) The $10,000 cash receipt on March 24, 2014 should be recorded as unearned revenue as no landscaping services have yet been performed. The unearned revenue should appear as a current liability on Greenthumb’s balance sheet at April 30, 2014. (b) Since Greenthumb’s practice is to prepare monthly financial statements, the revenue from providing landscaping services should be allocated to the month in which the services are performed. In this case the amount of $10,000 will be allocated to the five month period from May through September 2014 at the rate of $2,000 per month.

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Accounting Principles, Sixth Canadian Edition

Questions (Continued) 18. (a) Revenue from long-term service and construction contracts should be recognized as the revenue is earned, as long as the revenue recognition criteria are met. (b)

The three steps in the percentage-of-completion method include: 1. Progress toward completion is measured often by comparing the costs incurred in a period with the total estimated costs for the entire project. This indicates the percentage of the work that is complete. 2. This percentage is multiplied by the total revenue for the project, to determine the amount of revenue to be recognized for the period. 3. The costs incurred are then subtracted from the revenue recognized to arrive at the gross profit for the current period.

19. When goods are sold together with a service component, the amount collected from the sale must be divided between the two sources of revenue. The revenue from the sale of the goods should be recognized at the point of sale, while the service component must be recognized over the period in which the services are delivered. 20. Unless the company can reasonably and reliably estimate the amount of the returns it expects following the sale, in order to accrue the returns at the point of sale, the company should postpone the recognition of the sale until the return period has expired. Failing to do so would be in violation of the revenue recognition criteria. 21.

Expenses should be recognized when there is a decrease in an asset or increase in a liability, excluding transactions with owners. The timing of expenses recognition on the income statement depends on the nature of the expense. If there is a direct association between the cost and revenue, the expense is recognized on the income statement in the same period as the related revenue. Where there is no direct relationship between expense and revenue, a rational and systematic allocation process is adopted. In addition, for expenditures that do not qualify for recognition as assets, or previously recognized assets that cease to have future benefits, expenses are recognized immediately.

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Accounting Principles, Sixth Canadian Edition

Questions (Continued) 22.

In order to be relevant for decision making, the measurement of elements of financial statements need to reflect amounts that are reliable. For assets that are intended to be sold, the current fair value of the assets becomes the most relevant measurement as it approximates the current amount of cash that could be obtained on the sale of the asset. On the other hand, for assets held for use by the corporation, the value at resale is not as relevant to the financial statement user. In that case the cost of the assets is the better measurement for reporting the financial statement element. For example, inventory will become cost of goods sold when sold. It is relevant to compare the actual cost of the inventory to the amount of the revenue generated from its sale. Using the cost basis of accounting gives a faithful representation of the transaction that has occurred from the sale of inventory.

23.

Profits might be overstated on purpose by management to satisfy the owners’ expectations of performance or to allow certain members of the management to earn a bonus which is based on profits. For example, the seller might recognize sales revenues for goods that are shipped FOB destination when the goods are shipped instead of when the customer receives the goods. This would overstate revenues if the goods were shipped just prior to the company’s fiscal year end and received by the customer after the year end. Another means of overstating profits is to recognize revenue from the sale of extended warranties when the cash is collected instead of when the work is performed.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 (a) (b) (c) (d) (e) (f) (g)

F T F T F T T

BRIEF EXERCISE 11-2 (a) Yes (b) Yes (c) No

BRIEF EXERCISE 11-3 (a) (b) (c) (d) (e) (f)

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

Revenues Liabilities Assets Expenses Owner’s equity Assets

BRIEF EXERCISE 11-4 (a) No (b) Yes (c) Yes

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BRIEF EXERCISE 11-5 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)

4 6 3 5 7 10 1 9 8 2 11

BRIEF EXERCISE 11-6 (a) (b) (c) (d) (e)

1. 2. 3. 6. 4.

Going concern assumption Economic entity concept Full disclosure Materiality Cost

BRIEF EXERCISE 11-7 (a) (b) (c) (d) (e) (f) (g)

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

Full disclosure Expense recognition Revenue recognition Fair value Cost Revenue recognition Matching

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BRIEF EXERCISE 11-8 Revenue of $250,000; the value of the work completed in March. Salaries expense of $75,000.

BRIEF EXERCISE 11-9 The company should recognize sales for the full $450,000 in the month of September. All of the merchandise is sold FOB shipping point, which means that ownership has been transferred at the point when the goods left the seller. None of the merchandise in transit was owned by Mullen. Bad Debts Expenses in the amount of $4,500 need to be accrued. Sales Returns can be estimated at 2% of sales (2% × $450,000 = $9,000). If sales returns are material in amount and can be reasonably estimated, they should be accrued in the same period as the related sale and a liability for the estimated returns recognized. If they are not material, they are frequently recorded as they occur.

BRIEF EXERCISE 11-10 Sales ($350,000 – $40,000) Cost of goods sold ($200,000 – $23,000) Gross profit

$310,000 177,000 $133,000

The company can only recognize the sale when the ownership of the goods is transferred. For the goods in transit, since the shipping terms are FOB destination, Abbotsford Ltd. still owns the merchandise. Based on the concept of matching costs with revenues, the cost of goods is recognized on the income statement in the same period as the related sale. The cost of goods in transit would remain on the balance sheet as part of inventory. Solutions Manual .

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BRIEF EXERCISE 11-11 Revenue from Sales of $400,000 should be recorded for the month of December. The $25,000 for the sale of extended warranties should be initially recorded as unearned warranty revenue to recognize that Willow Appliances Company has an obligation (liability) to provide warranty service in the future. Warranty revenue will be recognized when the Willow satisfies its obligation by providing warranty service.

BRIEF EXERCISE 11-12 Costs Incurred

Year 2013 2014 2015

$ 840,000 1,120,000 840,000 $2,800,000

Year 2013 2014 2015

Total Percentage  Estimated Cost = Complete × $2,800,000 2,800,000 2,800,000

Revenue Recognized $1,260,000 1,680,000 1,260,000 $4,200,000

−

Total Revenue

30% 40% 30%

Costs Incurred

Revenue = Recognized

$4,200,000 4,200,000 4,200,000

$ 840,000 1,120,000 840,000 $2,800,000

$1,260,000 1,680,000 1,260,000 $4,200,000

Gross Profit $ 420,000 560,000 420,000 $1,400,000

BRIEF EXERCISE 11-13 Operating expenses from adjusted trial balance Add: Loss on damaged inventory Accrual of sales commissions expense Total operating expenses

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BRIEF EXERCISE 11-14 1.

The measurement criteria for cost has been violated. The accountant should not have recorded the increase in the value from the original cost to the fair value as this is not allowed under ASPE.

There is a violation of revenue recognition criteria. Since the musical production for which the ticket sales were made has not yet taken place as of the end of January, none of the revenue had been earned. Instead, Unearned Revenue should have been credited in the entry made by the accountant.

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SOLUTIONS TO EXERCISES EXERCISE 11-1 (a) Financial statements help the bank assess the financial position, profitability and liquidity of their customers. With accurate and complete financial information, the bank can determine the impact the expansion plans might have on Marc’s profitability and ability to repay any current and additional loans obtained. Financial statements will allow the bank to conduct some analysis and make comparisons of Marc’s business with other similar retail operations. (b) The bank manager wants reliable information to determine the amount of risk the bank is taking if it is to extend a loan to Marc for his inventory expansion. (c) Unless there is contractual relationship between the two companies, such as a guarantee for an existing loan, the two companies do not have a business relationship. The two companies should not be combined for purposes of preparing financial statements. Doing so would violate the economic entity concept of GAAP. (d) Although the rented store space is shared space with another business, there is likely other property, plant, and equipment owned by the business which is necessary to operate the store. These assets would be depreciated and would be reported on the balance sheet at their carrying amount. As for the inventory, the measurement of this current asset should be at the lower of cost and net realizable value.

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EXERCISE 11-2 (a) It is advisable for Susan to prepare monthly financial statements, particularly because the business is new. It is not unusual for new business owners to experience difficulty when starting a new business, for example in areas such as product pricing and expense management. Monthly financial statements will provide Susan the necessary frequent feedback she needs concerning the results of operations. Timely information will allow Susan to react quickly and make any necessary business decisions to assure her business’ success. (b) Since Susan’s business is quite small it is not cost effective for her to adopt IFRS. Only very large operations can justify the time, effort and cost of implementing IFRS. Consequently, Susan should follow ASPE.

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EXERCISE 11-3 (a) (b) (c) (d) (e) (f) (g) (h)

3 4 6 6 2 7 1 5

EXERCISE 11-4 (a) (b) (c) (d) (e) (f)

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

Economic entity concept Cost constraint Completeness Going concern assumption Materiality Cost

EXERCISE 11-5 1. Revenue recognition criteria 2. Full disclosure 3. Expense recognition criteria 4. Going concern assumption; full disclosure principle 5. No violation (lower of cost and net realizable value) 6. Timeliness characteristic 7. Cost concept 8. Economic entity concept 9. Cost constraint

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Accounting Principles, Sixth Canadian Edition

EXERCISE 11-6 1.

This is a violation of the cost measurement concept, because the inventory was recorded at its estimated fair value and not its cost. The correct journal entry is: Merchandise inventory.......................... Cash................................................

42,000 42,000

This is a violation of the economic entity concept. The treatment of the transaction treats Evan Ellis and Ellis Company as one entity when they are two separate entities. No journal entry should have been made since Evan Ellis should have used personal assets to purchase the computer. If cash assets of the company were used, the debit entry could be to Accounts Receivable—E. Ellis, or to E. Ellis, Drawings and the credit entry to Cash.

This is a violation of the cost measurement and matching concepts. Since the advertising has already appeared on television, the cost should be expensed immediately. The correct journal entry is: Advertising Expense ............................. Cash................................................

5,000 5,000

There is no violation of generally accepted accounting principles. The merchandise inventory is properly reported at the lower of cost and net realizable value.

This is a question of matching, materiality and cost constraint. In theory, the coffee machine should be depreciated to match the expense with revenue, since the coffee machine has estimated useful life of 5 years. However, because the cost of the coffee machine is not material, the cost of accounting for it as a long-lived asset will exceed any benefits from doing so. Office Expense ....................................... Cash ...............................................

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EXERCISE 11-6 (Continued) 6.

This is a violation of the revenue recognition criteria. The revenue should be recognized when the service is provided in April. When the cash is received, it should be credited to an unearned revenue account until the revenue is earned. Cash ....................................................... Unearned Revenue........................

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EXERCISE 11-7 1.

Since the service is not provided until the flight actually occurs, revenue should not be recognized until December. This will record the revenue in the period the expense occurs, as well.

If collection can be reasonably assured and an estimate of uncollectible amounts can be made, then revenue can be recognized at the point of sale. Otherwise, the revenue should be recognized at the time cash is collected. However, it is highly unlikely that Cygman would sell to customers with no credit check and that it would not be able to reasonably estimate its doubtful accounts based on past experience.

Revenue should be recognized on a per game basis over the season from April to October.

If collection can be reasonably assured and an estimate of uncollectible amounts can be made, then revenue can be recognized when the merchandise is received by the customer.

Tuition revenue should be recognized evenly over the term, from September through December. This will record the revenue in the period the expenses (e.g., teaching salaries, utilities expense, etc.) occur, as well.

If the Bookstore can estimate the volume of returns, revenue should be recorded at the point of sale along with an allowance for returns. Otherwise, recognition should be delayed until the right of return expires.

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EXERCISE 11-7 (Continued)

The portion of the sales that is attributed to the three-year service contract should be deferred and recorded to unearned revenue and subsequently adjusted to revenue as the services are provided over the three year period, when the updates are delivered. The rest of the sale can be recognized at the point of delivery.

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EXERCISE 11-8 March sales = 350 × $760 = $266,000 for services performed from May-September (5 months) June sales = 300 × $800 = 240,000 for services performed from June-September (4 months) July sales = 100 × $800 = 80,000 for services performed from July-September (3 months) Total sales $586,000 No revenue would be recorded in March or April because no services were provided. Assuming the same amount of work is provided to the customers each month from May to September, revenue would be recognized as follows: March April $266,000 $240,000 $ 80,000 Total

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May $53,200

June $53,200 60,000

July August Sept. $53,200 $53,200 $53,200 60,000 60,000 60,000 26,667 26,667 26,666 $53,200 $113,200 $139,867 $139,867 $139,866

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EXERCISE 11-9 1.

$2,000 × 4 = $8,000. By applying the revenue recognition criteria, one can determine that 3 months of rent (or $6,000) should be recognized as revenue in 2014, while the remaining amount of $2,000 is revenue in 2015.

$16,000. Ownership of the property transfers at December 31, 2014 because the terms are FOB shipping point. Thus, a sale took place in 2014 and revenue of $16,000 and the cost of goods sold in the amount of $9,000 should be recorded in 2014.

$2,000,000 × ($300,000 ÷ $1,400,000) = $428,517. If 3/14ths or 21.4% of the costs have been incurred, then the same percentage of the total revenue should be recognized, using the percentage-of-completion method.

$0. No revenue should be recognized since the right of return cannot be reliably measured. This means that the amount of revenue cannot be reliably measured. In addition, collectability is not reasonably certain since the customers have an extended payment period. There is no indication that Mitrovica does credit checks on its customers to ensure that payment will be made.

$5,000 × 4% × 4/12 = $67. Interest revenue should be recognized for the four months the note was outstanding in 2014.

$0. Even though collection is assured, the revenue has not been earned. The ownership of the product is not transferred until 2015.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 11-10 (a) Costs Incurred

Year 2012 2013 2014



$ 25,000,000 55,000,000 20,000,000 $100,000,000

Total Estimated Cost

2012 2013 2014

$ 37,500,000 82,500,000 30,000,000 $150,000,000

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Total Revenue

Revenue = Recognized

25% 55% 20%

$150,000,000 150,000,000 150,000,000

$ 37,500,000 82,500,000 30,000,000 $150,000,000

$100,000,000 100,000,000 100,000,000

Revenue Recognized

Year

Percentage = Complete × During Year

−

Actual Cost Incurred $ 25,000,000 55,000,000 20,000,000 $100,000,000

11-24

Gross Profit Recognized $12,500,000 27,500,000 10,000,000 $50,000,000

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EXERCISE 11-11 1.

Byer’s Innovations Co. should record rent expense in 2014 in the amount of $6,000 for the months of November and December at the rate of $3,000 per month.

The full amount of $35,000 for research must be expensed immediately as there is no assurance of any future benefit to be derived from the research activity.

An estimate can be made of the amount of monthly power and water expenses that should be accrued for the month of December 2014 in the amount of $5,000 ($55,000 ÷ 5). Consequently the cost of power and water for the fiscal year will be in the amount of $60,000 ($55,000 + $5,000).

No depreciation expense should be recognized in the 2014 fiscal year as the packaging equipment was not yet available for use.

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SOLUTIONS TO PROBLEMS PROBLEM 11-1A The objective of financial reporting is to provide useful information for decision-making. The major user groups of Reitmans (Canada) Limited include present and potential shareholders as well as creditors. These users need information to assess the company’s future commitments for payments in order to assess the company’s ability to pay dividends and repay debt. This information is relevant to the users’ needs. Because the information relates to future periods, it is predictive in nature and provides a basis for predicting future earnings and cash flows. Taking It Further: Reitmans (Canada) Limited also discloses future cash payments for principal repayment on long-term debt in note 14 to the financial statements.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 1127A (a) If a company files for bankruptcy, it may not satisfy the going concern assumption. The going concern assumption is a basic assumption underlying the preparation and presentation of financial statements. When this assumption is not satisfied, the balance sheet would not be classified, since all assets and liabilities would be current. The basis of measurement of assets would be liquidation or net realizable value, rather than their carrying amounts. (b) Companies that are under bankruptcy protection would disclose in the notes to their financial statements, their plan for restructuring their operations. Since many factors may remain outside of their control, depending on the circumstances, it is possible that some of the companies will not be able to continue and cannot be viewed as a going concern. Individual companies can be expected to survive bankruptcy protection and can continue to apply the going concern assumption, but the remarks in the notes to the financial statements will be strongly worded and send a clear message of warning to users. Usually, a company has to be virtually certain that it will not continue operations in the near future in order to not apply the going concern assumption. Taking It Further: In disclosing that a company may not be able to continue as a going concern, a company’s management faces the dilemma of a “self-fulfilling” prophecy. If a company prepares financial statements without applying the going concern assumption, this is a clear signal to users that the company’s management does not believe the company will survive beyond the coming year. This sends a clear signal to users to think in terms of liquidation; it encourages creditors to demand repayment of outstanding debt and discourages potential investors from investing in the company. Solutions Manual .

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PROBLEM 11-3A Private companies generally become public companies to increase their access to capital by issuing additional shares. Humpty’s Restaurants International Inc. had not been issuing new shares for financing in many years, nullifying the need for it to be a public company. The owners of Humpty’s likely decided to go private to save money and regain control over the business. Producing information for financial disclosure comes at a cost for companies. The International Financial Reporting Standards violate the cost constraint for most private enterprises as these companies have few users and their information needs are usually simpler. Their users usually consist of few creditors and investors, as opposed to thousands of investors for public companies. Producing the financial information required under IFRS places many private companies under significant financial burden because of the information systems required to accumulate the information, and the need to have sufficient knowledgeable personnel to prepare the information. The preparation of the detailed required disclosure under IFRS would also take significant amounts of time and would make the information less timely. Taking It Further: A Canadian private company may choose to report under IFRS under different scenarios:  If it anticipates becoming a public company in the near future.  If it is a subsidiary of a public company using IFRS.  If it wants to access international markets and have comparable financial reporting.

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PROBLEM 11-4A (a) and (b) 1.

Expense recognition criteria (matching concept). The cost of equipment should not be expensed immediately. Only costs which have no probable future benefits are recognized immediately as expenses. Therefore, the following entries are necessary: Equipment................................................... Cash.....................................................

80,000 80,000

Depreciation Expense [$80,000 × (100%  5 × 2)]........................... 32,000 Accumulated Depreciation—Equipment 32,000

Expense recognition criteria (matching concept). The cost of property, plant, and equipment should be allocated over its useful life in a rational and systematic manner. Deferring depreciation is not rational and systematic. Therefore, the following entry is necessary: Depreciation Expense ................................ Accumulated Depreciation .................

43,000

Measurement criteria (cost basis). Recording the transaction at its estimated fair value would not be proper because estimated fair value in this case does not represent an exchange price. The purchase should be recorded at cost, not at a fair value that someone believes the equipment is worth. The correct entry is: Equipment................................................... Cash.....................................................

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PROBLEM 11-4A (Continued) (a) and (b) (Continued)

Going concern assumption. Liquidation value is not appropriate because it assumes that the enterprise will not continue. No entry is necessary. Only when liquidation appears imminent is the going concern assumption inapplicable. Otherwise, the cost measurement basis applies.

Expense recognition criteria (matching concept). Expensing the cost of the rent immediately does not allow a proper matching of the expense with the revenue that will be earned over the next 6 months. The correct entry is: Prepaid Rent ............................................... Cash.....................................................

18,000 18,000

An adjusting entry is made at December 31 to record the proper rent expense. Rent Expense.............................................. Prepaid Rent........................................

12,000 12,000

Alternatively, the entry debiting Rent Expense can be recorded, but the adjusting entry at December 31 would then be as follows: Prepaid Rent ............................................... Rent Expense ......................................

6,000 6,000

If financial statements are prepared only once at the end of the fiscal year, it really doesn’t matter what entry is made originally (although debiting an asset account such as Prepaid Rent tends to result in better internal control), as long as the correct allocation is made at year end between the asset and the expense account.

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PROBLEM 11-4A (Continued) (a) and (b) (Continued)

Measurement criteria (cost basis). Appreciation in value does not justify recognizing a gain on the land, until the land is sold (since Kwick Kopy has not adopted the revaluation model for accounting for its property, plant, and equipment). Appreciation does not involve an exchange transaction. No entry is necessary.

Revenue recognition criteria. Kwick Kopy will not begin to perform the service until January 2015. Therefore the revenue has not been earned in 2014 and it would be inappropriate for the company to record any revenue in 2014. No entry is necessary in 2014.

Taking It Further: A liquidation basis may be appropriate for property, plant, and equipment if the company can no longer apply the going concern assumption. In such a case, the company’s demise would be imminent and liquidation is likely.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5A

(a) and (b) 1.

The sale should be recorded in the next year instead of the current year. Legal title of the goods does not change hands until the next year. Therefore, the revenue recognition criteria are violated. It should be noted that if the company is employing a perpetual inventory system in dollars and quantities, a debit to cost of goods sold and a credit to inventory are also necessary in the next year. Correcting entry required: Sales............................................................ Accounts Receivable ......................... Unearned Revenue .............................

90,000 80,000 10,000

The $5,000 for the sale of extended warranties should be recorded as unearned revenue to recognize that Durkovitch Company has an obligation (liability) to provide warranty service in the future. Warranty revenue will be recognized when the company satisfies its obligation by providing warranty service. Correcting

entry

required:

Sales............................................................ 5,000 Unearned Revenue .............................

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Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5A (Continued) (a) and (b) (Continued)

Depreciation is a means of cost allocation. Assets are not depreciated on the basis of the level of profitability, but are depreciated on the basis of systematic charges of expired costs against revenues. Recording additional depreciation to manipulate the current and future profit performance shows a violation of the representational faithfulness of the events that actually occurred and the expenses that were incurred to earn revenue. Correcting entry to reverse entry made is required: Accumulated Depreciation ........................ Depreciation Expense.........................

60,000 60,000

This entry violates the expense recognition criteria. The merchandise has not been sold and should not be shown on the income statement until it is sold. This will match the cost of merchandise sold against the revenue when recorded. Since the merchandise has probable future economic benefits, it should be shown on the balance sheet as an asset. Correcting entry required: Inventory ..................................................... Cost of Goods Sold ............................

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78,000 78,000

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5A (Continued) (a) and (b) (Continued)

Durkovitch Company has not adopted the revaluation model of accounting for its property, plant, and equipment. A loss should not be recognized based on the cost measurement criteria. In some circumstances, land may be written down if it is considered impaired. Correcting entry required: Land ........................................................... 30,000 Loss on Fair Value Adjustment of Land 30,000

Taking It Further: Yes, the answer would have been different. If the Durkovitch Company was a real estate company, the land would be inventory rather than property, plant, and equipment. For inventory, the measurement basis is cost combined with fair value, as lower of cost and net realizable value. This modified basis is considered more relevant to users’ needs because it provides information on the company’s liquidity and solvency. As part of inventory, the expectation is that the land will be sold in the short-term and its future economic benefits will be realized in the coming year. Any declines in value below original cost affect those future benefits in the current year, and should be recorded as such.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM 11-6A The revenue recognition criteria states that revenue cannot be recognized until it can be objectively measured. Since the production and sales effort is not substantially completed until the tree matures and is sold, revenue cannot be measured and recognized until that point. Since no buyer is identified during the period of growth, Santa’s Christmas Tree Farm retains the risks and rewards of ownership until the trees are sold. Santa’s Christmas Tree Farm, as seller, has control over the goods and has continuing managerial involvement over the years of growth. Taking It Further: In accordance with the matching concept, the annual costs of fertilizing, pruning and maintaining the trees are unexpired costs with future revenue producing potential. They should be recorded on the balance sheet as inventory and recognized as part of the cost of the goods sold in the same period as the related revenues.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 1136A Net sales to November 30, 2014 Add: Gross sales for December, 2014

$1,200,000 125,000 $1,325,000

Less: Sales returns, December, 2014 Goods sold FOB shipping point Estimated sales returns Net sales

$20,000 12,000 11,000

Cost of goods sold to November 30, 2014 Add: Cost of goods sold for Dec. 2014

$635,000 66,250

Less: Cost of goods returned, Dec. 2014 Goods sold FOB shipping point Estimated cost of goods return Cost of goods sold Gross profit

$10,600 6,300 5,800

43,000 $1,282,000

$701,250

22,700 678,550 $603,450

Taking It Further: If sales returns did not result in goods being returned to inventory for resale, the cost of these goods would not be deducted in the calculation of the cost of goods sold. Consequently, the results of the calculation would be as follows: Net sales Cost of goods sold to November 30, 2014 Add: Cost of goods sold for Dec. 2014 Less: Goods sold FOB shipping point Cost of goods sold Gross profit

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$1,282,000 $635,000 66,250

$701,250 6,300 694,950 $587,050

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM 11-8A (a) 



  

(b)

Dave’s Deep Discount Furniture Store’s source of revenue comes from the sale of goods. Revenue is recognized when all of the following conditions are met: The seller has transferred the significant risks and rewards of ownership – this condition is usually met when the customer takes possession of the furniture. In Dave’s case, it appears that delivery is included in the furniture purchase. Ownership would be transferred when the furniture arrives at the customer’s home. The seller does not have control over the goods or continuing managerial involvement. This criterion does not apply specifically to the sale of furniture. Control of the goods is transferred when the customer takes possession of the goods. The amount of the revenue can be reliably measured. This criterion is satisfied when there is an agreed-upon price, usually at the point of sale. It is probable cash will be collected. For Dave’s, collectability seems to be reasonably assured since they conduct credit checks of their customers. Costs relating to the sale of the goods can be reliably measured. For furniture sales, the costs usually relate to the cost of sales, sales commissions and delivery costs. These costs can be measured and matched to revenue. The critical factors are the transfer of ownership and collectability. For the sale of merchandise, the point where legal ownership is transferred is a critical factor since it represents the point where the risks and rewards of ownership are transferred. It also usually indicates the end of the earning process in that no future costs are associated with the process.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-8A (Continued) (b) (Continued) In some cases, costs such as warranty costs occur after the transfer of ownership, but revenue is recognized when ownership is transferred if these costs can be reliably estimated and recognized in the same period as the revenue. If collectability is reasonably ensured at the transfer of ownership, revenue is recognized at this point. The risk of non-collection can be reliably measured as bad debts expense and recognized in the same period as the sale. If the risk of non-collection cannot be reliably estimated, revenue recognition should be deferred until cash is received. (c)

Revenue of $310,000 should be recognized = Total sales $325,000 – $15,000 goods delivered in January 2013.

Taking It Further: Yes. The amount of revenue that Dave’s should recognize in 2012 would be $60,000. This is the amount of revenue for furniture delivered before year-end that has been collected in full. A thorough credit check is a critical factor since it provides support that cash will be collected, or that bad debts will be minimal and can be reasonably estimated and accrued. Since Dave’s opened for business in 2012, they do not have any prior experience to determine collectability on its credit sales.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-9A

Total Estimated Cost 

Year

Costs Incurred

2012 2013 2014 2015 Totals

$ 12,000,000 20,000,000 10,000,000 18,000,000 $60,000,000

$60,000,000 60,000,000 60,000,000 60,000,000

Revenue Recognized

Year 2012 2013 2014 2015 Totals

$ 18,000,000 30,000,000 15,000,000 27,000,000 $90,000,000

–

Percentage = Complete × During Year

Total Revenue

20.00% 33.33% 16.67% 30.00%

$90,000,000 90,000,000 90,000,000 90,000,000

Actual Cost Incurred $12,000,000 20,000,000 10,000,000 18,000,000 $60,000,000

Revenue = Recognized $18,000,000 30,000,000 15,000,000 27,000,000 $90,000,000

Gross Profit Recognized $ 6,000,000 10,000,000 5,000,000 9,000,000 $30,000,000

Note that the cash collections are not relevant in the percentage-of-completion method. Taking It Further: The revenue recognition criteria require that costs relating to the sale of the goods be reliably measured. Since Cosky can no longer rely on the original estimate of total costs for the construction project, it cannot use the percentage of completion method to recognize revenue for this contract.

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Chapter 11

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10A (a)

Financial statements help the bank assess the financial position, profitability and liquidity of their customers. With accurate and complete financial information, the bank can determine the impact the expansion plans might have on Kamloop’s profitability and ability to repay any current and additional loans obtained.

(b)

In order to ensure that the financial information provided by Kamloops is reliable, the bank will request that the financial statements be reviewed by an independent accountant.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10A (Continued) (c) Current assets Add: Cost of goods in transit (1) Less: Sale has not occurred (2) Accrued sales returns (3) Eliminate prepaid advertising (4) Revised current assets *($26,000 × 5%) Current liabilities Add: Invoice for goods in transit (1) Revised current liabilities

$120,000 15,000 (8,400) (1,300)* (3,500) $121,800

Net sales Less: Accrued sales returns (3) Sale has not occurred, no transfer of ownership (2) Revised net sales

560,000 (1,300) (8,400) $550,300

Total operating expenses Add: Advertising expense (4) Revised total operating expenses

$106,000 3,500 $109,500

$ 80,000 15,000 $ 95,000

1. Goods in transit must be included in inventory and accounts payable as the terms of shipment indicate that Kamloops owned the inventory as of December 31, 2014. 2. Kamloops has double counted the inventory items in accounts receivable and in inventory. The merchandise inventory was sold and so the recording of the sale and corresponding cost of goods sold is correctly recorded. The amount of the cost of the items sold must be removed from the inventory count and balance. 3. Sales returns for the last 15 days of the fiscal year need to be accrued as a reduction of sales and a reduction of accounts receivable. The amount accrued is 5% of $26,000 or $1,300.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10A (Continued) 4. The promotional expense recorded as a prepaid expense must be expensed and there is no measurable future benefit realized as of December 31, 2014.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10A (Continued) Taking It Further: (a)

Current ratio

$ 120,000 $ 80,000

1.50:1

(b)

Current ratio

$ 121,800 $ 95,000

1.28:1

As a result of the required adjustments, Kamloops’ current ratio is considerably worse as it has reduced by from the initial 1.5 to 1.28. Since the adjustments that were required are in the same direction (reducing profit, decreasing current assets, and increasing current liabilities), there appears to be a bias in the errors made by Kamloops. On the other hand, without knowing the level of training and expertise of Alphonzo, the company’s manager, who is the preparer of the financial statements, it is inappropriate to conclude if the errors were intentional.

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Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM 1144B Reitmans’ management is required to use estimates in order to provide information that is both relevant and timely to the users’ decision-making. Under the accrual accounting assumption, management is required to present events and transactions when they occur and not when cash is affected. Certain types of transactions and events have some level of uncertainty with respect to the amount or their ultimate resolution. In order to provide faithful representation and complete information of Reitmans’ transactions and events, some estimates are required so that the information is presented before their ultimate resolution. Taking It Further: The qualitative characteristic of faithful representation (under IFRS) and reliability (under ASPE) may be sacrificed if the estimates differ materially from actual results. Faithful representation and reliability involve completeness and accuracy of information, which is satisfied by disclosing information using estimates, but it also involves the concept that the information should be free from material error.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 1145B (a)

Air Canada prepared its financial statement using the cost model because it satisfied the going concern assumption for its operations.

(b)

Air Canada faces challenges but it is not insolvent, so not following the going concern assumption is premature and inappropriate. The company’s financial disclosure, such as its statement of earnings and balance sheet, will reflect the difficulties that the company is facing. A company has to be virtually certain that it will not continue operations in the near future in order to stop applying the going concern assumption.

Taking It Further: The full disclosure concept requires that the company provide information that can affect the financial health of a company. This disclosure involves the data in the financial statements as well as the accompanying notes. In the notes to its financial statements Air Canada is required to disclose the significant risks that it is subject to, such as interest rate, foreign exchange, liquidity, market, and fuel price risk.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-3B Privately owned companies reporting under ASPE should be given choices between different accounting methods to report certain events or transactions. Depending on the industry and financial environment in which the business operates, it might be worthwhile for the company to adopt an accounting policy or method that is consistent with that used by other companies in the same industry. Although this choice might require the business to incur additional costs, these costs are justified by making the performance measures of the business consistent with the industry, thereby enhancing comparability. On the other hand, if there is no reason for the adoption of a more complex and difficult method of accounting, the business should be allowed to choose the simpler method, based on the cost constraint, as long as the method allows for relevant and reliable information.

Taking It Further: Producing the financial information required under IFRS places a private company under significant financial burden because of the information systems required to accumulate the information, and the need to have sufficient knowledgeable personnel to prepare the information. In spite of the additional costs, a private company may choose to report under IFRS under different scenarios:  If it anticipates becoming a public company in the near future.  If it is a subsidiary of a public company using IFRS.  If it wants to access international markets and have comparable financial reporting.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-4B (a) and (b) 1.

Measurement criteria (cost basis). Recording the equipment at its estimated fair value would not be proper because estimated fair value in this case does not represent an exchange price. The purchase should be recorded at cost, not at a fair value that someone believes the equipment is worth. The correct entry is: Equipment................................................... Cash.....................................................

60,000 60,000

Measurement criteria (cost basis). Appreciation in value does not justify recognizing a gain on the land, until the land is sold (since Desktop has not adopted the revaluation model for accounting for its property, plant, and equipment). Appreciation does not involve an exchange transaction. No entry is necessary.

18,000

Expense recognition criteria (matching concept). The equipment should not be expensed immediately. Only costs which have no probable future benefits are recognized immediately as expenses. Therefore, the following entries are necessary:

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18,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-4B (Continued) (a) and (b) (Continued) 4. (Continued) Equipment................................................... Cash.....................................................

54,000

9,000 Depreciation Expense ($54,000  6) .......... Accumulated Depreciation—Equipment

54,000

9,000

Going concern assumption. The lower of cost and fair value is a conservative characteristic of accounting information. If a loss due to impairment is anticipated, it should be recorded immediately, rather than waiting until realized. But since the company will continue using the building in the foreseeable future, it is not intended to be sold, and the value is expected to increase in the future there does not appear to be an impairment. The adjustment should not be recorded. No entry is necessary.

Expense recognition criteria (matching concept). The marketing plan will be designed and implemented in 2014. To date, no revenue has been earned from the plan and no efforts spent to develop the plan. Therefore the marketing expense should be matched to revenue and recorded in 2014. No entry necessary.

Revenue recognition criteria. Desktop will not transfer ownership of the merchandise until January 2014. Therefore the revenue has not been earned in 2013 and it would be inappropriate for the company to record any revenue in 2013. No entry is necessary in 2013.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-4B (Continued) Taking It Further: The revaluation model of accounting for property, plant, and equipment is an alternative method under IFRS. Under the revaluation model, the carrying amount of the equipment can be adjusted to fair value. The revaluation model can be applied only to assets whose fair value can be reliably measured, and revaluations must be carried out often enough that the carrying amount is not materially different from the asset’s fair value at the balance sheet date.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5B (a) and (b) 1.

The entry violates the expense recognition criteria as cost of goods sold are not stated at cost. The cost basis is also violated concerning measurement of the merchandise inventory. Correcting entry required: Cost of Goods Sold .................................... Merchandise Inventory .......................

15,000 15,000

2. The sale should be recorded in the next year instead of the current year. Title to the inventory will not pass to the customer until next year. Therefore, the revenue recognition criteria would be violated if the sale is recorded in the current year. It should be noted that if the company is employing a perpetual inventory system in dollars and quantities, a debit to cost of goods sold and a credit to inventory are also necessary in the next year. Correcting entry required: Sales............................................................ Accounts Receivable .......................... Unearned Revenue .............................

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5B (Continued) (a) and (b) (Continued)

3. This entry violates the expense recognition criteria. Expenses are recognized when there is a decrease in an asset, in this case, prepaid insurance. The decrease in prepaid insurance will take place in the following year, as the insurance coverage is consumed. Correcting entry required: Prepaid Insurance ...................................... Insurance Expense .............................

24,000 24,000

4. The measurement criterion indicates that assets and liabilities are to be accounted for on the basis of cost. It should further be noted that the revenue recognition criteria provides the answer to when revenue (or a gain) should be recognized. Revenue should be recognized when it is earned. In this situation, an earnings process has definitely not taken place. Correcting entry required: Gain on Fair Value Adjustment of Equipment .......................................... Equipment ...........................................

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75,000 75,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-5B (Continued) (a) and (b) (Continued)

5. This violates the expense recognition criteria. Expenses are recognized when there is a decrease in an asset or an increase in a liability. Since utilities were used in December, an expense and a liability have been incurred and need to be recognized. Correcting entry required: Utilities Expense......................................... Accounts Payable ...............................

4,200 4,200

Taking It Further: No. For the majority of items, an accrual can be made by estimating the amount involved. This is possible by examining the expenses for recent months, or looking at the expense from the previous year. In some cases, an estimate may not be possible, but this would be a very rare circumstance. Usually, utilities may not be a material amount and the financial statements would not be materially misstated by omitting the expense and liability.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 1153B The revenue recognition criteria states that revenue cannot be recognized until it can be objectively measured. Since the production and sales effort is not substantially completed until the salmon matures and is sold, revenue cannot be measured and recognized until that point. Since no buyer is identified during the period of growth, Superior Salmon retains the risks and rewards of ownership until the fish are sold. Superior Salmon, as seller, has control over the goods and has continuing managerial involvement over the years of growth. In addition, collectability is not reasonably assured since the salmon are not sold, and no buyer is identified. Taking It Further: In accordance with the matching concept, the annual costs of feeding, monitoring and maintaining a healthy fish are unexpired costs because they have future revenue producing potential. They should be recorded on the balance sheet as inventory and recognized as part of the cost of goods sold in the same period that the revenue is recognized.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-7B Net sales to November 30, 2014 Add: Sales for December, 2014

$2,500,000 230,000 $2,730,000

Cost of goods sold to November 30, 2014 $1,500,000 Add: Cost of goods sold for Dec. 2014 138,000 $1,638,000 Warranty revenue to November 30, 2014 Add: Warranty services rendered Dec.

$15,000 10,000

$25,000

Service revenue to November 30, 2014 Add: Revenue for December, 2014 Less: Outstanding installation

$100,000 9,500 (1,200)

$108,300

Unearned revenue to November 30, 2014 Add: Collections for warranties Dec. 2014 Less: Warranty services rendered Dec.

$75,000 6,000 (10,000)

$71,000

Taking It Further: Sales commission expense should be accrued in the same period as the sale on which the commission is calculated. The fact that the commission is paid when the collection from the customer occurs does not change the need to match the expense to the revenue. The calculation of the amount of 31, 2014 commission expense to be accrued at December follows: Accounts receivable balance December 31, 2014 Less estimate of uncollectible receivables @ 2% Amount subject to 5% commission: Commission expense to accrue $186,200 × 5% =

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$190,000 3,800 $186,200 $ 9,310

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-8B (a)

I do not agree. For revenue to be recognized, collectability must be reasonably assured and all costs relating to the sale must be reliably measured. For this particular transaction, retailers can return the unsold vitamins up to March 31, 2014. Returns would reduce gross sales and accounts receivable. Vita X is a new product for the company and this form of promotion is new. This implies that Vitamins R Us does not have experience in determining the rate of return on this product or on the promotional extended right of return. Collectability may also be affected due to the extended payment terms provided to the retailers. Vitamins R Us does not have past experience to determine the increased risk from noncollection resulting from the extended payment terms. It is also not clear if the retailers have received the vitamins before December 31st since the goods were shipped during December on a FOB destination basis. This means that ownership is transferred when the retailers receive the product.

(b)

Revenue should be deferred until the right of return expires and payments are due on March 31, 2014.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-8B (Continued) Taking It Further: Yes. The same promotion on another product would give Vitamins R Us past experience to gauge the rate of return and collectability of outstanding receivables. Caution must be exercised however, when applying past experience. The same promotion used on another similar product may not yield the same results if other factors have changed. For example, due to changed economic conditions, sales of expensive vitamins to consumers may be significantly lower than in the past and affect the rate of return and collectability of receivables from retailers. Vitamins R Us needs to determine if historical rates of return apply to the current promotion. Another factor that might affect the business’ estimate for the rate of returns is the size and dollar value of the shipments. If Vitamins R Us concludes that it can reliably estimate the rate of return of the shipment of vitamins, it can record the revenue along with the accrual of estimated returns, when each shipment reaches its.

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PROBLEM 11-9B

Year

Costs Incurred

2012 2013 2014 2015 Totals

$ 24,000,000 18,000,000 30,000,000 48,000,000 $120,000,000

Percentage Complete During Year 20% 15% 25% 40%

$152,000,000 152,000,000 152,000,000 152,000,000

Year 2012 2013 2014 2015 Totals

$30,400,000 22,800,000 38,000,000 60,800,000 $152,000,000

Percentage Complete During Year

$120,000,000 120,000,000 120,000,000 120,000,000

Total Revenue

Revenue Recognized

Solutions Manual

Total Estimated Cost

–

Revenue Recognized $30,400,000 22,800,000 38,000,000 60,800,000 $152,000,000

Actual Cost Incurred $24,000,000 18,000,000 30,000,000 48,000,000 $120,000,000

11-57

20% 15% 25% 40%

Gross Profit Recognized $6,400,000 4,800,000 8,000,000 12,800,000 $32,000,000

Chapter 11

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-9B (Continued) Taking It Further: The revenue recognition criteria require that costs relating to the sale of the goods be reliably measured. Since MacNeil in no longer able to rely on the original estimate of total costs for the construction project, it cannot use the percentage of completion method to recognize revenue for this contract.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10B (a)

Financial statements help me as a potential partner in the business in my assessment of the business’s financial position, profitability and ability meet its financial obligations. With accurate and complete financial information, I can assess the impact the expansion plans will have on the financial performance of the business and determine if my investment can provide me with a return that is satisfactory based on the risks associated with making my investment.

(b) Current assets Less: Inventory already sold (3) Eliminate prepaid advertising (4) Revised current assets

$90,000 (35,000) (4,800) $50,200

Current liabilities Add: Unearned revenue from contract (1) Unearned warranty sales (2) Revised current liabilities

$65,000 22,000 10,000 $87,000

Net sales and consulting revenue

$650,000

Less: Reduce for unearned warranty sales (2) Less: Unearned Revenue (1)

(10,000)* (22,000)

Revised net sales and consulting revenue

$618,000

Total operating expenses Add: Advertising expense (4) Revised total operating expenses

$106,000 4,800 $110,800

* ($500 × 20)

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10B (Continued) 1. The service contract extends for a twelve month period and so 11 months or $22,000 remains unearned at December 31, 2014 ($24,000 × 11 ÷ 12).

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Accounting Principles, Sixth Canadian Edition

PROBLEM 11-10B (Continued) (b)

(Continued)

2. The cash obtained from the sale of extended warranties should not be included in revenue as no warranty services have yet been delivered to earn this revenue ($500 × 20). 3. Eugene has double counted the inventory items in accounts receivable and in inventory. The merchandise inventory was sold and so the recording of the sale and corresponding cost of goods sold is correctly recorded. The amount of the cost of the items sold must be removed from the inventory count and balance. 4. The promotional expense recorded as a prepaid expense must be expensed and there is no measurable future benefit realized as of December 31, 2014. Taking It Further: My review of the required revisions to Eugene Company’s financial statements lead to the recalculation of the current ratio below: Before adjustment

Current = ratio

$ 90,000 $ 65,000

1.38:1

After adjustment

Current = ratio

$ 50,200 $ 87,000

0.58: 1

As a result of the required adjustments, Eugene’s current ratio is considerably worse as it has reduced by from the initial 1.38 to 0.58. Since the adjustments that were required are in the same direction (reducing profit, decreasing current assets, and increasing current liabilities), there appears to be a bias in the errors made by Eugene. Whether the errors are intentional or not, I have concluded that the liquidity and profitability of Eugene Company does not warrant my investment. I would look into how Eugene has arrived at the pricing of the new extended warranty program, for any possible errors in the estimates used. Solutions Manual .

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CONTINUING COOKIE CHRONICLE (a)

1. Katy Paterson is not accounting for the revenue correctly. Although it is beneficial to a business to have an order to provide goods into the future, this does not constitute the earning of revenue. 2.

Katy Paterson is not accounting for purchase of baking supplies correctly. Since Katy has taken possession of the goods, she must recognize the liability for the purchase for the supplies based on the shipping terms of delivery.

The bank should be informed of the standing order for 1,500 cinnamon buns every week. This type of order is large and is also indicative of a steady source of revenue and cash flows for the future.

It is not clear if Katy does or doesn’t understand the consequences of her decision and if her goal in recording this revenue as earned on the income statement is to deceive the bank. As well, the treatment of the purchase of the supplies has the effect of showing an improved liquidity on the balance sheet from the postponement of the recording of the liability for the purchase. The conclusion to be reached is that Katy is being dishonest if she knowingly applied this accounting treatment with the sole purpose of deceiving the bank.

(b) Revenue will be earned when the goods will be delivered. Correspondingly, Katy’s customers will have an obligation to pay Katy for the goods when they are delivered and no earlier.

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CONTINUING COOKIE CHRONICLE (Continued) (c)

The purchase of baking supplies should be recorded based on the delivery terms of the shipment. Once Katy takes possession of the baking supplies, she should record the supplies and the corresponding accounts payable.

(d) Although the contractual arrangement with Coffee to Go is not a transaction that is reported on the financial statements, Katy could inform the bank of this order by showing some additional documentation concerning this order in her application for the loan.

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CUMULATIVE COVERAGE—CHAPTERS 6 TO 11 (a)

Information on the two companies’ accounting principles would be found in the first or second note to the financial statements. It is in the note on significant accounting policies that you would learn what inventory cost formula the company used, what depreciation method, including rates of depreciation or useful lives, and any significant estimates made by each company.

(b)

Johan Company

Nordlund Company

Cash Accounts receivable Allowance for doubtful accounts Merchandise inventory Total current assets

$ 70,300 309,700 (13,600) 477,000 843,400

$ 48,400 312,500 (20,000) 520,200 861,100

Property, plant, and equipment Accumulated depreciation (1) Net property, plant, and equipment

255,300 (188,374) 66,926

257,300 (189,850) 67,450

Total assets

$910,326

$928,550

Current liabilities Long-term liabilities Total liabilities

$440,200 78,000 518,200

$436,500 80,000 516,500

Owner’s equity (2)

392,126

412,050

Total liabilities and owner’s equity

$910,326

$928,550

Note: Supporting calculations are shown on the next page.

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CUMULATIVE COVERAGE (Continued) (b) (Continued)

Calculations (1) Accumulated depreciation—Johan:

Year 1 2 3 4 5 6

Carrying Amount $255,300 204,240 163,392 130,714 104,571 83,657

DiminishingBalance Rate (10% × 2) 20% 20% 20% 20% 20% 20%

Depreciation Expense $51,060 40,848 32,678 26,143 20,914 16,731

Accumulated Depreciation $ 51,060 91,908 124,586 150,729 171,643 188,374

(2) Owner’s equity: Johan: $454,750 + $13,100 ($477,000 – $463,900) change in inventory value – $75,724 ($188,374 – $112,650) change in accumulated depreciation = $392,126 Nordlund: $432,050 – $20,000 allowance for doubtful accounts = $412,050

(c) The quality of accounting information has increased for both companies. Better comparisons can now be made between the two businesses as there is now some consistency in the way in which the accounting policies have been applied and in the way in which the estimates have been arrived at. Users of the information will not be unduly influenced by the amounts reported that may be biased - based completely on the choices of accounting policies and the use of estimates.

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BYP 11-1 FINANCIAL REPORTING PROBLEM (a)

Reitmans (Canada) Limited reports its short-term investments in marketable securities at their fair value because this basis of measurement is required under IFRS followed by Reitmans and because this is a more relevant measure for these particular assets which are expected to be sold in the near future.

(b)

Revenue is recognized from the sale of merchandise when a customer purchases and takes delivery of the merchandise. Reported sales are net of returns and estimated possible returns and exclude sales taxes. Gift cards sold are recorded as deferred revenue and revenue is recognized when the gift cards are redeemed. An estimate is made of gift cards not expected to be redeemed based on the terms of the gift cards and historical redemption patterns. Loyalty points and awards granted under customer loyalty programs are recognized as a separate component of revenue, and are deferred at the date of initial sale. Revenue is recognized when the loyalty points and awards are redeemed and the Company has fulfilled its obligation. The amount of revenue deferred is measured based on the fair value of loyalty points and awards granted, taking into consideration the estimated redemption percentage. The policies on revenue recognition do seem reasonable given the nature of gift cards and loyalty point programs and are in conformity with the revenue recognition criteria set out in GAAP.

(c)

The disclosure provided in Note 23 on Credit Facility is required as a result of the full disclosure principle. The information provides relevant information to users of the financial statements concerning Reitmans’ ability to meet it short term liquidity and financing needs.

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BYP 11-1 (Continued) (d)

The auditors’ report adds credibility to Reitmans’ financial statements for users such as creditors and shareholders. In the last paragraph of their report, the auditors expressed the opinion that “the financial statements presented fairly, in all material respects, the financial position of Reitmans (Canada) Limited as at January 28, 2012, January 29, 2011 and January 31, 2010 and its financial performance and its cash flows for the years ended January 28, 2012, January 29, 2011 in accordance with International Financial Reporting Standards.”

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BYP 11-2 INTERPRETING FINANCIAL STATEMENTS (a)

Besides the owners, additional users of McCain’s financial statements include creditors and government entities such as the Canada Revenue Agency.

(b)

Since the vast majority of countries throughout the globe follow IFRS, it is most cost effective for McCain to adopt and follow IFRS.

(c)

In spite of the fact that McCain Foods Limited is a private company and is therefore not required to prepare financial statements in accordance with International Financial Reporting Standards, management has chosen to do so to enhance its ability to make comparison of its performance with other multinational companies that are public companies. As well, if at any time in the future McCain chooses to go public, or sells the business to an international public company already using IFRS, this decision will not cause any difficulty or delay in implementation because of the financial reporting standards followed for historical financial information.

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BYP 11-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resources site accompanying this textbook.

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Accounting Principles, Sixth Canadian Edition

BYP 11-4 COMMUNICATION ACTIVITY MEMO To:

President of Junk Grrlz

From:

Accountant

Re:

Revenue Recognition

The purpose of this memorandum is to provide you with my advice as to (a) when to recognize the revenue from the sale of real animal fur costs to Cheap But Good, and (b) the way in which these inventory of fur coats should be reported in the financial statements of Junk Grrlz for the year ending September 30, 2014.

(a)

In arriving at a reasonable conclusion as to when to recognize revenue on the transaction with Cheap But Good, some important factors need to be taken into account. You have provided Cheap But Good a very generous return policy and arrangement for payment. No orders have been received in the last year for real fur coats. It is unlikely that you can reasonably estimate how many of the coats will be returned by Cheap But Good. In order to be fair, you cannot predict the likely results from the transaction with Cheap But Good at this time. Consequently, you will need to postpone the revenue recognition until Cheap But Good actually sells the real fur coats and pays you for their purchase. This approach would be a similar treatment to a consignment sale.

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BYP 11-4 (Continued) (b)

Also similar to the treatment of a consignment sale will be the treatment of inventory of real fur coats on your balance sheet at September 30, 2014. The items should be reported as the lower of cost or the net realizable value of the items. Should Cheap But Good succeed in selling all of the coats, you will realize a gross profit on the sale. On the other hand, if no sales are made, the items of inventory might not have any realizable value by the end of your agreement with Cheap But Good, which is December 31, 2014. You will need to estimate the probability of these two results. If you are not optimistic of Cheap But Good’s potential for obtaining sales, you will need to write-down the value of the inventory to the best estimate of what you believe you will ultimately be able to obtain for these real fur coats.

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ETHICS CASE

(a) The stakeholders in this situation are: Carol DesChenes, accountant. Vice-president, Finance of Grocery Online All readers and users of Grocery Online’s financial statements, including the company’s shareholders. (b) It is neither illegal nor professionally unethical to adopt a new accounting recommendation early, nor to delay its implementation until the required date. However, since the new recommendation results in a much fairer presentation of Grocery Online's financial condition, early adoption might be beneficial to the shareholders. (c) Carol appears to have little to gain except the satisfaction of issuing a set of financial statements that apparently result in a much fairer presentation of the company's financial condition and performance. Because it affects profit, the decision concerning the implementation date will primarily affect the shareholders. Managers whose remuneration is based on profit may be adversely affected by early implementation. Other parties with a financial interest in the company will also be affected, to a lesser extent.

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BYP 11-6 “ALL ABOUT YOU” ACTIVITY (a) The bank is in the business to make profit for its shareholders at the least amount of risk. What the banker is trying to determine is what type of risk the bank is facing if they lend you money to purchase a car. To do this, the bank needs to determine your ability to repay the loan and the interest on the loan, when the amounts are due. The cash budget will tell the bank what kind of revenues and costs you expect to have during the loan period and when the corresponding cash inflows and outflows will occur. The second report will determine the amount of resources and obligations you will have at your disposal during the loan period. (b) In order for the bank manager to have confidence in you as a client, your financial information has to be complete and accurate. The qualitative characteristics of reliability and faithful representation best describe what the expectations of the bank manager are concerning the information you provide. As well, the information has to be verifiable. (c) The cash flow budget is part of your loan application and will provide information about what future cash inflows and outflows you are expected to experience. For example, when you provide information about your salary, the banker will likely ask you for a pay stub as evidence of the salary level you have provided in the loan application. If you have other sources of income, your personal income tax return might be used to provide evidence of the cash flows from additional sources of income. (d) If it is determined that the statements you have made in your loan application are false or misleading, the bank manager will surely deny you the loan. An example of misleading information is your claim to ownership of a home, which upon investigation, using a title search, reveals is owned jointly with someone else. Solutions Manual .

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CHAPTER 12 Accounting for Partnerships ASSIGNMENT CLASSIFICATION TABLE

Exercises

Problems Set A

Problems Set B

1, 6

5, 6, 7

2, 3

2, 6, 12

3. Allocate and record profit or loss to partners.

8, 9, 10

4, 5, 6, 7, 8

3, 4, 5, 6

3, 4, 5, 6, 9, 12

4. Prepare partnership financial statements.

11, 12, 13

5, 6

2, 3, 4, 5, 6, 12

5. Account for the admission of a partner.

14, 15, 16

10, 11

7, 8

7, 9, 12

6. Account for withdrawal of a partner.

17, 18, 19

12, 13,

9, 10

8, 9, 12

7. Account for liquidation of a partnership.

20, 21, 22, 23

14, 15, 16

11, 12, 13, 10, 11 14

10, 11

Study Objectives

Questions

1. Describe the characteristics of the partnership form of business organization.

1, 2, 3, 4

2. Account for the formation of a partnership.

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Discuss advantages and disadvantages of partnerships and partnership agreements.

Simple

10-15

Record formation of partnership and prepare balance sheet.

Simple

30-40

Calculate and record division of profit. Prepare statement of partners’ equity.

Moderate

30-40

Calculate division of profit or loss. Prepare income statement, statement of partners’ equity, and closing entries.

Moderate

25-35

Prepare financial statements and closing entries.

Moderate

30-40

Moderate

30-40

Prepare entries to form a partnership, allocate profit, and close temporary account; prepare financial statements. Record admission of partner.

Moderate

20-20

Record withdrawal of partner.

Moderate

20-20

Record withdrawal and admission of partner; allocate profit.

Complex

25-35

10A

Prepare and post entries for partnership liquidation.

Moderate

20-30

11A

Record liquidation of partnership.

Moderate

30-40

12A

Account for the formation of a partnership, allocation of profits, and withdrawal and admission of partners; prepare partial balance sheet. Discuss advantages and disadvantages of partnerships and partnership agreements. Record formation of partnership and prepare balance sheet.

Complex

40-50

Simple

10-15

Simple

30-40

Calculate and record division of profit. Prepare statement of partners’ equity.

Moderate

Calculate division of profit or loss. Prepare income statement, statement of partners’ equity, and closing entries.

Moderate

1B 2B

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare financial statements and closing entries.

Moderate

30-40

Moderate

30-40

Prepare entries to form a partnership, allocate profit, and close temporary account; prepare financial statements. Record admission of partner.

Moderate

20-20

Record withdrawal of partner.

Moderate

20-30

Record withdrawal and admission of partner; allocate profit.

Moderate

25-35

10B

Prepare and post entries for partnership liquidation.

Moderate

20-30

11B

Record liquidation of partnership.

Moderate

25-35

12B

Account for the formation of a partnership, allocation of profits, and admission and withdrawal of partners; prepare partial balance sheet.

Complex

40-50

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objective 1. Describe the characteristics of the partnership form of business organization. 2. Account for the formation of a partnership.

Knowledge Q12-3 Q12-4 BE12-1

Comprehension Q12-1 Q12-2 P12-1A P12-1B

Q12-5 Q12-6 Q12-7

Application P12-6A P12-6B

BE12-2 BE12-3 E12-2 P12-2A P12-6A

P12-12A P12-2B P12-6B P12-12B

Allocate and record profit or loss to partners.

Q12-8 Q12-9 Q12-10

BE12-4 BE12-5 BE12-6 BE12-7 BE12-8 E12-3 E12-4 E12-5 E12-6

Prepare partnership financial statements.

Q12-11 Q12-12 Q12-13

BE12-9 E12-5 E12-6 P12-2A P12-3A P12-4A P12-5A

Account for the admission of a partner.

Q12-15 Q12-16

Q12-14 BE12-10 BE12-11 E12-7 E12-8 P12-7A

P12-3A P12-4A P12-5A P12-6A P12-9A P12-12A P12-3B P12-4B P12-9B P12-12B P12-6A P12-12A P12-2B P12-3B P12-4B P12-5B P12-6B P12-12B P12-9A P12-12A P12-6B P12-7B P12-9B P12-12B

Account for the withdrawal of a partner.

Q12-17 Q12-18 Q12-19

BE12-12 BE12-13 E12-9 E12-10 P12-8A

P12-9A P12-12A P12-8B P12-9B P12-12B

Account for the liquidation of a partnership.

Q12-21

Q12-20 Q12-22 Q12-23

BE12-14 BE12-15 BE12-16 E12-11 E12-12 E12-13

E12-14 P12-10A P12-11A P12-10B P12-11B

BPY12-2

BYP12-1

BYP12-3 BYP12-6 Continuing Cookie Chronicle

Broadening Your Perspective

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12-4

Analysis E12-1

Synthesis Evaluation

BYP12-4

BYP12-5

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Accounting Principles, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

The advantages of a partnership are: (1) combining skills and resources of two or more individuals, (2) ease of formation, (3) relatively free from governmental regulations and restrictions, and (4) ease of decision-making. Disadvantages are: (1) mutual agency, (2) limited life, and (3) unlimited liability.

Each partner is jointly and severally liable for all partnership liabilities. Harjinder should be concerned with the possibility that the business does not succeed and there are insufficient assets to pay all debt outstanding. If this happens, the creditors could then make claims against the personal assets of the partners. In this case, Harjinder has more assets to lose than his partner Gurprinder, who is less cautious about handing expenses.

Other forms of partnership organization include limited partnerships and limited liability partnerships. In a limited partnership, one or more of the partners have unlimited liability. This type of partner is called a general partner. General partners are normally actively involved in the business. One or more other partners, called limited partners, have liability that is limited to the amount of capital they have contributed to the partnership. Normally, limited partners contribute assets to the business but are not actively involved in it. Limited liability partnerships are designed to protect innocent partners from actions of the other partners that result in lawsuits against the partnership. Partners have unlimited liability for their own negligence but limited liability for negligence of the other partners.

(a) The partnership agreement should contain basic information such as the name and location of the firm, the purpose of the business, and the date of inception. In addition, the agreement should specify the names and capital contributions of the partners, the rights and duties of the partners, the basis for sharing profit or loss, provisions for withdrawal of assets, procedures for settling disputes, procedures for withdrawal or admission of a partner, the rights and duties of a surviving partner if a partner dies, and procedures for liquidating a partnership. (b) If a partnership agreement is not written, the provisions of the Partnership Act will apply to the partnership. This could include equal sharing of profit and loss, amongst other provisions, which may not meet the requirements and needs of the partners.

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QUESTIONS (Continued) 5.

(a)

The value of the partners’ investment would equal the fair value of the contributed assets at the date of their transfer to the partnership.

(b) This is consistent with the cost principle because fair value represents the cost, or amount given up by the partnership, to acquire these assets. 6.

When a partner contributes equipment as his initial investment, any depreciation that has accumulated on the equipment and recorded in a previous business is not part of the investment transaction. Since the equipment is invested into a new business at its fair value, the investment is treated the same way as the purchase of a used asset. The equipment has not yet been used by the partnership so there is no accumulated depreciation.

When the accounts receivable are transferred into the partnership, they should be recorded at their realizable value. In the case of Naheed’s accounts receivable, although they total $8,000 their realizable value is only $6,000. Consequently, the amount recorded as accounts receivable will be the full $8,000 but that amount will be reduced by an allowance for doubtful accounts of $2,000 in Naheed’s investment entry. Similarly, Franca’s accounts receivable should be recorded at $8,000 but reduced by the allowance for doubtful accounts amount of $1,000 for a net realizable value of $7,000.

Hark and Green should not wait to see who has worked the hardest before agreeing on how to share the profit of their partnership. Although this allows for the flexibility of using hindsight in applying some sort of salary allowance formula in their profit allocation, it also has the disadvantage of allowing a dispute to happen in the future, at which time there will be no opportunity to rectify the agreement on profit allocation.

There is no direct relationship between a salary allowance for allocating profit among partners and partners’ cash withdrawals. While withdrawals reduce the capital balance of a partner, they are not used in profit allocation formulas, the way salary allowance can be used. A salary allowance is used when allocating profit to the partners and is intended to reward a partner for efforts he puts forth for the business.

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 10. Salary expense and interest expense are elements of the income statement and represent reductions of profit before it is allocated to the partners. Salary allowance and interest allowance are part of the process of allocating the profit to the partners, and are not elements of the income statement. Salary allowance is a means of recognizing levels of effort put forth by the partners in earning profit. Interest allowance rewards partners for their levels of investment in the partnership, based on the capital account balances. 11. The statement of partner’s equity has the same content as the statement of owner’s equity except that it contains the details of all the changes in each partner’s capital as well as the changes in total for the partnership. These changes include: investments, profits, losses and drawings. 12. The statement of income of a partnership does not include the details of how the profit or loss is divided among the partners. Instead, the statement of partners’ equity is used to show this information. 13. The equity section of a partnership’s balance sheet does not show the total amount invested by the partners separate from the profit earned to date and retained in the business. Rather, that distinction for the current fiscal year (between investments and profit) is outlined in the statement of partners’ equity. Once added (or deducted in the case of a loss) to each partner’s capital account balance, the distinction between the sources of changes is no longer tracked in the subsequent financial statements of the partnership. Only the balances of the capital accounts of each partner carry forward to the next fiscal year. 14. When an admission of a new partner into a partnership occurs as a result of a purchase of an existing partner’s interest, the net assets and corresponding total partners’ equity of the partnership will remain unaffected. If the interest is purchased with an additional investment of assets in the partnership, net assets and corresponding total partners’ equity will increase by the amount of the investment. 15. Partnership net assets increase $25,000. R. Minoa’s capital balance will not necessarily be $25,000. No, R. Minoa does not necessarily acquire a 1/6 profit and loss ratio. Profit and loss will be divided according to what is stated in the partnership agreement. If no division is specified, profit or loss is divided evenly.

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QUESTIONS (Continued) 16. Existing partners may be willing to pay a bonus to a new partner because the new partner may bring in a strong potential to increase profit in the future. For example, the new partner may bring goodwill he has generated in the past from a strong relationship with clients he is bringing to the business. 17. (a) There is no impact on the net assets or total capital on the partnership balance sheet if a withdrawing partner is paid from personal assets of remaining partners. In the equity section, the withdrawing partner’s capital account will be removed, and its balance added to one or more of the remaining partners’ capital accounts. (b)

If the withdrawing partner is paid from partnership assets, the net assets and the total capital of the partnership will decrease.

18. A bonus to the remaining partners occurs when the cash paid to the departing partner is less than the balance in their capital account. The departing partner may grant such a bonus to the remaining partners if the partners feel that the recorded assets are overvalued, if the partnership has a poor earnings record, or if the partner is anxious to leave the partnership. 19. The purpose of obtaining life insurance is to ensure that the partnership has sufficient funds to settle with the deceased partner’s estate and to spend money recruiting and attracting another partner as a replacement. 20. Liquidation of a partnership ends both the legal and economic life of the organization. In the dissolution of a partnership, the economic life of the organization continues. 21. The steps to liquidate a partnership are: (1) (2) (3) (4)

Solutions Manual .

Sell noncash assets for cash and recognize any gain or loss on realization. Allocate any gain or loss on realization to the partners, based on their profit and loss ratios. Pay partnership liabilities in cash. Distribute the remaining cash to partners, based on their capital balances.

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QUESTIONS (Continued) 22. If the partner with the capital deficiency pays the amount owed to the partnership, the deficiency is eliminated. The remaining cash is then distributed to the partners, based on their capital balances. If the partner with the deficiency is unable to pay the amount owed, the other partners must absorb the loss. This loss is allocated to the remaining partners in the ratio of their profit allocation formula. The remaining cash is then distributed to the partners, based on their reduced capital balances. 23. No, Joe is not correct. All gains and losses on liquidation should be allocated to the partners on the basis of their profit and loss sharing ratio. However, final cash distributions should be based on their capital balances.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

8 Limited liability partnership 9 General partnership 1 Profit and loss ratio 2 Admission by investment 6 Withdrawal by payment from partners’ personal assets 4 Mutual agency 5 Salary allowance 10 Partnership dissolution 7 Capital deficiency 3 Partnership liquidation

BRIEF EXERCISE 12-2 July 1

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Cash .................................................... 10,000 Equipment .......................................... 4,000 R. Black, Capital ............................ Accounts Receivable ......................... 2,400 Cash .................................................... 12,000* Allowance for Doubtful Accounts B. Rivers, Capital ........................... *[$14,000 – ($2,000 – $400) = $12,000

12-10

14,000

400 14,000

Chapter 12

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-3 BLACK RIVER PARTNERSHIP Balance Sheet (partial) July 1, 2014 (a) Assets Current assets Cash ............................................................................. $22,000 Accounts receivable ....................................... $2,400 Less: Allowance for doubtful accounts ....... 400 2,000 Total current assets ...................................... 24,000 Property, plant, and equipment Equipment ................................................................... 4,000 Total assets.................................................................. $28,000 (b) Partners’ Equity R. Black, capital ........................................................... $14,000 B. Rivers, capital........................................................... 14,000 Total partners’ equity .................................................. $28,000

BRIEF EXERCISE 12-4 (a)

Proportions 2:1

Fractions 2/3 & 1/3

Percentages 66.67% & 33.33%

(b)

6:4

3/5 & 2/5

60% & 40%

(c)

3:8

3/11 & 8/11

27.27% & 72.73%

4/9 & 3/9 & 2/9

44.45% & 33.33% & 22.22%

¼&½&¼

25% & 50% & 25%

(d)

4:3:2

(e)

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BRIEF EXERCISE 12-5 (a) A. Scrimger D. Woods (b)

$84,000 × 37.5% = $31,500 $84,000 × 62.5% = $52,500

Income Summary ........................................ 84,000 A. Scrimger, Capital................................ D. Woods, Capital ...................................

31,500 52,500

A. Scrimger, Capital .................................... 35,000 D. Woods, Capital ........................................ 35,000 A. Scrimger, Drawings ........................... D. Woods, Drawings ...............................

35,000 35,000

BRIEF EXERCISE 12-6 MET CO. Division of Profit M. TungJ. Moses T. Eaton Ching Total Profit ..................................... $70,000 Salary allowance J. Moses ........................... $24,000 T. Eaton ........................... $30,000 M. Tung-Ching.................. $5,000 Total ............................. 59,000 11,000 Profit remaining for allocation Fixed ratio 5,500 J. Moses ($11,000 × 50%) T. Eaton ($11,000 × 30%) . 3,300 M. Tung-Ching ($11,000 × 20%) 2,200 11,000 Total ............................. Profit remaining for allocation $ 0 Profit allocated to partners.. $29,500 $33,300 $7,200 $70,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-7 THE MILLSTONE PARTNERSHIP Division of Profit Year Ended February 28, 2014 H. Mills

S. Stone

Total $60,000

Profit................................................. Salary allowance H. Mills .......................................... $45,000 S. Stone ....................................... $25,000 Total ........................................ 70,000 Profit (deficiency) remaining for allocation ............. (10,000) Interest allowance H. Mills ($72,000 × 5%)................ 3,600 S. Stone ($47,000 × 5%) .............. 2,350 Total ........................................ 5,950 Profit (deficiency) remaining for allocation ............. (15,950) Fixed ratio H. Mills [$(15,950) × 50%] ............... (7,975) S. Stone [$(15,950) × 50%].......... (7,975) Total ........................................ (15,950) Profit (deficiency) remaining for allocation ............. $ 0 Profit allocated to the partners....... $40,625$19,375 $60,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-8 (a) TOGNAZZINI COMPANY Division of Profit – Oct. 31, 2014 Tognazzini Total Lilia Terry Loss.................................................. $(15,000) Salary allowance L. Tognazzini ................................ $25,000 T. Tognazzini ............................... $16,000 41,000 Total ........................................ (56,000) Deficiency remaining for allocation Interest allowance L. Tognazzini ............................... 5,000 T. Tognazzini ............................... 9,000 14,000 Total ........................................ (70,000) Deficiency remaining for allocation Fixed ratio L. Tognazzini [$(70,000) × 75%] . (52,500) T. Tognazzini [$(70,000) × 25%] . (17,500) (70,000) Total ........................................ Loss remaining for allocation ........ $ 0 Loss allocated to the partners........ $(22,500) $7,500 $(15,000)

(b)

A. Scrimger, Capital ..................................... 22,500 D. Woods, Capital........................................ Income Summary....................................

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7,500 15,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-9 (a) DRS. JARRATT AND BRAMSTRUP Income Statement Year Ended April 30, 2014 Service revenue ................................................................ $375,000 Operating expenses ......................................................... 145,000 Profit.................................................................................. $230,000 (b) DRS. JARRATT AND BRAMSTRUP Statement of Partners’ Equity Year Ended April 30, 2014

Capital, May 1, 2013 .................... Add: Profit.................................... Less: Drawings............................ Capital, April 30, 2014 .................

Solutions Manual .

12-15

W. M. Jarratt Bramstrup Total $ 35,000 $ 50,000 $ 85,000 115,000 115,000 230,000 150,000 165,000 315,000 125,000 120,000 245,000 $ 25,000 $ 45,000 $ 70,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-9 (Continued) DRS. JARRATT AND BRAMSTRUP Balance Sheet April 30, 2014 Assets Current assets Cash................................................................ Property, plant, and equipment Equipment ...................................................... $75,000 Less: Accumulated depreciation .................. 15,000 Total assets ........................................................

$35,000

60,000 $95,000

Liabilities and Partners’ Equity Current liabilities Accounts payable .......................................... Partners’ equity W. Jarratt, capital ........................................... $25,000 M. Bramstrup, capital .................................... 45,000 Total liabilities and partners’ equity .................

Solutions Manual .

12-16

$25,000

70,000 $95,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-10 (a) June 9 K. Carter, Capital .............................. 18,000 D. Dutton, Capital ........................ ($36,000 × ½ = $18,000)

18,000

(b) June 9 A. Ali, Capital.................................... 15,000 D. Dutton, Capital ........................ ($30,000 × ½ = $15,000)

15,000

BRIEF EXERCISE 12-11 (a) Investment of $40,000 Oct. 1 Cash .................................................... 40,000 J. Edie, Capital (62.5% × $8,000*) ........ 5,000 K. Zane, Capital (37.5% × $8,000*) ....... 3,000 J. Kerns, Capital (40% × $120,000)

48,000

* [($40,000 + $48,000 + $32,000) × 40%] – $40,000 = $8,000 (b) Investment of $60,000 Oct. 1 Cash .................................................... 60,000 J. Edie, Capital (62.5% × $4,000*) K. Zane, Capital (37.5% × $4,000*) J. Kerns, Capital (40% × $140,000)

2,500 1,500 56,000

* [($60,000 + $48,000 + $32,000) × 40%] – $60,000 = $(4,000)

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-12 (a) Dec. 31

T. Morden, Capital ......................... 25,000 R. Neepawa, Capital ................ S. Altona, Capital ....................

12,500 12,500

(b) Same journal entry as part (a). Regardless of the amount paid for T. Morden’s capital, the entry to record T. Morden’s withdrawal from the partnership would remain the same. (c) Dec. 31

T. Morden, Capital ......................... 25,000 R. Neepawa, Capital ................

25,000

BRIEF EXERCISE 12-13 (a) T. Morden receives $35,000 cash Dec. 31 T. Morden, Capital ......................... 25,000 R. Neepawa, Capital (62.5% × $10,000) .................... 6,250 S. Altona, Capital (37.5% × $10,000) .................... 3,750 Cash .........................................

35,000

(b) T. Morden receives $20,000 cash Dec. 31 T. Morden, Capital ......................... 25,000 R. Neepawa, Capital (62.5% × $5,000) S. Altona, Capital (37.5% × $5,000) Cash .........................................

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3,125 1,875 20,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-14 (a) Nov. 15 Cash .................................................... 20,000 Other Assets .................................. Gain on Realization........................

17,000 3,000

(b) Nov. 15 Gain on Realization ............................ D. Dupuis, Capital (1/3 × $3,000) ... V. Dueck, Capital (1/3 × $3,000)..... B. Veitch, Capital (1/3 × $3,000) ....

3,000 1,000 1,000 1,000

(c) Nov. 15 D. Dupuis, Capital ($12,000 + $1,000) 13,000 V. Dueck, Capital ($10,000 + $1,000) . 11,000 B. Veitch, Capital ($3,000 + $1,000) ... 4,000 Cash ($8,000 + $20,000).................

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28,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-15 (a) Nov. 15 Cash ................................................... 14,000 Loss on Realization............................ 3,000 Other Assets ..................................

17,000

(b) Nov. 15 D. Dupuis, Capital (1/3 × $3,000)........ V. Dueck, Capital (1/3 × $3,000) ......... B. Veitch, Capital (1/3 × $3,000) ......... Loss on Realization .......................

1,000 1,000 1,000 3,000

(c) Nov. 15 D. Dupuis, Capital ($12,000 – $1,000) 11,000 V. Dueck, Capital ($10,000 – $1,000) . 9,000 B. Veitch, Capital ($3,000 – $1,000) ... 2,000 Cash ($8,000 + $14,000).................

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22,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 12-16 (a) (1) Apr. 30 Cash ................................................. 4,000 G. Lodge, Capital ...................... (2)

4,000

30 L. McDonald, Capital ..................... 20,000 A. Norin, Capital............................. 24,000 Cash ($40,000 + $4,000) ............

44,000

(1) Apr. 30 L. McDonald, Capital ($4,000 × 3/5) ............................. 2,400 A. Norin, Capital ($4,000 × 2/5) ............................. 1,600 G. Lodge, Capital ......................

4,000

(b)

(2)

Solutions Manual .

30 L. McDonald, Capital ($20,000 – $2,400)...................... 17,600 A. Norin, Capital ($24,000 – $1,600)...................... 22,400 Cash ...........................................

40,000

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 12-1 1.

Since Angelique and David are only planning on operating the business for the summer, a partnership would probably be the best form of business organization. A partnership is easy to form and relatively free from government regulation and restriction, which would make it easy to operate during their summer break.

Since Joe and Cathy will need to raise funds in the next year, it would probably be advisable for them to operate their business as a corporation. While a new private corporation may have the same amount of difficulty as a partnership in raising capital, as shareholders of the corporation, Joe and Cathy will be personally liable for only the amounts they have invested in the business and the amount of loans they personally guarantee. If the business were to find itself in financial difficulty, Joe and Cathy would be held personally liable for all of the debt of the business if they were to operate it as a partnership.

A partnership would work for these professors but to avoid liability resulting from the negligence of the other partners, a limited liability partnership may be the best form of organization for this business.

A limited partnership may be appropriate, particularly if the venture is set up as a real estate investment trust. Myles would be a general partner, and the large amount of capital could be raised from the other investors who would be limited partners. Another option would be a corporation.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-2 (a) Jan. 1

Jan. 1

Cash......................................................... 10,000 Equipment ............................................... 6,000 Hollis Sourman, Capital .....................

16,000

Cash......................................................... 7,000 Accounts Receivable.............................. 6,500 Allowance for Doubtful Accounts ..... Heidi Sweetgrass, Capital..................

1,500 12,000

(b) SOUR AND SWEET PARTNERSHIP Balance Sheet (partial) January 1, 2014 Assets Current assets Cash................................................................ Accounts Receivable ....................................... $6,500 Less Allowance for doubtful accounts ........ 1,500 Total current assets .................................. Property, plant, and equipment Equipment ...................................................... Total assets ...............................................

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12-23

$17,000 5,000 22,000 6,000 $28,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-3 (a) (1) HUMA AND HOW Division of Profit Year Ended June 30, 2015 R. Huma Profit................................................. Salary allowance R. Huma ....................................... $30,000 W. How ....................................... Total ........................................ Profit remaining for allocation ....... Interest allowance R. Huma ($60,000 × 5%).............. 3,000 W. How ($55,000 × 5%) ............... Total ........................................ Profit remaining for allocation ....... Fixed ratio R. Huma ($12,250 × 60%)............ 7,350 W. How ($12,250 × 40%) ............. Total ........................................ Profit remaining for allocation ....... Profit allocated to the partners....... $40,350

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12-24

W. How

Total $70,000

$22,000 52,000 18,000

2,750 5,750 12,250

4,900 12,250 $ 0 $29,650 $70,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-3 (Continued) (a) (Continued) (2) HUMA AND HOW Division of Profit Year Ended June 30, 2015 R. Huma Profit................................................. Salary allowance R. Huma ....................................... $30,000 W. How ....................................... Total ........................................ Profit remaining for allocation ....... Interest allowance R. Huma ($60,000 × 5%).............. 3,000 W. How ($50,000 × 5%) ............... Total ........................................ Profit (deficiency) remaining for allocation ............ Fixed ratio R. Huma ($2,750 × 60%).............. (1,650) W. How ($2,750 × 40%) ............... Total ........................................ Profit remaining for allocation ....... Profit allocated to the partners....... $31,350

W. How

Total $55,000

$22,000 52,000 3,000

2,750 5,750 (2,750)

(1,100) (2,750) $ 0 $23,650 $55,000

(b) (1) June 30 Income Summary........................... 70,000 R. Huma, Capital ....................... W. How, Capital .........................

40,350 29,650

(2) June 30 Income Summary........................... 55,000 R. Huma, Capital ....................... W. How, Capital .........................

31,350 23,650

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-4 (a) BRODSKY AND LEIGH Division of Loss D. Brodsky J. Leigh Total Loss.................................................. $(15,000) Salary allowance D. Brodsky ................................... $60,000 J. Leigh ....................................... $40,000 Total ........................................ 100,000 Deficiency remaining for allocation (115,000) Interest allowance D. Brodsky ($62,000 × 8%) ......... 4,960 J. Leigh ($88,000 × 8%)............... 7,040 Total ........................................ 12,000 Deficiency remaining for allocation (127,000) Fixed ratio D. Brodsky ($127,000 × 55%) ....... (69,850) J. Leigh ($127,000 × 45%)........... (57,150) Total ........................................ (127,000) Loss remaining for allocation ......... $ 0 Loss allocated to the partners.......... $(4,890) $(10,110) $(15,000) (b) D. Brodsky, Capital.......................................... 4,890 J. Leigh, Capital ............................................. 10,110 Income Summary ................................

15,000

(c) Had there not been a partnership agreement in place to outline how the profit and loss would be allocated to each partner, any profit or loss would be shared equally.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-5 (a) COPPERFIELD DEVELOPMENTS Statement of Partners’ Equity Year Ended December 31, 2014

A. E. Rodriguez Carrieri Total Capital, January 1........................ $61,000 $79,000 $140,000 Add: Investment .......................... 4,000 4,000 Profit............................................. 33,000 * 44,000 ** 77,000 94,000 127,000 221,000 Less: Drawings............................ 32,000 55,000 87,000 Capital, December 31 .................. $62,000 $72,000 $134,000 * $77,000 × 3/7 = $33,000 ** $77,000 × 4/7 = $44,000 (b) COPPERFIELD DEVELOPMENTS Balance Sheet (partial) December 31, 2014 Partners' equity Alvaro Rodriguez, capital ............................................... $62,000 Elisabetta Carrieri, capital ........................................... 72,000 Total partners' equity ........................................................ $134,000 (c)

Income Summary ........................................ 77,000 A. Rodriguez, Capital.............................. E. Carrieri, Capital ..................................

33,000 44,000

A. Rodriguez, Capital .................................. 32,000 E. Carrieri, Capital ....................................... 55,000 A. Rodriguez, Drawings ......................... E. Carrieri, Drawings ..............................

32,000 55,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-6 (a) DRS. KOVACIK AND DONOVAN Income Statement Year Ended November 30, 2014 Fees earned ...................................................................... $422,000 Expenses Salaries expense ........................................ $ 78,500 Operating expenses ...................................... 81,500 Interest expense ........................................... 5,000 165,000 Profit.................................................................................. $257,000

DRS. KOVACIK AND DONOVAN Statement of Partners’ Equity Year Ended November 30, 2014

Capital, December 1, 2013 .......... Add: Profit.................................... Less: Drawings............................ Capital, November 30, 2014 ........

J. S. Kovacik Donovan Total $ 58,000 $ 32,000 $ 90,000 154,200* 102,800 257,000 212,200 134,800 347,000 140,000 90,000 230,000 $ 72,200 $ 44,800 $117,000

* $257,000 × 60% = $154,200

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-6 (Continued) (a) (Continued) DRS. KOVACIK AND DONOVAN Balance Sheet November 30, 2014 Assets Current assets Cash............................................................. $32,000 Supplies....................................................... 15,750 Total current assets ............................... 47,750 Property, plant, and equipment Equipment .................................................... $175,500 Less: Accumulated depreciation ............... 41,250 134,250 Total assets ............................................ $182,000 Liabilities and Partners’ Equity Current liabilities Accounts payable ....................................... $15,000 Long-term liabilities Note payable, due 2018 .............................. 50,000 Total liabilities ........................................ 65,000 Partners’ equity J. Kovacik, capital .......................................... $72,200 S. Donovan, capital..................................... 44,800 117,000 Total liabilities and partners’ equity ..... $182,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-6 (Continued) (b) Closing entries dated November 30, 2014 Fees Earned ................................................... 422,000 Income Summary.................................... 422,000 Income Summary .......................................... 165,000 Salaries Expense .................................... Operating Expenses ............................... Interest Expense.....................................

78,500 81,500 5,000

Income Summary........................................... 257,000 J. Kovacik, Capital .................................. 154,200 S. Donovan, Capital ................................ 102,800 J. Kovacik, Capital ......................................... 140,000 J. Kovacik, Drawings .............................. 140,000 S. Donovan, Capital ......................................... 90,000 S. Donovan, Drawings ...........................

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90,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-7 (a) (1) Sept. 1 A. Veveris, Capital................. 21,000 S. Weiss, Capital ............. ($42,000 × 1/2) = $21,000 (2) Sept. 1 A. Veveris, Capital ($42,000 × 25%)................. 10,500 J. Rubenis, Capital ($33,000 × 25%)................... 8,250 S. Weiss, Capital .............

21,000

18,750

(3) Sept. 1 Cash ....................................... 25,000 S. Weiss, Capital ............. 25,000 [($25,000 + $42,000 + $33,000) × 25%] = $25,000 (b) Alternative 1 Beginning balance S. Weiss admission Ending balance Alternative 2 Beginning balance S. Weiss admission Ending balance Alternative 3 Beginning balance S. Weiss admission Ending balance

Solutions Manual .

A. Veveris J. Rubenis Capital Capital $ 42,000 $ 33,000 (21,000) $ 21,000 $ 33,000

S. Weiss Capital

A. Veveris J. Rubenis Capital Capital $ 42,000 $ 33,000 (10,500) (8,250) $ 31,500 $ 24,750

S. Weiss Capital

A. Veveris J. Rubenis Capital Capital $ 42,000 $ 33,000

S. Weiss Capital

$ 42,000

$ 33,000

12-31

$ 21,000 $ 21,000

$ 18,750 $ 18,750

$ 25,000 $ 25,000

Total Capital $ 75,000 $ 75,000 Total Capital $ 75,000 $ 75,000 Total Capital $ 75,000 25,000 $100,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-8 (a) (1) Jan. 1 Cash ........................................................ 65,000 M. Stavros, Capital (3/5 × $10,000) .... 6,000 G. Metaxas, Capital (2/5 × $10,000) . 4,000 I. Xanthos, Capital............................

75,000

Total capital of existing partnership ......................... $160,000 Investment by new partner, I. Xanthos ...................... 65,000 Total capital of new partnership ................................ $225,000 I. Xanthos’ capital credit (33 1/3% × $225,000) ........... $75,000 Investment by new partner, I. Xanthos........................ $65,000 I. Xanthos’ capital credit .............................................. 75,000 Bonus to new partner ................................................... $10,000 (2) Jan. 1 Cash .................................................. 95,000 M. Stavros, Capital (3/5 × $10,000) G. Metaxas, Capital (2/5 × $10,000) I. Xanthos, Capital .......................

6,000 4,000 85,000

Total capital of existing partnership ......................... $160,000 Investment by new partner, I. Xanthos ..................... 95,000 Total capital of new partnership ................................ $255,000 I. Xanthos’ capital credit (33 1/3% × $255,000) ........... $85,000 Investment by new partner, I. Xanthos........................ $95,000 I. Xanthos’ capital credit .............................................. 85,000 Bonus to old partners .................................................. $10,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-8 (Continued) (b) Alternative 1 Beginning balance I. Xanthos admission Ending balance

Alternative 2 Beginning balance I. Xanthos admission Ending balance

M. Stavros Capital $ 95,000

G. Metaxas Capital $ 65,000

I. Xanthos Capital

(6,000) $ 89,000

(4,000) $ 61,000

$75,000 $75,000

M. Stavros Capital $ 95,000

G. Metaxas Capital $ 65,000

I. Xanthos Capital

6,000 $101,000

4,000 $ 69,000

$85,000 $85,000

Total Capital $160,000 65,000 $225,000

Total Capital $160,000 95,000 $255,000

(c) Total capital of existing partnership ......................... $160,000 Divide by 66 2/3% for combined partnership capital $240,000 I. Xanthos’ required investment for 33 1/3% interest: $240,000 - $160,000 = $80,000 Alternately: Total capital of existing partnership ....................... $160,000 Investment by new partner, I. Xanthos ................... 80,000 Total capital of new partnership.............................. $240,000 I. Xanthos’ capital credit (33 1/3% × $240,000) .......

$80,000

The amount of cash to be paid is therefore ...........

$80,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-9 (a) 1. Dec. 31 A. Noll, Capital ............................... 30,000 J. Lane, Capital.......................... S. Miles, Capital......................... 2.

15,000 15,000

Dec. 31 A. Noll, Capital ............................... 30,000 S. Miles, Capital.........................

30,000

Dec. 31 A. Noll, Capital ............................... 30,000 Cash ...........................................

30,000

Dec. 31 A. Noll, Capital ............................... 30,000 J. Lane, Capital (5/8 × $5,000)..... 3,125 S. Miles, Capital (3/8 × $5,000) . 1,875 Cash ...........................................

35,000

(b) Condition 1 Beginning balance A. Noll withdrawal Ending balance Condition 4 Beginning balance A. Noll withdrawal Ending balance

Solutions Manual .

J. Lane Capital $ 50,000 15,000 $ 65,000

S. Miles Capital $ 40,000 15,000 $ 55,000

A. Noll Capital $ 30,000 (30,000) 0

Total Capital $120,000

J. Lane Capital $ 50,000 (3,125) $ 46,875

S. Miles Capital $ 40,000 (1,875) $ 38,125

A. Noll Capital $ 30,000 (30,000) 0

Total Capital $120,000 (35,000) $ 85,000

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$120,000

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EXERCISE 12-10 (a) 1. Sept. 30 K. White, Capital ............................ 73,000 D. Nagel, Capital .............................. 8,000 I. Mbango, Capital ............................ 4,000 Cash ...........................................

85,000

Capital balance of withdrawing partner .................. Payment to withdrawing partner ............................. Bonus to retiring partner .........................................

$73,000 85,000 $12,000

Allocation of bonus: D. Nagel, Capital ($12,000 × 4/6) ................... $8,000 I. Mbango, Capital ($12,000 × 2/6) ................. 4,000

$12,000

Sept. 30 K. White, Capital ............................ 73,000 D. Nagel, Capital........................ I. Mbango, Capital ..................... Cash ...........................................

3,333 1,667 68,000

Capital balance of withdrawing partner .................. Payment to withdrawing partner ............................. Bonus to remaining partners...................................

$73,000 68,000 $ 5,000

Allocation of bonus: D. Nagel, Capital ($5,000 × 4/6) ........................$3,333 I. Mbango, Capital ($5,000 × 2/6) ..................... 1,667

$5,000

Sept. 30 K. White, Capital ............................ 73,000 E. Wolstenholme, Capital .........

73,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-10 (Continued) (b) Condition 2 Beginning balance K. White withdrawal Ending balance

Condition 3 Beginning balance K. White withdrawal Ending balance

Solutions Manual .

D. Nagel Capital $95,000 3,333 $ 98,333

D. Nagel Capital $95,000 $95,000

K. White Capital $73,000 (73,000) -

12-36

I. Mbango Capital $65,000 1,667 $66,667

I. Mbango Capital $65,000 $65,000

Total Capital $233,000 (68,000) $165,000 E. Wolstenholme Capital $ 73,000 $ 73,000

Total Capital $233,000 $233,000

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EXERCISE 12-11 (a)

Partners' Capital Cash

Windl

Houghton Pesowski

Capital

Total Capital

Balance before liquidation $172,500 $86,250 Final (172,500) (86,250) liquidation Final balances $ 0 $ 0

$34,500

$51,750 $172,500

(34,500) $ 0

(51,750) (172,500) $ 0 $ 0

(b)

Partners' Capital Cash

Windl

Houghton Pesowski

Capital

Total Capital

Balance before liquidation $172,500 $ 86,250 $34,500 $51,750 $172,500 Sale of assets share of loss (33,000) (11,000) (11,000) (11,000) (33,000) Balance 139,500 75,250 23,500 40,750 139,500 Final (139,500) (75,250) (23,500) (40,750) (139,500) liquidation Final balances $ 0 $ 0 $ 0 $ 0 $ 0

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Accounting Principles, Sixth Canadian Edition

EXERCISE 12-12 Summary (a), (b) and (c)

Cash

BAYLEE COMPANY Liquidation Schedule December 31 Assets = Liabilities + Partners' Capital Acc. Depr. H. Bayer J. Leech Total Equipment Equipment Capital Capital Capital

Account balances prior to liquidation $40,000 $ 130,000 Sale of assets and share of gain 100,000 (130,000) Balances 140,000 0 Payment of liabilities (55,000) Balances 85,000 0 Distribution of cash to partners (85,000) Final balances $ 0 $ 0

$ (40,000)

$ 55,000

$ 45,000

$30,000

$75,000

40,000 0

55,000

5,000 50,000

5,000 35,000

10,000 85,000

(55,000) 0

50,000

35,000

85,000

(50,000) (35,000) (85,000) $ 0 $ 0 $ 0

(a) Gain of $10,000 is (b) allocated equally between the partners $5,000 each. (c) Balance of cash paid Dec. 31: H. Bayer $50,000 and J. Leech $35,000.

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EXERCISE 12-13 (a) Dec. 31

Accumulated Depreciation ......... 40,000 Cash ............................................. 100,000 Equipment ............................... Gain on Realization.................

(b) Dec. 31 Gain on Realization ..................... 10,000 H. Bayer, Capital ($10,000 × 50%) ....................... J. Leech, Capital ($10,000 × 50%) ....................... (c) Dec. 31 Liabilities...................................... 55,000 Cash ......................................... (d) Dec. 31

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H. Bayer, Capital .......................... 55,000 J. Leech, Capital .......................... 35,000 Cash .........................................

12-39

130,000 10,000

5,000 5,000

55,000

85,000

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EXERCISE 12-14

Assets Noncash Cash Assets Account balances prior to liquidation Sale of assets and share of gain Balances (b) Payment of liabilities Balances (a) Payment of capital deficiency Balances Distribution of cash to partners Final balances

$15,000

$ 120,000

84,000 99,000

LOL PARTNERSHIP Liquidation Schedule December 31 = Liabilities + Partners' Capital O. Low A. Olson S. Lokum Total Capital Capital Capital Capital $20,000

$ 45,000

$ 60,000

$10,000

$115,000

(120,000) 0

20,000

(12,000) 33,000

(12,000) 48,000

(12,000) (2,000)

(36,000) 79,000

(20,000) 0

33,000

48,000

(2,000)

79,000

2,000 0

2,000 81,000

(81,000) $ 0

(20,000) 79,000 2,000 81,000 (81,000) $ 0 $

0 $

33,000

48,000

(33,000) $ 0

(48,000) $ 0 $

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EXERCISE 12-14 (Continued) (a) Proceeds from the sale of noncash assets Book value of noncash assets Loss on sale of noncash assets

$84,000 120,000 $36,000

Cash balance after paying the liabilities Refer to Liquidation Schedule above

$79,000

(b) Refer to Liquidation Schedule above (c) Dec. 31 Cash ............................................... S. Lokum, Capital ......................

2,000

31 O. Low, Capital............................... A. Olson, Capital............................ Cash ...........................................

33,000 48,000

(d) Dec. 31 O. Low, Capital ($2,000 × 50%) ..... A. Olson, Capital ($2,000 × 50%)... S. Lokum, Capital ......................

1,000 1,000

2,000

81,000

2,000

31 O. Low, Capital ($33,000 – $1,000) 32,000 A. Olson, Capital ($48,000 – $1,000) 47,000 79,000 Cash ...........................................

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SOLUTIONS TO PROBLEMS PROBLEM 12-1A (a) Advantages of forming a partnership instead of a corporation include: i. A partnership is easily formed and less expensive to establish than a corporation. ii. A partnership is controlled by fewer government regulations and restrictions than a corporation is. iii. Decisions can be made quickly on important matters that affect the firm. Disadvantages of forming a partnership instead of a corporation include: i. Mutual agency provides for the risk of the actions taken by any of the partners that affects all partners. The action of any partner is binding on all other partners. ii. Limited life since the ownership of the business is not easily transferred by the sale of shares as is the case for corporations. iii. Unlimited liability in general partnerships. Each partner is jointly and severally (individually) liable for all partnership liabilities.

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PROBLEM 12-1A (Continued) (b) The partnership agreement should specify the main location of the firm, the purpose of the business, and the date of inception. In addition, relationships among the partners must be specified, such as: 1. The names and capital contributions of partners 2. The rights and duties of partners 3. The basis for sharing profit or loss 4. Provisions for a withdrawal of assets 5. Procedures for submitting disputes to arbitration 6. Procedures for the withdrawal, or addition, of a partner 7. The rights and duties of surviving partners if a partner dies 8. Procedures for the liquidation of the partnership 9. The process used to solve ethical and legal problems Taking It Further: In order to reduce the effects of mutual agency, many large partnerships elect from among the partners, individuals who will be assigned the authority to make major purchases, incur debt, sign leases, and so on. The duties and responsibilities assigned to such a managing partner would be similar to those assigned to the chief executive officer or president of a corporation.

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PROBLEM 12-2A (a) Jan.

(b) Jan.

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1 Cash ................................................. 9,000 Accounts Receivable..................... 13,500 Merchandise Inventory.................. 14,000 Equipment ...................................... 18,000 Allowance for Doubtful Accounts Accounts Payable ................... I. Domic, Capital ......................

4,500 11,000 39,000

1 Cash ............................................. 10,000 Accounts Receivable .................. 24,000 Merchandise Inventory................ 13,000 Equipment.................................... 15,000 Allowance for Doubtful Accounts Accounts Payable ................... P. Dasilva, Capital ...................

3,000 34,000 25,000

1 Cash ($39,000 – $25,000)............... 14,000 P. Dasilva, Capital ...................

14,000

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PROBLEM 12-2A (Continued) (c) DOMIC DASILVA PARTNERSHIP Balance Sheet January 1, 2014 Assets Current assets Cash ($9,000 + $10,000 + $14,000) ............................. $ 33,000 Accounts receivable ($13,500 + $24,000) ..... $37,500 Less: Allowance for doubtful accounts ($4,500 + $3,000) ................................. 7,500 30,000 Merchandise inventory ($14,000 + $13,000) .............. 27,000 Total current assets ............................................... 90,000 Property, plant, and equipment Equipment ($18,000 + $15,000) ................................... 33,000 Total assets .............................................................. $123,000 Liabilities and Partners' Equity Current liabilities Accounts payable ($11,000 + $34,000) ......................... 45,000 Total current liabilities .............................................. 45,000 Partners' equity I. Domic, capital .......................................................... 39,000 P. Dasilva, capital ($25,000 + $14,000) ...................... 39,000 Total partners' equity ............................................. 78,000 Total liabilities and partners' equity............................... $123,000

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PROBLEM 12-2A (Continued) Taking It Further: Advantages of forming a partnership instead of operating as two proprietorships include: i.

ii. iii. iv. v.

The skills of the two individuals forming the partnership may be complementary and so their ability to provide better services to their customers is enhanced. The partnership will provide an ability to share the tasks involved in running the business. A partnership will likely provide more security to the individual partners in case of illness or absence. The combined capital of the partners will help secure debt for operations. The partnership structure might assist one of the partners in a succession plan.

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PROBLEM 12-3A (a) 1. Dec. 31 Income Summary ........................... 40,000 J. Chapman-Brown, Capital ...... C. Duperé, Capital ..................... H. Weir, Capital ..........................

6,666 14,667 18,667

CNW COMPANY Division of Profit Year Ended December 31, 2014 J. Chapman -Brown C. Duperé H. Weir Profit............................... Salary allowance C. Duperé................... $8,000 H. Weir ....................... $12,000 Total ...................... Profit remaining for allocation ............. Fixed ratio (remainder shared equally) J. Chapman-Brown ($20,000 × 1/3) ........... $6,666 C. Duperé ($20,000 × 1/3) ........... 6,667 H. Weir ($20,000 × 1/3) ........... 6,667 Total ...................... Profit remaining for allocation ............. _ _ _ Profit allocated to the partners ............... $6,666 $14,667 $18,667

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Total $40,000

20,000 20,000

20,000 0 $40,000

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PROBLEM 12-3A (Continued) (a) (Continued) 2. Dec. 31 Income Summary ........................... 40,000 J. Chapman-Brown, Capital ...... C. Duperé, Capital ..................... H. Weir, Capital ..........................

7,000 16,300 16,700

CNW COMPANY Division of Profit Year Ended December 31, 2014 J. Chapman -Brown C. Duperé H. Weir Total Profit............................... $40,000 Interest allowance J. Chapman-Brown ($30,000 × 5%) ........... $1,500 C. Duperé ($40,000 × 5%) $2,000 H. Weir ($50,000 × 5%) $2,500 Total ...................... 6,000 Profit remaining for allocation ............. 34,000 Salary allowance J. Chapman-Brown ... 15,000 C. Duperé .................. 20,000 H. Weir ....................... 18,000 Total ...................... 53,000 Profit (deficiency) remaining for allocation (19,000) Fixed ratio (remainder shared equally) Chapman-Brown [$(19,000) × 5/10] ....... (9,500) Duperé [$(19,000) × 3/10] (5,700) H. Weir [$(19,000) × 2/10] (3,800) Total ...................... (19,000) Profit remaining for allocation ............. __________________________ 0 Profit allocated to the partners ........... $7,000 $16,300 $16,700 $40,000 Solutions Manual .

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PROBLEM 12-3A (Continued) (b) Dec. 31 J. Chapman-Brown, Capital .......... 10,000 C. Duperé, Capital .......................... 8,000 H. Weir, Capital .............................. 6,000 J. Chapman-Brown, Drawings.. C. Duperé, Drawings ................. H. Weir, Drawings......................

10,000 8,000 6,000

(c) CNW COMPANY Statement of Partners’ Equity Year Ended December 31, 2014 J. ChapmanBrown C. Duperé Capital, January 1 $30,000 $40,000 Add: Profit 7,000 16,300 37,000 56,300 Less: Drawings 10,000 8,000 Capital, December 31 $27,000 $48,300

H. Weir Total $50,000 $120,000 16,700 40,000 66,700 160,000 6,000 24,000 $60,700 $136,000

Taking It Further: The partnership would include an interest allowance in its profit- and loss- sharing arrangements to reward those partners that assist in the financing of the business by leaving their capital in the business. Were it not for this willingness, the partnership would have to incur additional interest costs in order borrow cash to finance operations.

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PROBLEM 12-4A (a) STOREY ROGERS PARTNERSHIP Income Statement Year Ended December 31, 2014 Sales................................................................................. Cost of goods sold.......................................................... Gross profit...................................................................... Operating expenses ........................................................ Loss..................................................................................

$340,000 250,000 90,000 130,000 $( 40,000)

(b) STOREY ROGERS PARTNERSHIP Division of Loss Year Ended December 31, 2014 V. Storey G. Rogers

Total $(40,000)

Loss................................................ Salary allowance ........................... V. Storey ....................................... $30,000 G. Rogers .................................. $40,000 Total ...................................... 70,000 Deficiency remaining for allocation (110,000) Interest allowance V. Storey ($80,000 × 4%)........... 3,200 G. Rogers ($100,000 × 4%) ....... 4,000 Total ...................................... 7,200 Deficiency remaining for allocation (117,200) Fixed ratio V. Storey [$(117,200) × 2/5] ......... (46,880) G. Rogers [$(117,200) × 3/5] ..... (70,320) Total ...................................... (117,200) Loss remaining for allocation ........ 0 Loss allocated to the partners...... $(13,680) $(26,320) $(40,000)

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PROBLEM 12-4A (Continued) (c) STOREY ROGERS PARTNERSHIP Statement of Partners’ Equity Year Ended December 31, 2014 V. Storey G. Rogers $ 80,000 $100,000 24,000 32,000 13,680 26,320 37,680 58,320 $ 42,320 $ 41,680

Total $180,000 56,000 40,000 96,000 $ 84,000

(d) Dec. 31 Sales ............................................... 340,000 Income Summary ......................

340,000

31 Income Summary ........................... 380,000 Cost of Goods Sold .................. Operating Expenses..................

250,000 130,000

31 V. Storey, Capital .......................... 13,680 G. Rogers, Capital.......................... 26,320 Income Summary ......................

40,000

31 V. Storey, Capital ........................... 24,000 G. Rogers, Capital.......................... 32,000 V. Storey, Drawings................... G. Rogers, Drawings .................

24,000 32,000

Capital, January 1................... Less: Drawings...................... Loss ............................. Capital, December 31 .............

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PROBLEM 12-4A (Continued) Taking It Further: While it might be reasonable to revisit the agreement for sharing profit or loss in light of this information, Veda Storey cannot force a change in the agreement on her partner. Veda should appeal to fairness with her partner and either amend the agreement prior to the current year allocation of the loss, or devise another method, such as change the profit allocation formula in the immediate subsequent year.

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PROBLEM 12-5A (a) KANT-ADDER PARTNERSHIP Income Statement Year Ended March 31, 2014 Fees earned ....................................................................... $255,000 Expenses Salaries expense......................................... $80,000 Rent expense .............................................. 36,000 Interest expense ......................................... 5,000 Depreciation expense................................. 8,000 Supplies expense ....................................... 5,000 Total expenses .............................................................. 134,000 Profit................................................................................... $121,000 KANT-ADDER PARTNERSHIP Statement of Partners’ Equity Year Ended March 31, 2014 U. Adder Capital, April 1 ........................... $30,000 Add: Investment ........................ 0 Profit* ................................ 80,667 110,667 Less: Drawings.......................... 60,000 Capital, March 31....................... $ 50,667 * U. Adder: I. Kant:

Solutions Manual .

I. Kant $ 25,000 5,000 40,333 70,333 90,000 $(19,667)

Total $ 55,000 5,000 121,000 181,000 150,000 $ 31,000

$121,000 × 2/3 = $80,667 $121,000 × 1/3 = $40,333

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PROBLEM 12-5A (Continued) (a) (Continued) KANT-ADDER PARTNERSHIP Balance Sheet March 31, 2014

Assets Current assets Cash............................................................................. Accounts receivable ................................................... Supplies....................................................................... Total current assets ...............................................

$ 14,000 61,000 1,500 76,500

Property, plant, and equipment Equipment ...................................................... $42,000 Less: Accumulated depreciation .................. 12,000 30,000 Total assets .............................................................. $106,500 Liabilities and Partners' Equity Current liabilities Accounts payable ....................................................... $ 12,500 Salaries payable.......................................................... 8,000 Unearned revenue ...................................................... 5,000 Current portion of note payable ................................ 1,500 Total current liabilities ........................................... 27,000 Long-term liabilities Note payable, net of current portion.............................. 48,500 Total liabilities ........................................................... 75,500 Partners' equity U. Adder, capital ......................................................... 50,667 I. Kant, capital deficiency ........................................... (19,667) Total partners' equity ............................................. 31,000 Total liabilities and partners' equity............................... $106,500

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PROBLEM 12-5A (Continued) (b) Mar. 31 Fees Earned ................................... 255,000 Income Summary ......................

255,000

31 Income Summary ........................... 134,000 Salaries Expense....................... Rent Expense ............................ Interest Expense ....................... Depreciation Expense ............... Supplies Expense......................

80,000 36,000 5,000 8,000 5,000

31 Income Summary ........................... 121,000 U. Adder, Capital ....................... I. Kant, Capital ...........................

80,667 40,333

31 U. Adder, Capital .............................. 60,000 I. Kant, Capital .................................. 90,000 U. Adder, Drawings ................... I. Kant, Drawings .......................

60,000 90,000

Taking It Further: In this case, once the profit is added to the capital accounts drawings were larger than the capital balances in the case of I. Kant. The amount of the drawings taken by individual partners can be any amount that the partners agree to, but a deficit position in any capital account, should only occur on the approval of all partners. Creditors generally would not like to see any of the partners’ capital accounts in a deficit position, and a deficit may lead to difficulties in obtaining credit, especially since the note payable is already quite high.

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PROBLEM 12-6A (a) Jan. 1 Cash........................................................... 2,000 Equipment ................................................. 2,000 T. Gilligan, Capital.............................. Jan. 1

4,000

Cash........................................................... 1,000 Vehicles ................................................... 10,000 M. Melnyk, Capital ..............................

11,000

(b) Dec. 31 T. Gilligan, Drawings .............................. 20,000 M. Melnyk, Drawings .............................. 10,000 Salaries Expense................................

30,000

(c)

Profit as reported:................................... Add back salaries expense .................... Revised Profit .........................................

$11,600 30,000 $41,600

The profit allocation is $20,800 ($41,600 ÷ 2) to each partner since no agreement as to the allocation of profit was arrived at. (d) TY & MATT SNOW REMOVAL SERVICES Statement of Partners’ Equity Year Ended December 31, 2014 T. Gilligan M. Melnyk Capital, Jan. 1 ............................ 0 0 Add: Investment ............................ $ 4,000 $11,000 Profit .................................... 20,800 20,800 24,800 31,800 Less: Drawings............................. 20,000 10,000 Capital, March 31....................... $ 4,800 $21,800

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Total 0 $15,000 41,600 56,600 30,000 $26,600

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PROBLEM 12-6A (Continued) (e) TY & MATT SNOW REMOVAL SERVICES Balance Sheet December 31, 2014 Assets Current assets Cash................................................................................ $ 17,000 Property, plant, and equipment Equipment ......................................... $ 2,000 Less: Accumulated depreciation ... ... 400 $1,600 Vehicles .............................................. 10,000 Less: Accumulated depreciation ... 2,000 8,000 Total property, plant, and equipment........................ 9,600 Total assets ......................................................................... $26,600 Partners' Equity Partners' equity T. Gilligan, capital ....................................................... M. Melnyk, capital ...................................................... Total partners' equity ......................................................

$ 4,800 21,800 $26,600

(f) Dec. 31 Service Revenue ............................ 50,000 Income Summary ......................

50,000

31 Income Summary ........................... Depreciation Expense ............... Supplies Expense......................

2,400 6,000

8,400

31 Income Summary ........................... 41,600 T. Gilligan, Capital ..................... M. Melnyk, Capital .....................

20,800 20,800

31 T. Gilligan, Capital ......................... 20,000 M. Melnyk, Capital.......................... 10,000 T. Gilligan, Drawings ................. M. Melnyk, Drawings .................

20,000 10,000

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PROBLEM 12-6A (Continued) Taking It Further: Due to inexperience, Tyler and Matt failed to come to an agreement on their allocation of profit, before they began their business together. This failure caused the equal allocation of their profit to be made at the end of the first year of operations. While Tyler is correct that an equal allocation might not be fair if he worked twice as hard as Matt, Matt also has a good point in arguing that he should be rewarded for his larger investment into the business on January 1, 2014. Tyler and Matt should come to some agreement to a fair allocation of profit for the coming year and document their agreement details in writing.

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PROBLEM 12-7A

(a)

(b)

(c)

May 1 W. Sanga, Capital ($60,000 × 50%) 30,000 N. Osvald, Capital......................

30,000

May 1 K. Osbourne, Capital ($20,000 × 50%) ...................... 10,000 N. Osvald, Capital......................

10,000

May 1 Cash................................................ 70,000 R. Sanga, Capital ($6,000 × 3/9) .................................. 2,000 K. Osborne, Capital ($6,000 × 2/9) .................................. 1,333 W. Sanga, Capital ($6,000 × 4/9) .................................. 2,667 N. Osvald, Capital......................

76,000

Total capital of existing partnership.......... $120,000 Investment by N. Osvald ............................ 70,000 Total capital of new partnership ................ $190,000

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N. Osvald's capital credit ($190,000 × 40%)

$76,000

Investment by N. Osvald ............................ N. Osvald's capital credit ........................... Bonus to new partner .................................

$70,000 76,000 $ 6,000

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PROBLEM 12-7A (Continued) (d)

May 1 Cash .................................................. 40,000 R. Sanga, Capital ($8,000 × 3/9).............................. K. Osborne, Capital ($8,000 × 2/9).............................. W. Sanga, Capital ($8,000 × 4/9).............................. N. Osvald, Capital......................

2,667 1,778 3,555 32,000

Total capital of existing partnership ............ $120,000 Investment by N. Osvald ............................. 40,000 Total capital of new partnership .................. $160,000 N. Osvald's capital credit ($160,000 × 20%)

$32,000

Investment by N. Osvald ................................ $40,000 N. Osvald's capital credit ............................... 32,000 Bonus to old partners................................. $ 8,000 (e)

May 1 Cash .................................................. 30,000 N. Osvald, Capital......................

30,000

Total capital of existing partnership ............ $120,000 Investment by N. Osvald ............................. 30,000 Total capital of new partnership .................. $150,000 N. Osvald's capital credit ($150,000 × 20%) No bonus to new or existing partners

$30,000

Taking It Further: A new partner would be willing to give a bonus to existing partners because he does not have any experience in the business and would like to be in a position to take over parts of the business from any retiring partners in the future. The admission of the new partner fits within the succession plan of the existing partners. This is often true in a dental practice.

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PROBLEM 12-8A (a) Dec. 31 R. Antoni, Capital ........................... 49,000 H. Fercho, Capital...................... P. Jiang Capital .........................

24,500 24,500

(b) Dec. 31 R. Antoni, Capital ........................... 49,000 P. Jiang, Capital ........................

49,000

(c) Dec. 31 R. Antoni, Capital ........................... 49,000 H. Fercho, Capital ($9,000 × 6/9) .................................. 6,000 P. Jiang, Capital ($9,000 × 3/9) .................................. 3,000 Cash ...........................................

58,000

R. Antoni’s capital balance ........... $49,000 Payment to R. Antoni ..................... 58,000 Bonus to R. Antoni ........................ $ 9,000 (d) Dec. 31 R. Antoni, Capital ........................... 49,000 H. Fercho, Capital ($10,800 × 6/9)............................ P. Jiang, Capital ($10,800 × 3/9)............................ Cash ...........................................

7,200 3,600 38,200

R. Antoni's capital balance............ $49,000 Payment to R. Antoni ..................... 38,200 Bonus to remaining partners ........ $10,800

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PROBLEM 12-8A (Continued)

Taking It Further: The partnership agreement should contain a clause covering the options for payment to a withdrawing partner. Assuming the partnership agreement provides for some flexibility or choice, the next factor would be to determine if the necessary cash is currently available from the partnership assets. On the other hand, if the remaining partners have sufficient personal cash, they might be willing to pay the withdrawing partner from personal cash. This would ensure that sufficient cash remains in the business and the business does not have to take on additional debt to pay off the withdrawing partner.

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PROBLEM 12-9A (a) March 1 H. Deol, Capital .............................. 72,000 M. Kumar, Capital ($18,000 × 4/5)................... 14,400 A. Kassam, Capital ($18,000 × 1/5)................... 3,600 Cash .........................................

90,000

(b) M. Kumar, Capital $85,000 – $14,400 = $70,600 A. Kassam, Capital $43,000 – $3,600 = $39,400 (c) Feb. 28

Income Summary........................... 24,000 M. Kumar, Capital ($24,000 × 4/6) A. Kassam, Capital ($24,000 × 2/6)...................

(d) M. Kumar, Capital ($70,600 + $16,000) ....... A. Kassam, Capital ($39,400 + $8,000) ....... Total partnership capital ............................. (e) March 1 Cash ............................................... 75,000 M. Kumar, Capital ($19,050 × 4/6)................... 12,700 A. Kassam, Capital ($19,050 × 2/6)................... 6,350 C. Mawani, Capital............

16,000 8,000 $86,600 47,400 $134,000

94,050

Total capital of existing partnership.......... $134,000 Investment by C. Mawani ........................... 75,000 Total capital of new partnership ................ $209,000 C. Mawani’s capital credit ($209,000 × 45%) $94,050 Investment by C. Mawani ........................... C. Mawani’s capital credit .......................... Bonus to new partner .................................

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$75,000 94,050 $ 19,050

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PROBLEM 12-9A (Continued) (f) M. Kumar, Capital ($86,600 – $12,700) ....... A. Kassam, Capital ($47,400 – $6,350) ....... C. Mawani, Capital ...................................... Total partnership capital .............................

$73,900 41,050 94,050 $209,000

Taking It Further: The remaining partners would be willing to pay a bonus to a withdrawing partner if, for example, the withdrawing partner leaves their clients with the continuing partners. Or, there might have been conflict between the withdrawing and the remaining partners that lead to the remaining partners asking the withdrawing partner to withdraw. In that situation the remaining partners may pay a bonus the withdrawing partner to ensure they leave. A bonus to a withdrawing partner is also paid when the book value of the partnership’s assets is less than fair value.

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PROBLEM 12-10A (a) 1. May 4

2. May 6

Cash................................................ 18,000 Allowance for Doubtful Accounts. 1,700 Loss on Realization ....................... 3,800 Accounts Receivable ................

23,500

Cash................................................ 50,000 Accumulated Depreciation............ 16,800 Loss on Realization ....................... 8,900 Inventory.................................... Equipment..................................

47,100 28,600

6 A. Hoffer, Capital ($12,700 × 50%) ...................... K. Lonseth, Capital ($12,700 × 30%) ...................... D. Posca, Capital ($12,700 × 20%) ..................... Loss on Realization................... 3. May 7

4. May 9

6,350 3,810 2,540 12,700

Accounts Payable .......................... 30,200 Cash ...........................................

30,200

Cash ($1,300 – $2,540) ................... D. Posca, Capital .......................

1,240

5. May 12 A. Hoffer, Capital ($42,100 – $6,350) .................. 35,750 K. Lonseth, Capital ($18,800 – $3,810) .................. 14,990 Cash ($11,700 + $18,000 + $50,000 – $30,200 + $1,240) ....................

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PROBLEM 12-10A (Continued) (b) Cash

A. Hoffer, Capital

Apr. 30 Bal. 11,700 May 7 30,200 May 6 6,350 Apr. 30 Bal. 42,100 May 4 18,000 May 12 50,740 May 12 35,750 May 5 50,000 May 9 1,240 0

K. Lonseth, Capital

D. Posca, Capital

May 6 3,810 Apr. 30 Bal.18,800 May 12 14,990

May 6 2,540 Apr. 30 Bal. May 9

0 (c) 1.

May 9 A. Hoffer, Capital ($1,240 × 5/8)..... K. Lonseth, Capital ($1,240 × 3/8) . D. Posca, Capital .......................

775 465

12 A. Hoffer, Capital ($42,100 – $6,350 – $775)............... 34,975 K. Lonseth, Capital ($18,800 – $3,810 – $465)............... 14,525 Cash ($11,700 + $18,000 + $50,000 – $30,200)............

1,240

49,500

Taking It Further: The profit and loss ratio should not be used when distributing cash to partners in a liquidation. The relevant balance that must be used is the balance in each partner’s capital account, which will likely not bear any relationship to the profit and loss ratio.

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1,300 1,240

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PROBLEM 12-11A (a) Aug.

(2) Aug.

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(1) Cash ................................................ 430,000 Gain on Realization................. Supplies...................................

30,000 400,000

Gain on Realization .......................... 30,000 H. Brumby, Capital ($30,000 × ⅓) R. Criolio, Capital ($30,000 × ⅓) A. Paso, Capital ($30,000 × ⅓)

10,000 10,000 10,000

Bank Loan Payable ......................... 125,000 Cash .........................................

125,000

H. Brumby, Capital ($230,000 + $10,000) .............. 240,000 R. Criolio, Capital ($170,000 + $10,000) .............. 180,000 A. Paso, Capital ($25,000 + $10,000) ................ 35,000 Cash ($150,000 + $430,000 – $125,000).........................

455,000

Cash ................................................ 310,000 Loss on Realization ........................ 90,000 Supplies...................................

100,000

H. Brumby, Capital ($90,000 × ⅓) .. 30,000 R. Criolio, Capital ($90,000 × ⅓)..... 30,000 A. Paso, Capital ($90,000 × ⅓) ....... 30,000 Loss on Realization ................

90,000

Bank Loan Payable......................... 125,000 Cash .........................................

125,000

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PROBLEM 12-11A (Continued) (a) (2) Continued Aug.

(b) Aug.

Cash .................................................... 5,000 A. Paso, Capital ($25,000 – $30,000)...............

5,000

H. Brumby, Capital ($230,000 – $30,000)................ 200,000 R. Criolio, Capital ($170,000 – $30,000)................ 140,000 Cash ($150,000 + $310,000 – $125,000 + 5,000) ..........

340,000

H. Brumby, Capital ($5,000 × 50%) 2,500 R. Criolio, Capital ($5,000 × 50%) ...... 2,500 A. Paso, Capital ($25,000 – $30,000) ...........

5,000

H. Brumby, Capital ($230,000 – $30,000 – $2,500) ............. 197,500 R. Criolio, Capital ($170,000 – $30,000 – $2,500) ............. 137,500 Cash ($150,000 + $310,000 – $125,000) .......................

335,000

Taking It Further: In order to ensure that no partners have a deficit (debit balances) when the partnership is liquidated, the partnership agreement should provide for a minimum capital balance which should be sufficient to address any losses experienced on liquidation.

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PROBLEM 12-12A (a) 2013 Mar. 2

Cash ....................................................... Equipment.............................................. Z. Moreau, Capital ............................

15,000 18,000

Cash ....................................................... Furniture ................................................ Notes Payable .................................. K. Krneta, Capital .............................

10,000 17,000

Cash ....................................................... Equipment.............................................. V. Visentin, Capital...........................

20,000 13,000

Dec. 20 Z. Moreau, Drawings ............................. K. Krneta, Drawings .............................. V. Visentin, Drawings ............................ Cash..................................................

30,000 30,000 30,000

33,000

5,000 22,000

33,000

90,000

31 Income Summary................................... 110,000 Z. Moreau, Capital ($110,000 × 3/8). 41,250 K. Krneta, Capital ($110,000 × 2/8).. 27,500 V. Visentin, Capital ($110,000 × 3/8) 41,250 MKV PERSONAL COACHING Capital Balances December 31, 2013 Investments Drawings Profit Ending Balance

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Z. Moreau K. Krneta V. Visentin Total $33,000 $22,000 $33,000 $88,000 (30,000) (30,000) (30,000) (90,000) 41,250 27,500 41,250 110,000 $44,250 $19,500 $44,250 $108,000

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PROBLEM 12-12A (Continued) 2014 Jan. 5

K. Krneta, Capital................................... Z. Moreau, Capital ............................ V. Visentin, Capital........................... Cash..................................................

19,500 2,250 2,250 15,000

Capital balance of withdrawing partner .................. Payment to withdrawing partner ............................. Bonus to remaining partners................................... Allocation of bonus: Z. Moreau, Capital ($4,500 × 3/6) .................. $2,250 V. Visentin, Capital ($4,500 × 3/6) ............. 2,250 Dec. 20 Z. Moreau, Drawings ............................. V. Visentin, Drawings ............................ Cash..................................................

$19,500 15,000 $ 4,500 $4,500

42,750 45,000 87,750

31 Income Summary................................... 123,750 Z. Moreau, Capital ($123,750 × 4/9) . 55,000 V. Visentin, Capital ($123,450 × 5/9) 68,750 2015 Jan. 4

Cash ....................................................... Z. Moreau, Capital (4/9 × $9,000) .......... V. Visentin, Capital (5/9 × $9,000) ......... D. Hirjikaka, Capital .........................

31,000 4,000 5,000 40,000

Total capital of existing partnership [see (b)]......... $129,000 Investment by new partner, D. Hirjikaka ................. 31,000 Total capital of new partnership.............................. $160,000 D. Hirjikaka capital credit (25% × $160,000)............

$40,000

Investment by new partner, D. Hirjikaka ................. D. Hirjikaka capital credit ......................................... Bonus to new partner...............................................

$31,000 40,000 $ 9,000

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PROBLEM 12-12A (Continued) (b) MKV PERSONAL COACHING Balance of Partners’ Capital Accounts January 4, 2015

Balance Dec. 31, 2013 Withdrawal of partner Drawings 2014 Profit 2014 Balance Dec. 31, 2014 Admission new partner Balance Jan. 4, 2015

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Z. Moreau

$40,000 $40,000

$44,250 2,250 (42,750) 55,000 58,750 (4,000) $54,750

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K. Krneta V. Visentin $19,500 (19,500)

$44,250 2,250 (45,000) 68,750 70,250 (5,000) $65,250

Total $108,000 (15,000) (87,750) 123,750 129,000 31,000 $160,000

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PROBLEM 12-12A (Continued) (b) (Continued) MKV PERSONAL COACHING Balance Sheet (partial) January 4, 2015 Partners’ equity D. Hirjikaka, Capital Z. Moreau, Capital V. Visentin, Capital Total partners' equity

$40,000 54,750 65,250 $160,000

Taking It Further: Most partnerships agree to continue the partnership year while allowing partners to withdraw or be admitted to the partnership. This is particularly the case in large partnerships where these events often occur. The process to be followed should be spelled out in the partnership agreement. Formulas on how to calculate and allocate the profit for a partial year are necessary so that a partner can be admitted or withdrawn without the books being closed. In the case of MKV Personal Coaching, the business carried on in spite of the withdrawal by Karen Krneta and the admission of Dela Hirjikaka. None of the temporary accounts of the partnership were closed, nor were new accounting records created.

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PROBLEM 12-1B

(a) Advantages of forming a partnership instead of a corporation include: i. A partnership is easily formed and less expensive to establish than a corporation. ii. A partnership is controlled by fewer government regulations and restrictions than a corporation is. iii. Decisions can be made quickly on important matters that affect the firm. Disadvantages of forming a partnership instead of a corporation include: i. Mutual agency provides for the risk of the actions taken by any of the partners that affects all partners. The action of any partner is binding on all other partners. ii. Limited life since the ownership of the business is not easily transferred by the sale of shares as is the case for corporations. iii. Unlimited liability in general partnerships. Each partner is jointly and severally (individually) liable for all partnership liabilities. (b) One alternative available to Max and Rubin in running their lawn and yard maintenance company, besides using the corporate structure, is operating the business as a limited partnership. One of the owners will need to be the general partner and the remaining owner can enjoy the benefits of being the limited partner whose liability is limited to the amount of capital that he has contributed to the partnership. It might not be obvious to either of the two partners which one will enjoy the reduced risk as a limited partner and who will have to shoulder the risk that the general partner role brings. Another alternative is the limited liability partnership structure which is most often used in partnerships of professionals such as lawyers and accountants.

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PROBLEM 12-1B (Continued) (c) The partnership agreement should specify the main location of the firm, the purpose of the business, and the date of inception. In addition, relationships among the partners must be specified, such as: 1. The names and capital contributions of partners 2. The rights and duties of partners 3. The basis for sharing profit or loss 4. Provisions for a withdrawal of assets 5. Procedures for submitting disputes to arbitration 6. Procedures for the withdrawal, or addition, of a partner 7. The rights and duties of surviving partners if a partner dies 8. Procedures for the liquidation of the partnership 9. The process used to solve ethical and legal problems

Taking It Further: Considering the size and nature of their business, Max and Rubin should probably dismiss the possibility of using the limited partnership or limited liability partnership structure for their lawn and yard maintenance business. The additional costs and concerns that come with these alternative structures are not justified under these circumstances.

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PROBLEM 12-2B (a) Jan. 1 Cash .................................................... 9,500 Accounts Receivable ....................... 15,000 Merchandise Inventory .................... 20,000 Equipment ........................................ 18,000 Allowance for Doubtful Accounts Accounts Payable ....................... F. Visanji, Capital.........................

3,500 25,000 34,000

1 Cash .................................................... 5,000 Accounts Receivable ....................... 20,000 Merchandise Inventory .................... 15,000 Equipment ........................................ 14,000 Allowance for Doubtful Accounts Accounts Payable ....................... P. Vanbakel, Capital ....................

4,500 20,000 29,500

(b) Jan. 1 Cash ($34,000 – $29,500) ................... 4,500 P. Vanbakel, Capital ....................

4,500

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PROBLEM 12-2B (Continued) (c) VARSITY PARTNERSHIP Balance Sheet January 1, 20XX Assets Current assets Cash ($9,500 + $5,000 + $4,500) ........................ $ 19,000 Accounts receivable ($15,000 + $20,000).......... $35,000 Less: Allowance for doubtful accounts ($3,500 + $4,500) ..................................... 8,000 27,000 Merchandise inventory ($20,000 + $15,000) ..... 35,000 Total current assets .................................. 81,000 Property, plant, and equipment Equipment ($18,000 + $14,000) ..................... Total assets ...............................................

32,000 $113,000

Liabilities and Partners' Equity Current liabilities Accounts payable ($25,000 + $20,000) ....................... Total current liabilities ............................................

45,000 45,000

Partners' equity F. Visanji, Capital ........................................................ 34,000 P. Vanbakel, Capital ($29,500 + $4,500)..................... 34,000 Total partners' equity ............................................. 68,000 Total liabilities and partners' equity...................... $113,000

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PROBLEM 12-2B (Continued) Taking It Further: Advantages of forming a partnership instead of operating as two proprietorships include: i.

ii. iii. iv. v.

The skills of the two individuals forming the partnership may be complementary and so their ability to provide better services to their customers is automatically enhanced. The partnership will provide an ability to share the tasks involved in running the business. A partnership will likely provide more security to the individual partners in case of illness or absence. The combined capital of the partners will help secure debt for operations. The partnership structure might assist one of the partners in a succession plan.

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PROBLEM 12-3B (a) 1.

Dec. 31 Income Summary..............................55,000 S. Little, Capital ......................... L. Brown, Capital....................... P. Gerhardt, Capital...................

10,000 30,000 15,000

LBG COMPANY Division of Profit Year Ended December 31, 201 S. L. P. Little Brown Gerhardt Total Profit............................... $55,000 Salary allowance S. Little .......................... $5,000 L. Brown .................... P. Gerhardt ................ Total ...................... Profit remaining for allocation ............. Fixed ratio (remainder shared equally) S. Little ($15,000 × 1/3) ........... $5,000 L. Brown ($15,000 × 1/3) ........... P. Gerhardt ($15,000 × 1/3) ........... Total ...................... Profit remaining for allocation ............. _ Profit allocated to the partners ............... $10,000

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$25,000 $10,000 40,000 15,000

5,000 5,000 15,000 _ $30,000

$15,000 $55,000

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PROBLEM 12-3B (Continued) (a) (Continued) 2.

Dec. 31 Income Summary........................... 25,000 S. Little, Capital.............................. 5,125 L. Brown, Capital....................... P. Gerhardt, Capital...................

11,667 18,458

LBG COMPANY Division of Profit Year Ended December 31, 2014 S. L. P. Little Brown Gerhardt Total Profit............................... $25,000 Interest allowance S. Little ($65,000 × 5%) $3,250 L. Brown ($45,000 × 5%) $2,250 P. Gerhardt ($25,000 × 5%) $1,250 6,750 Total ...................... Profit remaining for allocation 18,250 Salary allowance L. Brown .................... 15,000 P. Gerhardt ................ 20,000 Total ...................... 35,000 Profit (deficiency) remaining for allocation (16,750) Fixed ratio (remainder shared equally) S. Little [$(16,750) × 3/6]......... (8,375) L. Brown [$(16,750) × 2/6]......... (5,583) P. Gerhardt (2,792) [$(16,750) × 1/6]......... Total ...................... (16,750) Profit remaining for allocation ............. _ _ _ 0 Profit allocated to the partners ........... $(5,125) $11,667 $18,458 $25,000 Solutions Manual .

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PROBLEM 12-3B (Continued) (b) Dec. 31

S. Little, Capital.............................. 20,000 L. Brown, Capital ........................... 15,000 P. Gerhardt, Capital ....................... 10,000 S. Little, Drawings ..................... L. Brown, Drawings................... P. Gerhardt, Drawings ..............

20,000 15,000 10,000

Capital, January 1 Add: Profit Less: Drawings Capital, December 31

S. Little $65,000 (5,125) 59,875 20,000 $39,875

L. P. Brown Gerhardt Total $45,000 $25,000 $135,000 11,667 18,458 25,000 56,667 43,458 160,000 15,000 10,000 45,000 $41,667 $33,458 $115,000

Taking It Further: The partnership would include a salary allowance in its profitand loss-sharing arrangements to reward partners that contribute more time and effort in generating revenues for the business or bring specialized talents. This element of the allocation of profit provides fairness in rewarding effort.

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PROBLEM 12-4B (a) LAM TAN PARTNERSHIP Income Statement Year Ended January 31, 2014 Sales................................................................................. Cost of goods sold.......................................................... Gross profit...................................................................... Operating expenses ........................................................ Loss..................................................................................

$395,000 275,000 120,000 150,000 $( 30,000)

(b) LAM TAN PARTNERSHIP Division of Loss Year Ended January 31, 2014 T. Lam

C. Tan

Total $(30,000)

Loss................................................ Salary allowance T. Lam........................................ $25,000 C. Tan ........................................ $35,000 Total ...................................... 60,000 Deficiency remaining for allocation (90,000) Interest allowance T. Lam ($110,000 × 6%)............. 6,600 C. Tan ($130,000 × 6%) ............. 7,800 Total ...................................... 14,400 Deficiency remaining for allocation (104,400) T. Lam [($104,400 × 3/7)] .......... (44,743) C. Tan [($104,400 × 4/7)] ........... (59,657) Total ...................................... (104,400) Loss remaining for allocation ...... _ _ 0 Loss allocated to the partners $(13,143) $(16,857) $(30,000)

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PROBLEM 12-4B (Continued) (c) LAM TAN PARTNERSHIP Statement of Partners’ Equity Year Ended January 31, 2014

Capital, February 1, 2013 ............ Less: Drawings........................... Loss .................................. Capital, January 31, 2014............

T. Lam C. Tan Total $110,000 $130,000 $240,000 25,000 35,000 60,000 13,143 16,857 30,000 38,143 51,857 90,000 $ 71,857 $ 78,143 $150,000

(d) Jan. 31 Sales ............................................. 395,000 Income Summary ....................

395,000

31 Income Summary ........................ 425,000 Cost of Goods Sold................. Operating Expenses ...............

275,000 150,000

31 T. Lam, Capital ............................. 13,143 C. Tan, Capital.............................. 16,857 Income Summary ....................

30,000

31 T. Lam, Capital ............................. 25,000 C. Tan, Capital.............................. 35,000 T. Lam, Drawings .................... C. Tan, Drawings .....................

25,000 35,000

Taking It Further: There is no relationship between the salary allowance specified in the profit and loss ratio and a partner’s drawings.

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PROBLEM 12-5B (a) CLAY AND OGLETREE, LLP Income Statement Year Ended September 30, 2014 Fees earned ..................................................... $515,000 Expenses Salaries expense......................................... $225,000 Depreciation expense................................. 12,000 Insurance expense ..................................... 18,500 Interest expense ......................................... 5,000 Property tax expense ................................. 15,000 Total expenses............................................ 275,500 Profit................................................................. $239,500

CLAY AND OGLETREE, LLP Statement of Partners’ Equity Year Ended September 30, 2014 G. Clay M. Ogletree Total Capital, October 1, 2013............ $ 65,000 $ 37,500 $102,500 Add: Investment ........................ 10,000 0 10,000 Profit* ................................ 143,700 95,800 239,500 218,700 133,300 352,000 Less: Drawings.......................... 150,000 100,000 250,000 Capital, September 30, 2011 ..... $68,700 $ 33,300 $102,000 *G. Clay $239,500 × 3/5 = $143,700 M. Ogletree $239,500 × 2/5 = $95,800

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PROBLEM 12-5B (Continued) (a) (Continued) CLAY AND OGLETREE, LLP Balance Sheet September 30, 2014 Assets Current assets Cash............................................................................. $ 13,500 Accounts receivable................................................... 105,000 Prepaid insurance....................................................... 3,500 Total current assets ............................................... 122,000 Property, plant, and equipment Equipment ...................................................... $60,000 Accumulated depreciation ........................... 12,000 Total property, plant, and equipment ................... 48,000 Total assets ..................................................................... $170,000 Liabilities and Partners' Equity Current liabilities Accounts payable ....................................................... $ 21,500 Unearned revenue ...................................................... 24,000 Current portion of note payable ................................... 5,000 Total current liabilities ........................................... 50,500 Long-term liabilities Note payable, net of current portion............................. 17,500 Total liabilities ........................................................... 68,000 Partners' equity G. Clay, Capital ........................................................... 68,700 M. Ogletree, Capital .................................................... 33,300 Total partners' equity ............................................. 102,000 Total liabilities and partners' equity............................... $170,000

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PROBLEM 12-5B (Continued) (b) Sept. 30 Fees Earned .............................. Income Summary .................

515,000

30 Income Summary...................... Salaries Expense ................. Depreciation Expense.......... Insurance Expense .............. Interest Expense .................. Property Tax Expense .........

275,500

30 Income Summary...................... G. Clay, Capital..................... M. Ogletree, Capital..............

239,500

30 G. Clay, Capital ......................... M. Ogletree, Capital .................. G. Clay, Drawings ................ M. Ogletree, Drawings .........

150,000 100,000

515,000 225,000 12,000 18,500 5,000 15,000 143,700 95,800

150,000 100,000

Taking It Further: The amount of the drawings taken by individual partners can be of any amount that the partners agree to, although a deficit position in any capital account should be avoided. Since the amount of the capital balances at September 30, 2014 are disproportionate, the partners may want to provide for an interest allowance in their formula to arrive at the allocation of any profit in the future. M. Ogletree should not be allowed to draw as high an amount in the future because he will risk having a deficit position in his capital account.

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PROBLEM 12-6B (a) Jan. 1

Cash......................................................... 1,000 Equipment ............................................... 1,500 C. Maguire, Capital .............................

2,500

Cash......................................................... 750 Vehicles................................................... 8,000 F. Whelan, Capital ..............................

8,750

(b) Dec. 31 C. Maguire, Drawings ............................. 12,000 F. Whelan, Drawings ................................. 8,000 Salaries Expense................................

20,000

Jan. 1

(c)

Profit as reported:................................... Add back salaries expense .................... Revised Profit .........................................

$10,100 20,000 $30,100

The profit allocation is $15,050 ($30,100 ÷ 2) to each partner since no agreement as to the allocation of profit was arrived at. (d) MAGUIRE & WHELAN CLEANING SERVICES Statement of Partners’ Equity Year Ended December 31, 2014 C. Maguire F. Whelan Capital, Jan. 1 ............................ 0 0 Add: Investment ........................ $ 2,500 $8,750 Profit ................................. 15,050 15,050 17,550 23,800 Less: Drawings.......................... 12,000 8,000 Capital, March 31....................... $ 5,550 $15,800

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Total 0 $11,250 30,100 41,350 20,000 $21,350

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PROBLEM 12-6B (Continued) (e) MAGUIRE & WHELAN CLEANING SERVICES Balance Sheet December 31, 2014 Assets Current assets Cash................................................................................ $ 13,750 Property, plant, and equipment Equipment ......................................... $ 1,500 Less: Accumulated depreciation ... 300 $1,200 Vehicles ........................................... 8,000 Less: Accumulated depreciation ... 1,600 6,400 Total property, plant, and equipment........................ 7,600 Total assets ......................................................................... $21,350 Partners' Equity Partners' equity C. Maguire, capital ...................................................... F. Whelan, capital ...................................................... Total partners' equity ......................................................

$ 5,550 15,800 $21,350

(f) Dec. 31 Service Revenue ............................ 35,000 Income Summary ......................

35,000

31 Income Summary ........................... Depreciation Expense ............... Supplies Expense......................

1,900 3,000

4,900

31 Income Summary ........................... 30,100 C. Maguire, Capital .................... F. Whelan, Capital .....................

15,050 15,050

31 C. Maguire, Capital......................... 12,000 F. Whelan, Capital .......................... 8,000 C. Maguire, Drawings ................ F. Whelan, Drawings .................

12,000 8,000

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PROBLEM 12-6B (Continued) Taking It Further: Due to inexperience, Caitlin and Fiona failed to come to an agreement on the allocation of profit before they began their business together. This failure caused the equal allocation of their profit to be made at the end of the first year of operations. While Caitlin is correct that an equal allocation might not be fair if she worked twice as hard as Fiona, Fiona also has a good point in arguing that she should be rewarded for her larger investment into the business on January 1, 2014. Caitlin and Fiona should come to some agreement to a fair allocation of profit for the coming year and document their agreement details in writing.

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PROBLEM 12-7B

(a) Oct. 1

A. Nolan, Capital ($62,000 × 25%) ..... 15,500 C. Santos, Capital ......................... 15,500

(b) Oct. 1

D. Elder, Capital ($48,000 × 1/3) ........ 16,000 C. Santos, Capital ......................... 16,000

Cash ................................................... 80,000 A. Nolan, Capital (50% × $18,800) 9,400 D. Elder, Capital (40% × $18,800) . 7,520 T. Wuhan, Capital (10% × $18,800) 1,880 C. Santos, Capital ......................... 61,200

Total capital of existing partnership ................ Investment by C. Santos ................................... Total capital of new partnership.......................

$124,000 80,000 $204,000

C. Santos' capital credit ($204,000 × 30%) .......

$61,200

Investment by new partner, C. Santos ............. C. Santos’ capital credit .................................... Bonus to old partners .......................................

$80,000 61,200 $18,800

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PROBLEM 12-7B (Continued) (d) Oct. 1

Cash .................................................... 36,000 A. Nolan, Capital ($12,000 × 50%) ... 6,000 D. Elder, Capital ($12,000 × 40%) .... 4,800 T. Wuhan, Capital ($12,000 × 10%) . 1,200 C. Santos, Capital ....................... 48,000

Total capital of existing partnership .............. Investment by C. Santos ................................. Total capital of new partnership.....................

$124,000 36,000 $160,000

C. Santos’ capital credit ($160,000 × 30%).....

$48,000

Investment by new partner ............................. C. Santos’ capital credit .................................. Bonus to new partner......................................

$36,000 48,000 $12,000

(e) Solve for x 30% × ($124,000 + x) = x $37,200 + .3x = x $37,200 = .7x x = $53,143 Proof: ($124,000 + $53,143) × 30% = $53,143 Taking It Further: Existing partners would be willing to give a bonus to a new partner because he is bringing badly needed expertise and an excellent reputation to the partnership. These qualities will yield greater revenues and consequently profits for all partners. The skills of the new partner are very complementary to the existing partners, making it easier to obtain and retain clients. This is often true in law firms offering a variety of specialties to clients.

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PROBLEM 1291B (a) Dec. 31 R. Dixon, Capital .......................... 37,500 B. Vuong, Capital .................... G. Khan, Capital ......................

18,750 18,750

(b) Dec. 31 R. Dixon, Capital .......................... 37,500 G. Khan, Capital ......................

37,500

(c) Dec. 31 R. Dixon, Capital .......................... 37,500 B. Vuong, Capital ($10,000 × 5/8) 6,250 G. Khan, Capital ($10,000 × 3/8).. 3,750 Cash .........................................

47,500

Dixon's capital balance ............... Payment to Dixon ........................ Bonus to Dixon ............................

$37,500 47,500 $10,000

(d) Dec. 31 R. Dixon, Capital .......................... 37,500 B. Vuong, Capital ($8,000 × 5/8) G. Khan, Capital ($8,000 × 3/8) Cash ......................................... Dixon's capital balance ............... Payment to Dixon ........................ Bonus to old partners .................

5,000 3,000 29,500

$37,500 29,500 $ 8,000

Taking It Further: In order for a new partner to be admitted, the remaining partners must approve Dixon’s sale of her interest to S. Meyers. The remaining partners cannot be forced to accept a change in partners dictated by the withdrawing partner.

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PROBLEM 12-9B (a) Feb.

1 T. Radzik, Capital ........................... 98,000 Cash ......................................... S. Kopel, Capital ($8,000 × ¾) E. Falkenberg, Capital ($8,000 × ¼).......................

90,000 6,000 2,000

(b) S. Kopel, Capital $79,000 + $6,000 = $85,000 E. Falkenberg, Capital $47,000 + $2,000 = $49,000 (c) Dec. 31 Income Summary........................... 45,000 S. Kopel, Capital ($45,000 × 2/3) E. Falkenberg, Capital ($45,000 × 1/3)................... (d) S. Kopel, Capital ($85,000 + $30,000) ......... E. Falkenberg, Capital ($49,000 + $15,000) Total partnership capital ............................. (e) Mar . 1

Cash ............................................. 110,000 S. Kopel, Capital ($20,050 × 2/3) . 13,367 E. Falkenberg, Capital ($20,050 × 1/3)................... 6,683 D. Malkin, Capital..............

30,000 15,000 $115,000 64,000 $179,000

130,050

Total capital of existing partnership.......... $179,000 Investment by D. Malkin ............................. 110,000 Total capital of new partnership ................ $289,000 D. Malkin’s capital credit ($289,000 × 45%) $130,050 Investment by D. Malkin ............................. $110,000 D. Malkin’s capital credit ............................ 130,050 Bonus to new partner ................................. $ 20,050

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PROBLEM 12-9B (Continued) (f) S. Kopel, Capital ($115,000 – $13,367) ....... E. Falkenberg, Capital ($64,000 – $6,683) .. D. Malkin, Capital ........................................ Total partnership capital .............................

$101,633 57,317 130,050 $289,000

Taking It Further: There might be several reasons why a withdrawing partner would be motivated to agree to a cash payment that results in a bonus to the remaining partners. A penalty might have been applied because of some circumstances that were adverse to the partnership caused by the withdrawing partner. The partnership agreement might contain a clause which provides for the discounting of the withdrawing partners’ capital upon his departure under certain circumstances. Or, the withdrawing partner may have personal reasons for needing cash immediately, and is willing to accept a lesser amount as a result.

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PROBLEM 12-10B (a) (1) June 2 Cash....................................................... 20,000 Allowance for Doubtful Accounts ....... 1,200 Loss on Realization .............................. 8,800 Accounts Receivable ....................... (2) 3 Cash....................................................... 48,000 Accumulated Depreciation................... 6,600 Loss on Realization .............................. 12,000 Inventory........................................... Equipment ........................................ (3)

30,000

41,400 25,200

3 L. Sciban, Capital ($20,800 × 5/10)....... 10,400 V. Subra, Capital ($20,800 × 3/10) ........ 6,240 C. Werier, Capital ($20,800 × 2/10) ....... 4,160 Loss on Realization .........................

20,800

(4) 4 Accounts Payable................................. 53,160 Cash ..................................................

53,160

(5) 6 Cash....................................................... C, Werier, Capital ............................. ($3,840 – $4,160) = $320

320

(6) 9 L. Sciban, Capital ($39,600 – $10,400) . 29,200 V. Subra, Capital ($25,200 – $6,240) .... 18,960 Cash ..................................................

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PROBLEM 12-10B (Continued) (b) Cash Bal. 33,000 (1) 20,000 (2) 48,000 (4) 320

L. Sciban, Capital (3) 10,400 Bal. (5) 29,200

39,600

(4) 53,160 (5) 48,160

V. Subra, Capital (3) 6,240 Bal. (5) 18,960

C. Werier, Capital

25,200

(3)

4,160 Bal. (4)

3,840 320 0

(2) June

9 L. Sciban, Capital ($320 × 5/8) ......... V. Subra, Capital ($320 × 3/8) ............ C. Werier, Capital ..........................

200 120

9 L. Sciban, Capital ($29,200 – $200)... V. Subra, Capital ($18,960 – $120) .... Cash ...............................................

29,000 18,840

320

47,840

Taking It Further: Creditors must be paid before the partners upon liquidation and failing to do so would be defrauding creditors of their legal claim against the business.

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PROBLEM 12-11B (a) Sept. 30

Sept. 30

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(1) Cash ................................................ 130,000 Gain on Realization................. Supplies...................................

20,000 110,000

Gain on Realization .......................... 20,000 M. Nokota, Capital ($20,000 × ½) S. Taishuh, Capital ($20,000 × ¼) A. Paso, Capital ($20,000 × ¼)

10,000 5,000 5,000

Accounts Payable ............................. 90,000 Cash .........................................

90,000

M. Nokota, Capital ($70,000 + $10,000) ................ 80,000 S. Taishuh, Capital ($30,000 + $5,000) .................. 35,000 A. Paso, Capital ($20,000 + $5,000) .................. 25,000 Cash ($100,000 + $130,000 – $90,000)................................

140,000

(2) Cash ................................................ 25,000 Loss on Realization ........................ 85,000 Merchandise Inventory ...........

110,000

M. Nokota, Capital ($85,000 × ½) ... 42,500 S. Taishuh, Capital ($85,000 × ¼) .. 21,250 A. Paso, Capital ($85,000 × ¼) ....... 21,250 Loss on Realization ................

85,000

Accounts Payable........................... 90,000 Cash .........................................

90,000

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PROBLEM 12-11B (Continued) (a) (2) Continued Sept. 30

(b) Sept. 30

Cash .................................................... 1,250 A. Paso, Capital ($20,000 – $21,250)..................

1,250

M. Nokota, Capital ($70,000 – $42,500).................. 27,500 S. Taishuh, Capital ($30,000 – $21,250).................. 8,750 Cash ($100,000 + $25,000 – $90,000 + $1,250) ..........

36,250

M. Nokota, Capital ($1,250 × 2/3) ........................... S. Taishuh, Capital ($1,250 × 1/3) ........................... A. Paso, Capital ($20,000 – $21,250) ...........

1,250

833 417

M. Nokota, Capital ($70,000 – $42,500 – $833) ...... 26,667 S. Taishuh, Capital ($30,000 – $21,250 – $417) ...... 8,333 Cash ($100,000 + $25,000 – $90,000) .........................

35,000

Taking It Further: The reasons a partnership might decide to liquidate might include: 1) the activity generating the revenue of the business has stopped; 2) government regulations have caused the business to be no longer viable; 3) internal discord among the partners; and 4) the business might not have intended to last very long and this is the logical end of the business model.

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PROBLEM 12-12B (a) 2013 Feb. 14 Cash ....................................................... Furniture ................................................ I. Moretti, Capital ..............................

9,000 15,000 24,000

14 Cash ....................................................... Equipment.............................................. A. Kam, Capital ................................

12,000 24,000

14 Cash ....................................................... Equipment.............................................. Accounts Payable ............................ C. Fenandoe, Capital .......................

18,000 40,000

Dec. 20 I. Moretti, Drawings ($72,000 × 2/9) ...... A. Kam, Drawings ($72,000 × 3/9) ......... C. Fenandoe, Drawings ($72,000 × 4/9) Cash..................................................

16,000 24,000 32,000

36,000

10,000 48,000

72,000

31 Income Summary................................... 81,900 I. Moretti, Capital ($81,900 × 2/9) ..... 18,200 A. Kam, Capital ($81,900 × 3/9) ....... 27,300 C. Fenandoe, Capital ($81,900 × 4/9) 36,400 MKF MARKETING Capital Balances December 31, 2013 C. FeI. Moretti A. Kam nandoe Total Investments $24,000 $36,000 $48,000 $108,000 Drawings (16,000) (24,000) (32,000) (72,000) Profit 18,200 27,300 36,400 81,900 Ending Balance $26,200 $39,300 $52,400 $117,900

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PROBLEM 12-12B (Continued) 2014 Jan. 5

C. Fenandoe, Capital (1/2 × $52,400) ........ 26,200 C. Wells, Capital .......................... 26,200

Dec. 20 I. Moretti, Drawings ($91,800 × 2/9) .......... 20,400 A. Kam, Drawings ($91,800 × 3/9) ............. 30,600 C. Fenandoe, Drawings ($91,800 × 2/9) 20,400 C. Wells, Drawings ($91,800 × 2/9) ........... 20,400 Cash.................................................. 91,800 31 Income Summary .................................... 103,050 I. Moretti, Capital ($103,050 × 2/9) ... A. Kam, Capital ($103,050 × 3/9) ..... C. Fenandoe, Capital ($103,050 × 2/9) C. Wells, Capital ($103,050 × 2/9) .... 2015 Jan. 2

22,900 34,350 22,900 22,900

C. Fenandoe, Capital ................................. 28,700 I. Moretti, Capital .............................. 900 A. Kam, Capital ................................ 1,350 C. Wells, Capital ............................... 900 Cash.................................................. 25,550

Capital balance of withdrawing partner .................. Payment to withdrawing partner ............................. Bonus to remaining partners...................................

$28,700 25,550 $ 3,150

Allocation of bonus: I. Moretti, Capital ($3,150 × 2/7) .................. A. Kam, Capital ($3,150 × 3/7) ..................... C. Wells, Capital ($3,150 × 2/7) ...................

$3,150

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PROBLEM 12-12B (Continued) (b) MKFW MARKETING Statement of Partners’ Equity Year ending December 31, 2014

Capital January 1 Admission of partner Add: Profit Less: Drawing Capital, December 31

I. Moretti $26,200 22,900 49,100 20,400 $28,700

A. Kam $39,300 34,350 73,650 30,600 $43,050

C. Fenandoe $52,400 (26,200) 22,900 49,100 20,400 $28,700

C. Wells

Total $117,900

$26,200 22,900 49,100 20,400 $28,700

103,050 220,950 91,800 $129,150

Balance Dec. 31, 2014 Withdrawal of partner Balance Jan. 2, 2015

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I. Moretti

A. Kam

C. Fenandoe

C. Wells

Total

$28,700 900 $29,600

$43,050 1,350 $44,400

$28,700 (28,700) $ 0

$28,700 900 $29,600

$129,150 (25,550) $103,600

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PROBLEM 12-12B (Continued) Taking It Further: Often, partnerships agree not to change the name of the partnership each time a partner withdraws or is admitted. This is particularly the case in large partnerships where all of the names of the partners do not appear in the name. Doing so avoids disruption, additional costs and confusion with customers, suppliers and the general public. Generally, the name of some of the oldest partnerships in Canada is not based on the name of any living partner.

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CONTINUING COOKIE CHRONICLE (a) 1. A formalized partnership agreement is imperative. A formal agreement will ensure that you consider all possible situations, contingencies and disagreements that could arise. At present, you may be in agreement with all the decisions being made. However, if a disagreement occurs later on, you will be able to turn to the partnership agreement for guidance. The partnership agreement should contain basic information such as the name and principal location of the partnership, the purpose of the business and the date of inception. In addition, the agreement should specify the names and capital contributions of the partners, the rights and duties of the partners, the basis for sharing profit or loss, provisions for withdrawal of assets, procedures for settling disputes, procedures for the withdrawal or admission of a partner, the rights and duties of a surviving partner if a partner dies, and procedures for liquidating a partnership.

2. Katy Peterson would need to borrow $6,900. Total fair value of Cookie Creations’ net assets: ($8,050 + $800 + $1,200 + $450 + $1,500) $12,000 Total fair value of K. Peterson’s (The Baker’s Nook) net assets: ($1,500 + $5,250 + $500 + $350 + $7,500 – $10,000) 5,100 Difference $ 6,900

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CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) 3. Both the total amount of assets and the total amount of Katy Peterson’s debt should be considered in making this decision. Each partner is jointly and severally liable for all partnership liabilities. If you go forward with the partnership, both partners will be signing the lease agreement. This debt will be in addition to the bank loan payable, which is due in the near future. If the business does not succeed and there are insufficient assets to pay all debt outstanding, creditors could then make claims against the personal assets of the partners. Katy Peterson appears to have few personal assets. This could leave you (Natalie Koebel) responsible for repaying all liabilities of the partnership. 4. Before becoming a partner with Katy Peterson, you (Natalie Koebel) should ask to see the financial statements of The Baker’s Nook to assess its profitability. You should also consider what benefits (if any) would result from combining the businesses. Lastly, it would be helpful to develop a cash flow budget to see if the new business will generate enough cash to cover the lease payment and the upcoming bank loan repayment.

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CONTINUING COOKIE CHRONICLE (Continued) (b) COOKIE CREATIONS AND MORE Balance Sheet August 1, 2014 Assets Current assets Cash............................................................................. $16,450* Accounts receivable ................................................... 6,050 Inventory ..................................................................... 1,700 Supplies....................................................................... 800 Total current assets ............................................... 25,000 Property, plant, and equipment Equipment ...................................................................... 9,000 Total assets ................................................................ $34,000 Liabilities and Partners' Equity Current liabilities Bank loan payable .......................................................... $10,000 Partners' equity K. Peterson, Capital ....................................... $12,000 N. Koebel, Capital ......................................... 12,000 24,000 Total liabilities and partners' equity.......................... $34,000 * Value of N. Koebel’s proprietorship net assets .............. $12,000 Value of K. Peterson’s proprietorship net assets .......... 5,100 Cash K. Peterson borrowed.......................................... 6,900 Cash from N. Koebel’s proprietorship ......................... 8,050 Cash from K. Peterson’s proprietorship ......................... 1,500 Total cash when partnership is formed ........................... $16,450

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BYP 12-1 FINANCIAL REPORTING PROBLEM (a) The main deciding factor in choosing between the proprietorship and the corporate structure when the business was founded was likely the availability of cash needed to finance the business. If the majority of the cash came from personal family funds, there would not have been the need to obtain financing from a bank. The more likely situation is that creditors were involved from the start to finance the purchase of merchandise inventory necessary to start the business. In this case the owners likely chose the corporate structure. Limited liability may have also been a welcome feature of the corporate form of organization. (b) In order to have its shares traded on a stock exchange, Reitmans would have needed to adopt the corporate structure. The transfer of ownership from generation to generation, prior to Reitmans becoming a public company, would have been easier with the corporate structure. With the continued expansion came a greater need for financing and consequently the involvement of more and more creditors. Consequently, the owners needed the corporate structure to attract more capital and ensure limited liability to its owners. (c) 1) Statements of Earnings: There would not be any income tax on the partnership income statement. Partnership earnings are taxed in the hands of the partners. Nor would there be any earnings per share disclosure. 2) Balance Sheet: The equity section of the balance sheet would be called Partnership Equity instead of Shareholders’ Equity. Each partner’s capital account balance would be listed, in place of Share Capital, Contributed Surplus and Retained Earnings. 3) The Statements of Changes in Shareholders’ Equity would be replaced with a Statement of Partners’ Equity. 4) Statement of Cash Flows: There would be no difference. Solutions Manual .

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BYP 12-2 INTERPRETING FINANCIAL STATEMENTS (a) The advantage of operating as a limited partnership is that it allows some (limited) partners to invest in the partnership and have limited liability. This appeals to many individuals who want to invest in the business but do not want to take the risk of having unlimited liability for all the partnership liabilities. From the business’ perspective the company would be able to attract more investors and capital if they could offer investors limited liability. The General Partner also maintains control of the day-to-day operations. (b) The reason for the restriction on the ability of the limited partners to be involved in matters involving the partnership or in determining who is the general partner is a matter of practicality. It is not realistic to expect the unitholders to be consulted repeatedly in matters over which they may have little interest or opinion. Like shareholders in a corporate structure of a public company, the shareholders that hold voting shares exercise their rights to vote in a very limited number of decisions, such as electing the board of directors and appointing the auditor.

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BYP 12-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resources site accompanying this textbook.

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BYP 12-4 COMMUNICATION ACTIVITY To:

Drs. Chatterjie and Unger

From:

Your Accountant

Subject:

Partnership Agreement for Medical Practice

All provinces have a Partnership Act that provides the basic rules for the formation and operation of partnerships. Partnerships are easy to form and are not subject to much government regulation. There are three forms of partnership organizations that share the following characteristics:  A partnership is a voluntary association of individuals.  Assets of the partnership are co-owned.  Profit is divided among the partners as specified in the partnership agreement.  Each partner acts for the partnership when doing partnership business and the action of any partner is binding on all other partners.  The life of the partnership is not unlimited. Any change in ownership dissolves the partnership. 1.

General Partnership Each partner has unlimited personal liability for all of the debts of the partnership. This is the main disadvantage of a general partnership.

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BYP 12-4 (Continued) 2.

Limited Partnership (LP) One or more of the partners retain unlimited liability and are called general partners. The remaining partners have limited liability and are called limited partners. Limited partners tend to be investors who are not active in the business. Their liability is limited to their initial investment in the business.

Limited Liability Partnership (LLP) Most professionals form this type of partnership, which is designed to protect innocent partners from negligent actions of other partners. Partners remain fully liable for their own negligence as well as those they supervise and control, but have limited liability for negligence of the other partners.

I look forward to a productive session with both of you.

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BYP 12-5 ETHICS CASE (a) The stakeholders are Susan and Erin. (b) The problem with Susan’s actions is that they cause significant differences in the time worked between the partners and in the amount of drawings made by each partner. Sooner or later, this could cause difficulties for the business and friction between the partners. The differences here emphasize the importance of a written partnership agreement. Time to be worked by each partner and allowable drawings are two subjects that should be in the agreement. Based on the information given, ethical considerations rest primarily on the issue of fairness. Susan is not trying to hide anything from Erin. However, her actions do not seem to be fair given the fact that profit and loss is shared equally. (c) For the differences in time worked, two changes in the partnership agreement should be considered. First, Erin could be given a higher salary allowance than Susan. Second, because Erin is contributing more to profit than Susan, she could be given a higher percentage of profit after deducting salary allowances. For the differences in drawings, the partnership agreement could be altered to allow for interest on average monthly "net" partners’ capitals. Net partners’ capitals would be the difference between the balances of the capital and drawings accounts at the end of each month. If this is not agreeable to Susan, then the partnership agreement should be changed to limit the drawings of each partner to a fixed amount.

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BYP 12-6 “ALL ABOUT YOU” ACTIVITY (a)

A partnership can exist although there might not be a formal agreement in place.

(b)

The revenues that could be earned from the band include: 1. Fees for performances 2. Royalties of proceeds on sale of songs to other performers 3. Fees for endorsements of products if they obtain sponsors or on sales of merchandise 4. SOCAN royalties for airing music

(c)

Expenses to operate the band could include: 1. Studio time to record songs 2. Repair on musical instruments 3. Rent for space to work 4. Electricity and other utilities 5. Travel costs to promote their music 6. Accommodation and meals while delivering performances in other cities 7. Promotion costs 8. Professional fees from an agent 9. Depreciation expense on musical instruments.

(d)

Some of the issues relating to sharing of the revenues and the costs incurred by the band could include: 1. Some band members might own their own musical instruments and feel that they should be reimbursed for the costs of these instruments. 2. Some band member might have contributed more talent and effort in writing songs or lyrics that are used by all band members. 3. Additional personal assets, such as a car might be used to travel. 4. Money might be used to finance the band which might have been spent more by one band member than the others.

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BYP 12-6 (Continued)

(e)

Should one of the band member want to leave, the issues that could come up and should be dealt with the partnership agreement on his departure include: 1. How to deal with musical instruments that were used by this band member, and determining whose property it is if a new instrument was purchased. 2. The ownership of copyrights of the lyrics. 3. Royalties yet to be earned by the use of the songs created while in the band. 4. Cash invested to finance the operations of the band. 5. The possible need to change the name of the band. 6. Allowing the member leaving the band the right to use a song and receive a portion of the royalty of a song created while with the band but very successful after the member leaves the band.

(f)

Should another band member join the band, when revenues have already been earned issues would include: 1. A requirement for the new member to purchase some of the goodwill that has already been established by the existing band. 2. The ownership of copyrights of the lyrics already in place. 3. Royalties yet to be earned by the future use of the songs created before joining the band. 4. The possible need to change the name of the band.

(g)

Issues that would need to be dealt with if a band member were to do solo performances include: 1. Determining the rights to the songs being used in a performance. 2. Use of equipment or resources that are controlled and paid for by the band. 3. Association of the performance to the band and the repercussion on reputation and future earning ability.

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BYP 12-6 (Continued) (h)

Should the band decide to split up, issues will be similar to the ones dealt with when the band was formed. They would include: 1. How to deal with musical instruments that were purchased. 2. Dealing with outstanding debts or obligations of the band, including any outstanding claims from previous band members. 3. The ownership of copyrights of the lyrics. 4. Royalties yet to be earned by the use of the songs created while in the band. 5. Rights to the band name.

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Accounting Principles, Sixth Canadian Edition

CHAPTER 13 Corporations: Organization and Share Capital Transactions

ASSIGNMENT CLASSIFICATION TABLE Problems Brief Set A Exercises Exercises

Problems Set B

1, 2, 3, 4, 10

1, 2

2. Account for the issuance of common and preferred shares.

5, 6, 7, 8, 9, 11

2, 3, 4, 5, 6

1, 3, 4, 5, 6, 8, 12

2, 3, 4, 7, 8, 12

3. Prepare a corporate income statement.

7, 10, 12

5, 6, 9, 10, 12

8, 10, 12

9, 10

9, 10, 12

4, 5, 6, 7, 8, 12 5, 6, 9, 10, 12

11, 12

7, 8, 9, 10, 11, 12

Study Objectives

Questions

1. Identify and discuss the major characteristics of the corporate form of organization.

4. Account for cash 13, 14, 15 dividends. 5. Prepare a statement 16, 17 of retained earnings and closing entries for a corporation. 18, 19, 20 6. Prepare the shareholders’ equity section of the balance sheet and calculate return on equity.

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Chapter 13

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine form of business organization.

Simple

15-20

Record and post share transactions. Determine balances and answer questions.

Moderate

25-30

Allocate dividends between preferred and common shares.

Simple

15-20

Allocate dividends between preferred and common shares and record conversion.

Simple

25-30

Record dividends, prepare income statement and statement of retained earnings.

Simple

25-30

Adjust income tax, prepare income statement, statement of retained earnings, and closing entries.

Moderate

35-40

Record and post transactions. Prepare shareholders’ equity section.

Moderate

40-50

Record and post transactions. Prepare shareholders’ equity section.

Moderate

50-60

Prepare financial statements and closing entries.

Moderate

40-50

10A

Prepare financial statements and calculate return on equity.

Moderate

50-60

11A

Calculate return on assets and equity and comment.

Simple

10-15

12A

Record transactions and adjustments, prepare financial statements.

Moderate

35-40

Identify and discuss major characteristics of a corporation.

Simple

15-20

Record and post share transactions. Determine balances and answer questions.

Moderate

25-30

Allocate dividends between preferred and common shares.

Simple

15-20

Allocate dividends between preferred and common shares and record conversion.

Simple

25-30

Record dividends, prepare income statement and statement of retained earnings.

Simple

25-30

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Difficulty Level

Time Allotted (min.)

Adjust income tax, prepare income statement, statement of retained earnings, and closing entries Record and post transactions. Prepare shareholders’ equity section.

Moderate

35-40

Moderate

40-50

Record and post transactions. Prepare shareholders’ equity section.

Moderate

50-60

Prepare financial statements and closing entries.

Moderate

40-50

10B

Prepare financial statements and calculate return on equity.

Moderate

50-60

11B

Calculate return on assets and equity and comment.

Simple

10-15

12B

Record transactions and adjustments, prepare financial statements.

Moderate

35-40

6B 7B

Description

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Accounting Principles, Sixth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objectives

Knowledge

Comprehension

Identify and discuss the major characteristics of the corporate form of organization.

E13-1

Q13-1 Q13-2 Q13-3 Q13-4 BE13-1 E13-2

Q13-10

Account for the issuance of common and preferred shares.

E13-1

Q13-5 Q13-6 Q13-7 Q13-9

Q13-8 Q13-11 BE13-2 BE13-3 BE13-4 BE13-5 BE13-6 E13-3 E13-4 E13-5 E13-6 E13-8 E13-12 P13-2A P13-3A P13-4A

P13-7A P13-8A P13-12A P13-2B P13-3B P13-4B P13-7B P13-8B P13-12B

Prepare a corporate income statement.

Q13-12

BE13-7 E13-7 E13-10 E13-12 P13-5A P13-6A P13-9A P13-10A

P13-12A P13-5B P13-6B P13-9B P13-10B P13-12B

Account for cash dividends

Q13-15

BE13-8 E13-8 E13-10 E13-12 P13-4A P13-5A P13-6A P13-7A P13-8A P13-12A

P13-4B P13-5B P13-6B P13-7B P13-8B P13-12B

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Q13-13 Q13-14

13-4

Application

Analysis

Synthesis

P13-1A P13-1B

Chapter 13

Evaluation

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Accounting Principles, Sixth Canadian Edition

BLOOM’S TAXONOMY TABLE (Continued) 5.

Prepare a statement of retained earnings and closing entries for a corporation

Prepare the shareholders’ equity section of the balance sheet and calculate return on equity.

Broadening Your Perspective

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Q13-18

Q13-16 Q13-17

BE13-9 BE13-10 E13-9 E13-10 E13-12 P13-5A P13-6A

P13-9A P13-10A P13-12A P13-5B P13-6B P13-9B P13-10B P13-12B

Q13-19 Q13-20

BE13-11 BE13-12 E13-11 E13-12 P13-7A P13-8A

P13-9A P13-10A P13-11A P13-12A P13-7B P13-8B P13-9B P13-10B P13-11B P13-12B

BYP13-1 BYP13-3

BYP13-2 Continuing Cookie Chronicle

13-5

BYP13-4

BYP13-5 BYP13-6

Chapter 13

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Accounting Principles, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

Classified by Purpose: A business may be incorporated to make a profit, like Tim Hortons. Or, it may be incorporated as a not-for-profit, like the Canadian Cancer Society. Classified by Ownership: A corporation can be publicly held or privately held. A publicly held corporation, like Reitmans (Canada) Ltd., may have thousands of shareholders, and its shares trade in an organized securities market. A privately held corporation, like McCain Foods Limited, usually only has a few shareholders, and its shares are not offered for sale to the general public.

(a) Limited liability of shareholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of shareholders is normally limited to their investment in the corporation. (b) Transferable ownership rights. Ownership of a corporation is held in capital shares. The shares are transferable units. Shareholders may dispose of part or all of their interest by simply selling their shares. The transfer of ownership to another party is usually entirely at the discretion of the shareholder. (c)

Ability to acquire capital. A corporation has an easier time raising capital because of features such as limited liability and the ease of transferring shares. Also, because only small amounts of money need to be invested, many individuals can become shareholders. However, small, privately held corporations can have as much difficulty getting capital as any proprietorship or partnership.

A corporation provides several advantages over proprietorships and partnerships. The separate legal existence of the corporation from its owners, as well as the limited liability protection offered to shareholders, allow the corporation to acquire capital more easily and in larger amounts than the other two forms of business. The corporate form of business also provides a continuous life beyond the life of the individuals who own it. Corporations also have more easily transferable ownerships rights and enjoy certain forms of income tax advantages. The disadvantages of corporations include increased administrative burden and cost due to additional government regulations and the potential for additional income taxes.

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QUESTIONS (Continued) Question 3 (Continued) Small, privately held corporations are riskier than large publicly held ones and frequently do not enjoy the same advantages as larger corporations. Lenders will often require the owners to sign personal guarantees, thus eliminating the limited liability normally associated with corporations. Because the shares are not offered for sale to the general public, it is more difficult to raise capital. Small corporations may be run by the shareholders, rather than professional managers. This also means that if one of these shareholders sells his or her ownership interest, the corporation may be significantly affected. 4.

The ownership rights of shareholders are the rights to:  Vote on the election of the board of directors with each shareholder normally having one vote for each common share  Receive dividends on a pro-rata basis with other shareholders, and  Receive assets upon liquidation on a pro-rata basis with other shareholders. Shareholders manage the corporation indirectly through the board of directors that they have elected. The board of directors can then select and hire officers of the corporation to conduct business on a day-to-day basis. The board of directors decides on the corporation’s operating policies and the officers of the corporation execute the policies.

The total number of shares a company is allowed to sell is called its authorized shares—it may be an unlimited amount or a specified amount. No journal entry is recorded when the number of authorized shares is set. The number of authorized shares fixes the upper limit of how many shares can be sold by the corporation. This provides shareholders with an indication of the potential dilution of their ownership share. Issued shares are shares that have been sold. A journal entry will be prepared when shares are issued. The number of issued shares can never exceed the number of authorized shares. The number of shares issued allows users of financial statements to determine how many additional shares can be sold (up to the number authorized) and determine any future dilution of their ownership percentage. That said, under ASPE it is not necessary to show the number of shares authorized, just the number issued.

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 6.

When Paul purchases the original shares as part of TechTop’s initial public offering, he is purchasing from the company. The $1,200 (100 × $12) he spends to buy the shares goes directly to TechTop and increases the company’s assets and shareholders’ equity. In the subsequent purchase, Paul is buying in the secondary market from another investor. The proceeds from this sale go to the seller and not to TechTop. Therefore there is no impact on TechTop’s financial statements as a result of the second purchase.

The transaction would be recorded by debiting the equipment and crediting common shares. If the company follows IFRS, the transaction will be valued at the fair value of the equipment received. If this value cannot be determined, then the transaction is recorded at the fair value of the shares given in exchange. If the company follows ASPE, the transaction is valued at whichever amount can be more reliably determined; either the fair value of the equipment or the fair value of the shares given in exchange.

The basic ownership rights of preferred shareholders are the rights to receive:  dividends ahead of the common shareholder, and  assets upon liquidation ahead of the common shareholder. They may also have priority for reacquisition if they are redeemable or retractable. In exchange for these preferences, preferred shareholders normally are not entitled to vote. In the absence of restrictive provisions, the basic ownership rights of common shareholders are the rights to:  vote in the election of the board of directors and in corporate actions that require shareholders' approval,  share in corporate profit by receiving dividends, and  share in assets upon liquidation.

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QUESTIONS (Continued) 9.

Cumulative preferred shares are those that require preferred shareholders be paid both current year dividends and unpaid prior year dividends before common shareholders receive any dividends. In contrast, dividends not declared for noncumulative preferred shares are lost forever. Redeemable preferred shares can be purchased from the shareholders, by the issuing corporation, at the option of the corporation. If the shares are retractable they can be sold by the shareholder, to the issuing corporation, at the option of the shareholder. Convertible preferred shares are preferred shares that can be converted into common shares, at the option of the shareholder, at a specified ratio.

10. (a) The company is required to pay the previous two years of arrears on the cumulative preferred share dividends only, before paying current year dividends. (b) Dividends in arrears are disclosed in the notes to the financial statements; they are not recorded as liabilities. 11. When convertible preferred shares are converted into common shares, the shareholder simply exchanges preferred shares for common shares, according to a predetermined rate. To record the conversion, the amount originally paid for the preferred shares is transferred from the preferred shares account into the common shares account. If multiple share issues have occurred at varying prices, then the average cost for each preferred share is used instead of the original cost. This entry has no effect on (a) total assets, (b) total liabilities, or (c) total shareholders' equity. 12.

The unique feature of corporation income statements is a separate section that shows income tax expense. The presentation is as follows: Profit before income tax........................................................... Income tax expense* ............................................................... Profit ........................................................................................

$500,000 150,000 $350,000

* This is usually subdivided, to show the portion which is currently due and the portion which is due in future periods. Proprietorship and partnership income statements do not show a section for income taxes since income is taxed personally in the hands of the proprietor or partner.

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 13.

Pro rata means proportional. If you own 5% of the shares, you are entitled to 5% of the dividends that are declared.

14.

A cash dividend becomes a liability on the declaration date. This is the date the board of directors formally declares the cash dividend and announces it to shareholders. This commits the corporation to a binding legal obligation that cannot be rescinded. On the declaration date, the company debits Cash Dividends and credits Dividends Payable. On the record date, there is no entry; the company simply determines ownership of the shares. On the payment date, the Dividends Payable is debited and Cash is credited as the dividend is paid out.

15.

The requirement to have a positive (or credit) balance in retained earnings is usually a legal requirement set out in the incorporating act of most jurisdictions. Dividends are paid out of retained earnings and most incorporating acts restrict the payment of dividends if it creates or increases a deficit. These restrictions are for the protection of creditors and to ensure that the company can honour its obligations.

16.

A statement of retained earnings shows the increases to retained earnings from profits generated on the income statement (or decreases due to losses) and decreases from the declaration of dividends. The statement is similar to a statement of owner’s equity in that increases from profit and distributions to owners are shown on both statements. The statement of owner’s equity is different in that it also includes investments by owners.

17. Temporary accounts such as the revenue, expenses, gains, and losses from the income statement are closed to the Income Summary account. The Income Summary account is then closed to Retained Earnings. The Cash Dividend accounts are also closed to Retained Earnings. This process is the same as for proprietorships except that proprietorships have a capital account instead of retained earnings and a withdrawal account instead cash dividends.

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QUESTIONS (Continued) 18. The main components of shareholders' equity are: Contributed capital, Retained earnings, and Accumulated other comprehensive income (loss) for companies that follow IFRS. Contributed capital represents the amounts contributed by the shareholders. Share capital and additional contributed surplus (e.g., from reacquisition of shares) are components of contributed capital. Retained earnings represent the cumulative profit (or loss) since incorporation that has been retained in the company and not distributed to shareholders as dividends. Accumulated other comprehensive income (loss) represents gains and losses not resulting from share transactions, that bypass profit. The most common example is unrealized gains and losses on certain types of investments. 19. Company 1 would be a better investment since it can generate the same amount of profit using a smaller investment of capital by the shareholders. This can be shown by comparing the return on shareholders’ equity for each company. Company 1: $100,000 ÷ $300,000 = 33.3% and Company 2: $100,000 ÷ $350,000 = 28.6%. 20. Return on equity is the return earned by all the shareholders — both the preferred and common shareholders. It is calculated by dividing profit by the average shareholders’ equity. Common shareholders can obtain a more precise measure by calculating the return on common shareholders’ equity. Return on common shareholder’s equity is the return earned by the common shareholders. It is calculated by dividing the profit available to the common shareholders by the average common shareholders’ equity. Preferred dividends are deducted from profit to determine the numerator. The legal capital of the preferred shareholders is deducted from total shareholders’ equity before calculating the average common shareholders’ equity.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 Characteristic Proprietorship Partnership Corporation 1. Continuous life X 2. Unlimited liability X X 3. Ease of formation X X 4. Separate legal X existence 5. Ability to acquire X X capital 6. Shared skills and X X resources 7. Fewer government X X regulations 8. Separation of ownership and X management 9. Owners’ acts are X X binding 10. Easy transfer of X ownership rights

BRIEF EXERCISE 13-2 (a) Aug.

Sep. 10

Cash (2,000 × $12) ......................... Common Shares .......................

24,000

Cash (500 × $13) ............................ Common Shares .......................

6,500

24,000 6,500

(b) Average cost per share: ($24,000 + $6,500) ÷ (2,000 + 500) = $12.20

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BRIEF EXERCISE 13-3 (a) Sep. 10

Equipment ..................................... Common Shares .......................

9,500 9,500

The fair value of the equipment received has been used to value the transaction. Since Juke Joint Ltd. Is a private company, the shares are not widely traded and the $20 per share price from March 12th is likely not a reliable indicator of fair value on September 10th. (b) The answer would not change since IFRS requires that the fair value of the goods received is used.

BRIEF EXERCISE 13-4 (a) Jan. 13

Cash (3,000 × $90) ............................ 270,000 Preferred Shares......................

270,000

(b) Total dividend: $4 per share × 3,000 shares = $12,000

BRIEF EXERCISE 13-5 (a) Dividends are in arrears by $225,000 ([45,000 × $2.50] × 2). If the shares are noncumulative, there are no dividends in arrears. (b) Dividends in arrears should be reported in the notes to the financial statements.

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BRIEF EXERCISE 13-6 (a) May 10

(b) Nov. 21

Cash (25,000 × $35) .......................... 875,000 Preferred Shares......................

Preferred Shares (5,000 × $35) ........ 175,000 Common Shares ...................... (5,000 x 2 = 10,000 common shares)

875,000

175,000

BRIEF EXERCISE 13-7 (a) June 30 Income Tax Expense ...................... 33,750 Income Tax Payable ................... ($800,000 − $575,000) × 15%

33,750

(b) VICERON INC. Income Statement Year Ended June 30, 2014 Revenues ................................................................ Expenses................................................................. Profit before income tax......................................... Income tax expense ............................................... Profit ........................................................................

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$800,000 575,000 225,000 33,750 $191,250

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BRIEF EXERCISE 13-8 Oct. 14 Cash Dividends—Preferred ............... 131,250 Dividends Payable (25,000 × $5.25) Nov.

131,250

1 No journal entry.

Nov. 21 Dividends Payable.............................. 131,250 Cash................................................

131,250

BRIEF EXERCISE 13-9 GRAYFAIR INC. Statement of Retained Earnings Year Ended December 31, 2014 Retained earnings, January 1......................................... $248,000 Add: Profit...................................................................... 175,000 423,000 Less: Cash dividends .................................................... 120,000 Retained earnings, December 31 ................................... $303,000

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BRIEF EXERCISE 13-10 (a) Dec. 31

Sales ............................................. Income Summary.....................

745,000

Income Summary ......................... Cost of Goods Sold ................. Operating Expenses ................ Income Tax Expense ...............

620,000

Income Summary ......................... Retained Earnings ...................

125,000

745,000

450,000 135,000 35,000

Retained Earnings........................ 50,000 Cash Dividends—Common ($25,000 × 2)

125,000

50,000

(b) Clos. Clos.

Income Summary 620,000 Clos. 745,000 Bal. 125,000 125,000 Bal. -

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Retained Earnings Bal. 382,000 Clos. 50,000 Clos. 125,000 Bal. 457,000

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BRIEF EXERCISE 13-11 TRUE GREEN NURSERIES LTD. Balance Sheet (Partial) December 31, 2014 Shareholders' equity Share capital* $6.50 cumulative preferred shares, 1,000 issued Common shares, 15,000 issued Total share capital Retained earnings Total shareholders' equity

$100,000 150,000 250,000 285,000 $535,000

* Under ASPE it is not necessary to show the number of shares authorized.

BRIEF EXERCISE 13-12 (a) Return on equity $51,951 ($638,995 + $663,602) ÷ 2 (b)

= 7.98%

It would be the same because the company does not have any preferred shares.

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SOLUTIONS TO EXERCISES EXERCISE 13-1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

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

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Retractable preferred shares Public corporation Redeemable preferred shares Authorized shares Issued shares Initial public offering Secondary market Retained earnings Liquidation preference Legal capital Convertible Cumulative

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EXERCISE 13-2 Report to: Client From: Insite Consulting Advice has been sought regarding the form of organization your new business should take. Based on the information provided, the corporate form of organization would best meet your business’s needs. A corporate structure has an indefinite life and the ownership structure consisting of shares will allow you to easily transfer ownership of your company to your children. You also mentioned that lawsuits occur frequently in the medical industry. A corporation will allow you to limit liability to lawsuits for shareholders. This advantage is not available if you operate your business as a partnership or as a sole proprietorship. A corporation is taxable as a separate legal entity. There may be opportunities to defer the payment of taxes by reinvesting the profits in the business since you expect to generate significant taxable income in the early years. Finally, a corporation will also allow you to raise capital by selling shares. Since you are anticipating growth, the corporate form of business will also allow you to more easily separate management from ownership and hire professional managers. Consider that selling shares will dilute your ownership and hiring professional managers will signify a less active role in the business on your part.

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EXERCISE 13-3 (a) Jan. 12 Cash (50,000 × $5) ................... Common Shares ................. 24

250,000 250,000

Legal Fees Expense ................ Common Shares .................

4,500

July 11 Cash (1,000 × $25) ................... Preferred Shares .................

25,000

Oct.

55,000

Land.......................................... Common Shares .................

4,500

25,000 55,000

(b)

The average cost for the common shares is $5.08 [($250,000 + $4,500 + $55,000)  (50,000 + 950 + 10,000)].

(c)

The value assigned to the shares on October 1 would not change. Under IFRS, the value of the land received is used to assign the value to the common shares.

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EXERCISE 13-4 (a) Shares issued to Mah.............................. Shares issued to Manji and MacDonald. Total number of shares issued...............

1,000 9,000 10,000

Ownership percentage to Mah = 1,000 / 10,000 = 10% Alternatively, total number of shares issued = 9,000 / (1 – 10%) = 10,000 shares (b) Jan. 1 Legal Fees Expense ................ 5,000 Common Shares ................. 5,000 Issued 1,000 common shares in payment of legal services. (c) By issuing shares to Mah, Mah becomes one of the common shareholders of Southwest Corporation. Manji and MacDonald may not want to issue shares because this allows Mah to share in future dividend payments and future profits. This could increase the cost of Mah’s legal services. This would also mean that Mah would share in the decisionmaking.

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EXERCISE 13-5 (a) The preferred shareholders will convert their shares when the fair value of the common shares is either equal to or higher than the value of the preferred shares. The fair value of the common shares must be equal to at least $110 ÷ 4 = $27.50 each. This occurs on September 19. On September 28, the fair value of the common shares is in excess of $27.50. Therefore if the preferred shares had not already converted, they would also be willing to convert on that day. (b) Sept. 19 Preferred Shares...................... 11,000,000 Common Shares ................. 11,000,000 100,000 × $110 = $11,000,000 (c) Preferred shareholders will want to convert their preferred shares into common shares before the fair value of the common shares reaches $28.75 per share ($115 ÷ 4). At this price, the company will likely redeem the shares.

EXERCISE 13-6 (a) 150,000 × $4.50 = $675,000 (b) Regular dividend Arrears from Year 1 Dividend paid Arrears

Year 1 $675,000

450,000 $225,000

Year 2 $675,000 225,000 900,000 900,000 $ 0

(c) Dividends in arrears should be disclosed in the notes to the financial statements. They are not recorded in the general ledger accounts. (d) The likely amount is $4.50 per share, for a total of $675,000.

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EXERCISE 13-7 SHRUNK INC. Income Statement Year Ended July 31, 2014 Sales................................................................................ $665,000 Cost of goods sold......................................................... 310,000 Gross profit..................................................................... 355,000 Operating expenses: Salaries expense .......................................... 140,000 Supplies expense ........................................ 10,000 150,000 Profit from operations.................................................... 205,000 Other expenses: Interest expense ........................................................ 5,000 Profit before income tax ................................................ 200,000 Income tax expense ($200,000 × 20%) .......................... 40,000 Profit................................................................................ $160,000

July 31

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Income Tax Expense ............... 10,000 Income Tax Payable............ ($200,000 × 20%) – $30,000 = $10,000

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EXERCISE 13-8 (a) Preferred shares, $3.50, cumulative: Arrears: $3.50 × 20,000 shares × 2 years = Current amount: Total

$140,000 70,000 $210,000

Preferred shares, $4.50, noncumulative: Current amount: $4.50 × 10,000 shares =

$45,000

Common shares: Current amount: $0.50 × 300,000 shares = Total

$150,000 $405,000

(b) 2014 Oct. 30 Cash Dividends—Preferred* .............. 255,000 Cash Dividends—Common................ 150,000 Dividends Payable ......................... *($210,000 + $45,000)

405,000

Nov. 16 No journal entry. Dec. 1

Dividends Payable ............................. 405,000 Cash................................................

405,000

(c) Dividends in arrears would be $10,000 ($210,000 owing to the preferred shareholders [$3.50 cumulative per share] – $200,000 maximum dividend).

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EXERCISE 13-9 (a) SHRUNK INC. Statement of Retained Earnings Year Ended July 31, 2014 Balance, August 1, 2013 ................................................. $352,000 Add: Profit ..................................................................... 160,000 512,000 Less: Cash dividends .................................................... 60,000 Balance, July 31 .............................................................. $452,000 (b) July 31 Sales.................................................... 665,000 Income Summary ...........................

665,000

31 Income Summary ............................... 505,000 Cost of Goods Sold ....................... Supplies Expense .......................... Salaries Expense ........................... Interest Expense ............................ Income Tax Expense .....................

310,000 10,000 140,000 5,000 40,000

31 Income Summary ............................... 160,000 Retained Earnings ......................... ($665,000 – $505,000) 31 Retained Earnings ................................ 60,000 Cash Dividends—Common ...........

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160,000

60,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 13-9 (Continued) Income Summary Date

Explanation

Ref.

July 31 31 31

Closing entry Closing entry Closing entry

Debit

Credit

Balance

J1 J1 505,000 J1 160,000

665,000

665,000 160,000 0

Retained Earnings Date

Explanation

Ref.

Credit

Balance

Aug. 1 July 31 31

Balance Closing entry Closing entry

 J1 160,000 J1 60,000

352,000 512,000 452,000

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Debit

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Accounting Principles, Sixth Canadian Edition

EXERCISE 13-27 (a) DIDSBURY DIGITAL LTD. Income Statement Year Ended September 30, 2014 Service revenue.............................................................. Operating expenses ....................................................... Profit from operations.................................................... Interest expense ............................................................. Profit before income tax ................................................ Income tax expense ($84,500 × 15%) ............................ Profit................................................................................ Sep. 30 Income Tax Expense ............... Income Tax Payable............ ($84,500 × 15%) – $10,000 = $2,675

$529,000 442,000 87,000 2,500 84,500 12,675 $71,825

2,675 2,675

(b) DIDSBURY DIGITAL LTD. Statement of Retained Earnings Year Ended September 30, 2014 Retained earnings, October 1, 2013 .................... Add: Profit............................................................. Less: Cash dividends declared ........................... Retained earnings, September 30 .......................

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$237,500 71,825 309,325 40,000 $269,325

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Accounting Principles, Sixth Canadian Edition

EXERCISE 13-11 (a) RAIDERS LIMITED Partial Balance Sheet December 31, 2014

Shareholders' equity Share capital* $5 cumulative preferred shares, 1,000 issued 1 $ 105,000 2 Common shares, 35,000 issued 350,000 Total share capital ........................................... 455,000 3 ....................................................... Retained earnings 337,000 Total shareholders’ equity ............................................$792,000 * Under ASPE it is not necessary to show the number of authorized shares. 1 1,000 shares × $105 = $105,000 2 35,000 shares × $10 = $350,000 3 $287,000 + $125,000 – $75,000 = $337,000

(b) Return on equity $125,000 ($742,000* + $792,000) ÷ 2

= 16.30%

* Shareholders’ equity December 31, 2013 = $455,000 share capital + $287,000 beginning retained earnings = $742,000.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 13-12 (a) 2014 Jan. 1

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

150,000 150,000

Cash ......................................... 1,200,000 Preferred Shares ................. 1,200,000

Dec. 1 Cash Dividends—Preferred 1 .. Cash Dividends—Common 2 .. Dividends Payable .............. 1 2

120,000 105,000 225,000

$4 × 30,000 shares = $120,000 $225,000 – $120,000 = $105,000

Dec. 13 No journal entry. 2015 Jan. 5 Dividends Payable ....................... 225,000 Cash.....................................

225,000

(b) OZABAL INC. Income Statement (partial) Year Ended December 31, 2014 Revenues ........................................................................ Operating expenses ....................................................... Profit before income tax ................................................ Income tax expense ($305,000 × 15%) .......................... Profit ............................................................................... Dec. 31 Income Tax Expense ............... Income Tax Payable............

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$915,000 610,000 305,000 45,750 $259,250

45,750 45,750

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Accounting Principles, Sixth Canadian Edition

EXERCISE 13-12 (Continued) (c) OZABAL INC. Statement of Retained Earnings Year Ended December 31, 2014 Retained earnings, January 1.............................. Add: Profit ............................................................ Less: Preferred share dividends ................... $120,000 Common share dividends .................... 105,000 Retained earnings, December 31 .......................

0 259,250 259,250

225,000 $ 34,250

OZABAL INC. Partial Balance Sheet December 31, 2014 Shareholders' equity Share capital* $4 noncumulative preferred shares, 30,000 issued $1,200,000 Common shares, 300,000 issued ........................ 150,000 Total share capital ...............................................1,350,000 Retained earnings ...................................................... 34,250 Total shareholders’ equity .........................................$1,384,250 * Under ASPE it is not necessary to show the number of authorized shares.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 13-1A 1.

A partnership would be the most likely form of business for the students to choose. It is simpler to form than a corporation and less costly.

Darien would likely form a corporation because he needs to raise funds to buy equipment. It is normally easier to raise funds through a corporation. A corporation is also the only form of business that provides limited liability to it owners.

Joanna will likely operate her cottage inspection service as a proprietorship because it is the simplest and least costly to form and maintain. If Joanna feels that she has legal exposure to lawsuits from her customers or as she expands her business, she may choose to incorporate in order to limit her liability.

Joel will likely operate his roofing services as a proprietorship because it is the simplest and least costly to form and maintain. If he feels that he has legal exposure to lawsuits from customers, he may choose to incorporate in order to limit his liability.

A proprietorship would be the most likely form of business for Frank. It is simpler to form than a corporation and less costly. A corporation is the only form of business that provides limited liability to it owners. However, it is unlikely that incorporating the business would shield Frank from personal liability in the event of an accident. In addition, a sole proprietorship means that Frank maintains control of the company. This could also be achieved in a corporation if it is closely held, although it would make attracting investors unlikely.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-1A (Continued) Taking It Further: The corporation’s by-laws would detail who can act as agent on behalf of the corporation. The shareholders vote to approve the by-laws. These types of decisions are usually made at the annual general meeting and determine who has signing authority to make payments from the company’s bank account and who has signing authority to enter into contracts on behalf of the corporation.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-2A

GENERAL JOURNAL

(a) Date

Debit

Credit

Feb. 10 Cash (80,000 × $4) .............................. 320,000 Common Shares ............................

320,000

Mar. 1 Cash (5,000 × $115) ............................ 575,000 Preferred Shares............................

575,000

Apr.

Account Titles and Explanation

1 Land .................................................... 90,000 Common Shares ............................

90,000

Jun. 20 Cash (78,000 × $4.50) ......................... 351,000 Common Shares ............................

351,000

July

7 Legal Fees Expense ........................... 45,000 Common Shares ............................

45,000

Sep. 1 Cash (10,000 × $5) .............................. 50,000 Common Shares ............................

50,000

Nov. 1 Cash (1,000 × $117) ............................ 117,000 Preferred Shares............................

117,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-2A (Continued) (b) Preferred Shares Date Mar. Nov.

Explanation

Ref.

Debit

J1 J1

1 1

Credit

Balance

575,000 117,000

575,000 692,000

Credit

Balance

320,000 90,000 351,000 45,000 50,000

320,000 410,000 761,000 806,000 856,000

Common Shares Date Feb. 10 Apr. 1 June 20 July 7 Sept. 1

Explanation

Ref. J1 J1 J1 J1 J1

Debit

(c) Number of preferred shares = 5,000 + 1,000 = 6,000 shares Average cost per preferred share = $692,000 ÷ 6,000 shares = $115.33 Number of common shares = 80,000 + 22,500 + 78,000 + 10,000 + 10,000 = 200,500 shares Average cost per common share = $856,000 ÷ 200,500 shares = $4.27 (d) The company is authorized to issue an additional 94,000 preferred shares (100,000 shares authorized – 6,000 shares issued) and an unlimited number of common shares.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-2A (Continued) (e) Yes. Features can be added to preferred shares to make them more attractive to potential investors. The cumulative feature assures investors that dividends not currently declared may be paid out at some point in the future. With non-cumulative preferred shares, if no dividends are declared, the dividend entitlement lapses and is lost to the investor. Since this feature makes the shares more attractive, it also results in a higher price for the shares.

Taking It Further: April 1 and July 7 are examples of issuing share for services or noncash assets. If Wetland was a public corporation, the transactions would be valued at the fair value of the assets or services received. In this case, the fair value of the land received and of the service received are the only amounts the company has to value the transactions. This is typical for private companies where the shares are not widely traded and the fair value of the shares given in exchange cannot be determined. For Wetland, the journal entries would be the same.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-3A

Year Dividend Paid 1 $20,000 2 15,000 3 30,000 4 35,000

(a) (b) Noncumulative Common Cumulative Common Preferred Preferred $20,000 $ 0 $20,000 $ 0 15,000 0 15,000 0 20,000 10,000 25,000 5,000 20,000 15,000 20,000 15,000

1. Regular dividend is $4 × 5,000 = $20,000 2b. Arrears = $20,000 − $15,000 = $5,000 3b. Preferred dividend = $20,000 (regular) + $5,000 (arrears) = $25,000 Taking It Further: Common shares have voting rights which allows investors some degree of influence over the company depending on how many shares are owned. Also, if the company is successful, the common shareholders will benefit more than the preferred shares from an increase in the value of the shares.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-4A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

2013 Jan. 10 Cash Dividends—Preferred ................. 12,000 Cash................................................

12,000

2014 Jan. 10 Cash Dividends—Preferred* ................ 68,000 Cash Dividends—Common ................... 4,000 Cash................................................

72,000

* Arrears from 2013: 2013 Dividend: (8,000 × $5) ............ $40,000 Less: Dividend paid in 2013............ 12,000 Current year dividend (8,000 × $5) ........... Cash Dividend to Preferred.......................

$28,000 40,000 $68,000

Mar. 1 Preferred Shares (8,000 shares) .........528,000 Common Shares (16,000 shares).. (8,000 × $66)

528,000

(b) The company needs to disclose dividends in arrears of $28,000 in 2013, in the notes to the financial statements.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-4A (Continued) (c) A preferred shareholder will usually convert preferred shares to common shares to participate in the growth of the market value of the common shares. Since preferred shares usually have no voting rights and carry a fixed dividend amount, their market price tends to remain fairly stable and is not subject to significant growth. Shareholders that own preferred shares can choose to keep their shares and receive stable, predictable dividends, but they can also choose to participate in the growth potential of common shares through conversion. If, through conversion, the market value of the common shares exceeds the market value of the preferred shares given up in the conversion, this would be a strong motivator to the preferred shareholder to convert, particularly if the shareholder intends to sell his investment. Taking It Further: The conversion option allows a preferred shareholder to convert their shares to common shares and to participate in the growth of the market value of the common shares. Since preferred shares usually have no voting rights and carry a fixed dividend amount, their market price tends to remain fairly stable and is not subject to significant growth. Shareholders that own preferred shares can choose to keep their shares and receive stable, predictable dividends, but they can also choose to participate in the growth potential of common shares through conversion. This additional choice and possibility for additional returns on their investment makes convertible preferred shares more attractive to investors.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-5A

(a)

GENERAL JOURNAL

Date

Debit

Credit

2014 June 30 Cash Dividends—Common ............... 25,000 Dividends Payable .........................

25,000

July

Account Titles and Explanation

8 Dividends Payable.............................. 25,000 Cash................................................

25,000

Dec. 31 Cash Dividends—Common ............... 25,000 Dividends Payable .........................

25,000

(b) ZURICH LIMITED Income Statement Year Ended December 31, 2014 Sales ................................................................................$1,650,000 Cost of goods sold......................................................... 1,225,000 Gross profit .................................................................... 425,000 Operating expenses ....................................................... 210,000 Profit from operations.................................................... 215,000 Interest revenue ................................................ $12,500 Interest expense ................................................ 35,000 22,500 Profit before income tax ................................................ 192,500 Income tax expense ($192,500 × 20%) .......................... 38,500 Profit ............................................................................... $154,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-5A (Continued) (c) ZURICH LIMITED Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1............................................... Add: Profit ............................................................ Less: Cash dividends declared* ......................... Retained earnings, December 31 ........................

$ 550,000 154,000 704,000 50,000 $654,000

* $25,000 + $25,000 Taking It Further: A statement of retained earnings shows increases from profit and decreases from distributions to owners through dividends. It does not show investments by owners through the sale of shares or repurchases of shares. In contrast, a statement of owner’s equity shows investments by owner in addition to increases from profit and distributions to owners through withdrawals.

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PROBLEM 13-6A (a) MEMPHIS LIMITED Income Statement Year Ended October 31, 2014 Service revenue.............................................................. Operating expenses: Depreciation expense................................... $34,375 Insurance expense .................................... 6,900 Rent expense ............................................. 28,800 Salaries expense ......................................... 195,000 Profit from operations.................................................... Interest expense............................................................. Profit before income tax ................................................ Income tax expense ($175,425 × 20%) .......................... Profit ............................................................................... 2014 Oct. 31 Income Tax Expense .............................10,085 Income Tax Payable ...................... ($35,085 – $25,000)

$445,000

265,075 179,925 4,500 175,425 35,085 $140,340

10,085

(b) MEMPHIS LIMITED Statement of Retained Earnings Year Ended October 31, 2014 Balance, November 1 ........................................... Add: Profit ............................................................ Less: Cash dividends .......................................... Retained earnings, October 31............................

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$ 430,000 140,340 570,340 80,000 $490,340

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-6A (Continued) GENERAL JOURNAL

Account Titles and Explanation

Debit

Credit

Oct. 31 Service Revenue ................................ 445,000 Income Summary...........................

445,000

31 Income Summary ................................304,660 Depreciation Expense ................... Income Tax Expense ..................... Insurance Expense ........................ Interest Expense ............................ Rent Expense ................................. Salaries Expense ...........................

34,375 35,085 6,900 4,500 28,800 195,000

31 Income Summary ............................... 140,340 Retained Earnings .........................

140,340

31 Retained Earnings ................................ 80,000 Cash Dividends—Common ...........

80,000

(d) Income Summary Date

Explanation

Ref.

Debit

Oct. 31 31 31

Closing entry Closing entry Closing entry

J1 J1 J1

304,660 140,340

Debit

Credit

Balance

445,000

445,000 140,340 0

Retained Earnings Date

Explanation

Ref.

Oct. 31 31 31

Balance Closing entry Closing entry

J1 J1 J1

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80,000

Credit

Balance

140,340

430,000 570,340 490,340

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-6A (Continued) Taking It Further: The calculation of income tax expense involves the final amounts for the remainder of the income statement, so the calculation must be prepared after all adjustments have been considered. The company also has to calculate the difference between the income tax expense and the instalments remitted earlier in the year. In addition, certain opportunities for tax planning exist and managers need to calculate the income before tax before finalizing the income tax expense for the year.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-7A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 2 Cash ................................................. 5,000,000 Preferred Shares ............................ 5,000,000 Apr. 1 Cash Dividends—Preferred ............... 100,000 Cash (100,000 × $4  4)..................

100,000

July 1 Cash Dividends—Preferred ............... 100,000 Cash................................................

100,000

Aug. 12 Cash (100,000 × $1.70) ....................... 170,000 Common Shares ............................

170,000

Oct.

1 Cash Dividends—Preferred ............... 100,000 Cash Dividends—Common* .............. 275,000 Cash................................................ (1,000,000 + 100,000) × $0.25 = $275,000

375,000

Dec. 31 Retained Earnings .............................. 100,000 Income Summary ...........................

100,000

Dec. 31 Retained Earnings .............................. 575,000 Cash Dividends—Preferred........... Cash Dividends—Common ...........

300,000 275,000

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PROBLEM 13-7A (Continued) (b) Preferred Shares Date Jan.

Explanation 2

Ref.

Debit

Credit

Balance

5,000,000

Credit

Balance

170,000

1,500,000 1,670,000

Credit

Balance

300,000

100,000 200,000 300,000 0

Credit

Balance

275,000

275,000 0

Common Shares Date Jan. Aug.

1 1

Explanation

Ref.

Balance

 J1

Debit

Cash Dividends—Preferred Date Apr. 1 July 1 Oct. 1 Dec. 31

Explanation

Ref.

Debit 100,000 100,000 100,000

Closing entry

J1 J1 J1 J1

Explanation

Ref.

Debit

Closing entry

J1 J1

Cash Dividends—Common Date Oct. 1 Dec. 31

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275,000

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PROBLEM 13-7A (Continued) (b) (Continued) Retained Earnings Date

Explanation

Ref.

Debit

Jan. 1 Dec. 31 31

Balance Closing entry Closing entry

 J1 100,000 J1 575,000

Credit

Balance 1,800,000 1,700,000 1,125,000

(c) SCHIPPER LTD. Balance Sheet (Partial) December 31, 2014 Shareholders' equity Share capital* $4 noncumulative preferred shares, 100,000 issued ................................................. Common shares, 1,100,000** issued .................. Total share capital................................................ Retained earnings..................................................... Total shareholders’ equity ..............................

$5,000,000 1,670,000 6,670,000 1,125,000 $7,795,000

* Under ASPE it is not necessary to show the number of authorized shares. ** 1,000,000 + 100,000 = 1,100,000 common shares No disclosure of arrears is required since the preferred shares are noncumulative.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-7A (Continued)

Taking It Further: The conditions to declare and pay dividends include (1) having sufficient cash to pay for ongoing operations and not make the company insolvent by paying a dividend; (2) maintain legal capital; and (3) a decision by the board of directors of the corporation. If all of these conditions are met, the company is allowed to declare and pay dividends even though it generated a loss in the current year.

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PROBLEM 13-8A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

Feb. 28 Cash ................................................. Preferred Shares ..........................

J1 Debit

Credit

275,000 275,000

Apr. 12 Cash ................................................. 3,200,000 3,200,000 Common Shares .......................... May 25 Land ................................................. Common Shares ..........................

75,000

Jan. 1 Cash Dividends—Preferred ............ Cash [(10,000 + 5,000) × $2.50]....

37,500

Jan. 31 Retained Earnings ........................... Income Summary .........................

50,000

Jan. 31 Retained Earnings ........................... Cash Dividends—Preferred.........

37,500

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75,000

37,500

50,000 37,500

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-8A (Continued) (b) Preferred Shares Date

Explanation

Ref.

Debit

Feb. 1 Feb. 28

Balance

 J1

Credit

Balance

475,000 275,000 750,000

Common Shares Date

Explanation

Ref.

Feb. 1 Apr. 12 May 25

Balance

 J1 J1

Debit

Credit

Balance

1,050,000 3,200,000 4,250,000 75,000 4,325,000

Cash Dividends—Preferred Date Jan. 1 Jan. 31

Explanation

Ref.

Debit 37,500

Closing entry

J1 J1

Credit

Balance

37,500

37,500 0

Retained Earnings Date

Explanation

Ref.

Feb. 1 Balance Jan. 31 Closing Entry Jan. 31 Closing Entry

 J1 J1

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Debit 50,000 37,500

Credit

Balance 700,000 650,000 612,500

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PROBLEM 13-8A (Continued) (c) CATTRALL CORPORATION Balance Sheet (Partial) January 31, 2015 Shareholders' equity Contributed capital Share capital* $5 cumulative preferred shares, 15,000** issued $ 750,000 Common shares, 275,000*** issued .................... 4,325,000 Total share capital................................................ 5,075,000 Retained earnings..................................................... 612,500 Total shareholders’ equity............................................ $5,687,500 * Under ASPE it is not necessary to show the number of authorized shares. ** 10,000 + 5,000 = 15,000 preferred shares *** 70,000 + 200,000 + 5,000 = 275,000 common shares Dividends of $37,500 [15,000 × ($5 ÷ 2)] are in arrears at January 31, 2012. Taking It Further: Under ASPE, shares issued in exchange for noncash assets are recorded at the fair value of whatever can more reasonably be determined — the fair value of the assets or the fair value of the shares. For a company applying ASPE, the fair value of the shares given in exchange can be particularly difficult to determine if there are no recent share transactions to provide a reliable fair value of the shares. For companies applying ASPE, the fair value of the noncash asset or service received can be used to value the transaction. The challenge remains of determining how many shares to issue if a fair value per share cannot be determined. This will usually be resolved by negotiation between the company and the supplier of the noncash asset or service.

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PROBLEM 13-9A (a) CHOKE CHERRY LTD. Income Statement Year Ended December 31, 2014 Sales revenue ................................................................. $515,000 Cost of goods sold......................................................... 159,000 Gross profit..................................................................... 356,000 Operating expenses: Depreciation expense ..................................... 20,000 Insurance expense ........................................... 8,200 Rent expense .................................................. 32,600 Salaries expense .......................................... 185,000 Supplies expense ........................................ 12,500 258,300 Profit from operations.................................................... 97,700 Other expenses: Interest expense ........................................................ 1,800 Profit before income tax ................................................ 95,900 Income tax expense ....................................................... 14,385 Profit................................................................................ $ 81,515 CHOKE CHERRY LTD. Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1............................................... Add: Profit.............................................................

$ 73,000 81,515 154,515

Less: Preferred share dividends ....................... $4,000 Common share dividends ........................ 50,000 54,000 Retained earnings, December 31 ........................ $100,515

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PROBLEM 13-9A (Continued) (a) (Continued) CHOKE CHERRY LTD. Balance Sheet December 31, 2014 Assets Current assets Cash............................................................................. $ 28,000 Inventory ..................................................................... 26,500 Supplies ........................................................................ 5,000 Total current assets ............................................... 59,500 Property, plant, and equipment Equipment .................................................... $300,000 Accumulated depreciation........................... (65,000) Total property, plant, and equipment...................... 235,000 Total assets .......................................................... $294,500 Liabilities and Shareholders’ Equity Current liabilities Accounts payable ....................................................... $ 34,000 Income tax payable..................................................... 8,985 Unearned revenue ...................................................... 21,000 Current portion of note payable ................................ 12,000 Total current liabilities ........................................... 75,985 Long-term debt Note Payable, net of current portion ......................... 18,000 Total liabilities ........................................................... 93,985 Shareholders’ equity* Share capital* $4 noncumulative preferred shares, 1,000 issued 40,000 Common shares, 120,000 issued .......................... 60,000 Total share capital.................................................. 100,000 Retained earnings ......................................................... 100,515 Total shareholders’ equity.............................................. 200,515 Total liabilities and shareholders’ equity ............. $294,500 * Under ASPE, not required to show the number authorized. Solutions Manual .

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PROBLEM 13-9A (Continued) (b) Dec. 31 Sales.................................................... 515,000 Income Summary ...........................

515,000

31 Income Summary ............................... 433,485 Cost of Goods Sold ....................... Depreciation Expense ................... Insurance Expense ........................ Rent Expense ................................. Salaries Expense ........................... Supplies Expense .......................... Interest Expense ............................ Income Tax Expense .....................

159,000 20,000 8,200 32,600 185,000 12,500 1,800 14,385

31 Income Summary ............................... 81,515 Retained Earnings ......................... ($515,000 – $433,485) 31 Retained Earnings .............................. 54,000 Cash Dividends—Preferred........... Cash Dividends—Common ...........

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81,515

4,000 50,000

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PROBLEM 13-9A (Continued) Taking It Further: Withdrawals by partners are based on mutually agreed amounts amongst the partners and on the partnership’s and the partner’s cash needs for the year. Dividends are paid to the shareholders of the corporation on a pro-rata basis based on the number of shares within a class of shares. For preferred shares, the dividend amount is usually fixed and preferred shareholders cannot receive more than their specified dividend rate. Dividends must be approved and voted by the corporation’s board of directors before they can be paid out. Corporations must also abide by the Corporations Act in paying out dividends to ensure the company remains solvent and to ensure there is a positive balance in retained earnings. Because withdrawals are a return to a partner or owner of his investment or of profit on which he has been taxed personally, the amount of a withdrawal has no tax consequences. On the other hand, dividends are generally taxable to those who receive them as income.

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PROBLEM 13-10A (a) NORTHWOOD ARCHITECTS LTD. Income Statement Year Ended March 31, 2014 Consulting revenue ........................................................... $404,500 Operating expenses: Depreciation expense .................................. $ 11,825 Insurance expense ..................................... 6,550 Rent expense .................................................. 35,800 Salaries expense........................................... 245,400 Supplies expense ........................................ 25,800 325,375 Profit from operations.................................................... 79,125 Other expenses: Interest expense ........................................................ 3,000 Profit before income tax ................................................ 76,125 Income tax expense ....................................................... 16,535 Profit................................................................................ $ 59,590 NORTHWOOD ARCHITECTS LTD. Statement of Retained Earnings Year Ended March 31, 2014 Balance, April 1 .................................................... Add: Profit............................................................. Less: Preferred share dividends ....................... $4,500 Common share dividends ........................ 40,000 Retained earnings, March 31 ...............................

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$ 64,800 59,590 124,390 44,500 $ 79,890

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PROBLEM 13-10A (Continued) (a) NORTHWOOD ARCHITECTS LTD. Balance Sheet March 31, 2014 Assets Current assets Cash ......................................................................... Accounts receivable ................................................ Prepaid expenses .................................................... Total current assets ............................................ Property, plant, and equipment: Equipment .................................... $224,000 Less: Accumulated depreciation . (23,650) Total property, plant, and equipment Total assets..............................................................

$ 54,600 38,700 6,150 99,450

200,350 $299,800

Liabilities and Shareholders’ Equity Current liabilities Accounts payable .................................................... $ 21,350 Dividends payable ................................................... 15,000 Salaries payable....................................................... 2,310 Total current liabilities ........................................ 38,660 Long-term note payable............................................... 50,000 Total liabilities.......................................................... 88,660 Shareholders’ equity Share capital* 56,250 $3 cumulative preferred shares, 1,500 issued ..... Common shares, 75,000 issued ............................ 75,000 Total share capital.................................................. 131,250 Retained earnings.................................................... 79,890 Total shareholders’ equity.................................. 211,140 Total liabilities and shareholders’ equity ............... $299,800 * Under ASPE, not required to show the number authorized. Solutions Manual .

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PROBLEM 13-10A (Continued) (b) Return on equity = Profit ÷ Average shareholders’ equity $59,590 ($196,050* + $211,140) ÷ 2

= 29.27%

* $196,050 = Beginning Retained Earnings + Share Capital = $64,800 + $131,250 Taking It Further: Retained earnings represent the amount of past earnings that can be distributed to owners in the form of dividends. Share capital represents legal capital that cannot be distributed to shareholders. It must remain for the protection of corporate creditors.

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PROBLEM 13-11A

(a) 2011 Canadian Pacific Railway Limited Return on assets 4.10% (1) Return on equity 12.03% (3)

4.68% (2) 13.73% (4)

Canadian National Railway Company Return on assets 9.59% (5) Return on equity 22.37% (7)

8.35% (6) 18.69% (8)

(1) (2) (3) (4) (5) (6) (7) (8)

2010

4.10% = $570 ÷ (($14,110 + $13,676) ÷ 2) 4.68% = $651 ÷ (($13,676 + $14,155) ÷ 2) 12.03% = $570 ÷ (($4,649 + $4,824) ÷ 2) 13.73% = $651 ÷ (($4,824 + $4,658) ÷ 2) 9.59% = $2,457 ÷ (($26,026 + $25,206) ÷ 2) 8.35% = $2,104 ÷ (($25,206 + $25,176) ÷ 2) 22.37% = $2,457 ÷ (($10,680 + $11,284) ÷ 2) 18.69% = $2,104 ÷ (($11,284 + $11,233) ÷ 2)

Canadian Pacific Railway Limited: The Return on assets ratio has deteriorated slightly as has the return on equity. Canadian National Railway Company: The Return on assets and return on equity ratios have both improved substantially. (b) Canadian Pacific`s return on assets and return on equity ratios both underperformed compared to those of Canadian National in 2010 and 2011.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-11A (Continued)

(c) Canadian Pacific underperformed compared to the industry average in 2011. By contrast, Canadian National significantly exceeded the industry average for return on equity in 2011.

Taking It Further: Comparisons can be made using intracompany (comparing within a company with prior years), intercompany (comparing with a competing company) and industry averages. In evaluating ratios, different bases of comparison allow the user to extract additional information. Intracompany comparison allows the user to determine significant trends in financial relationships over time. Intercompany comparison allows users to evaluate a company`s competitive position. Comparison with industry averages allows users to examine the performance of a company within its industry. Using Canadian Pacific and Canadian National results, the intracompany comparison allows us to examine the change in the relationship of profit to shareholders’ equity and assets from 2010 to 2011 and determine whether improvement or deterioration is occurring. In this case, the performance of Canadian Pacific is deteriorating whereas Canadian National is improving substantially. The intercompany comparison allows us to examine each company’s performance by comparison to its competitor. In this case, the comparison shows that Canadian National’s performance exceeds that of Canadian Pacific and is showing an increasing trend whereas Canadian Pacific is showing a decreasing trend. Finally, the industry average comparison allows us to compare how each firm is performing within its industry and to note that Canadian Pacific underperforms compared to the industry but that Canadian National`s performance outperforms the industry.

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PROBLEM 13-12A (a) Jan. 1 Cash ................................................. Common Shares ..........................

50,000 50,000

Jan. 2 Cash ................................................. Preferred Shares ..........................

35,000

Dec. 1 Cash Dividends—Preferred*........... Cash Dividends—Common ............ Dividends Payable ....................... *(1,000 × $2.50) (b) 1. Cash ................................................. Consulting Revenue ....................

2,500 10,000

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35,000

12,500

349,000 349,000

Salaries Expense ............................. Rent Expense .................................. Office Expense ................................ Cash..............................................

184,200 48,000 15,000

Equipment........................................ Cash..............................................

150,000

Depreciation Expense ..................... Accumulated Depreciation ..........

15,000

Accounts Receivable ...................... Consulting Revenue ....................

16,000

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

5,800

Income Tax Expense ....................... Income Tax Payable..................... See part (d)

14,550

13-60

247,200

150,000

15,000

16,000

5,800

14,550

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PROBLEM 13-12A (Continued) (c) Cash Date Jan. Jan. 1. 2. 3.

Explanation 1 2

Ref.

Debit

J1 J1 J1 J1 J1

50,000 35,000 349,000

Credit

247,200 150,000

Balance 50,000 85,000 434,000 186,800 36,800

(d) MAPLE CORPORATION Income Statement Year Ended December 31, 2014 Consulting revenue ($349,000 + $16,000) ..................... $365,000 Operating expenses: Salaries expense ($184,200 + 5,800).......... $190,000 Rent expense .................................................. 48,000 Office expense ................................................ 15,000 Depreciation expense .................................. 15,000 268,000 Profit from operations before income tax .................... 97,000 Income tax expense (15% × $97,000) ............................ 14,550 Profit................................................................................ $ 82,450 MAPLE CORPORATION Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1............................................... Add: Profit............................................................. Less: Preferred share dividends ....................... $2,500 Common share dividends ........................ 10,000 Retained earnings, December 31 ........................ Solutions Manual .

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$0 82,450 82,450 12,500 $69,950 Chapter 13

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-12A (Continued) (d) (Continued) MAPLE CORPORATION Balance Sheet December 31, 2014 Assets Current assets Cash ......................................................................... $ 36,800 Accounts receivable ................................................ 16,000 Total current assets ............................................ 52,800 Property, plant, and equipment: Equipment .................................... $150,000 Less: Accumulated depreciation . (15,000) Total property, plant, and equipment 135,000 Total assets.............................................................. $187,800 Liabilities and Shareholders’ Equity Current liabilities Dividends payable ................................................... $ 12,500 Salaries payable....................................................... 5,800 Income tax payable.................................................. 14,550 Total current liabilities ........................................ 32,850 Total liabilities.......................................................... 32,850 Shareholders’ equity Share capital* $2.50 cumulative preferred shares, 1,000 issued. 35,000 Common shares, 5,000 issued ............................... 50,000 Total share capital.................................................. 85,000 Retained earnings.................................................... 69,950 Total shareholders’ equity.................................. 154,950 Total liabilities and shareholders’ equity ............... $187,800 * Under ASPE, not required to show number of shares authorized. Solutions Manual .

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PROBLEM 13-12A (Continued) Taking It Further: Common shareholders are referred to as “residual owners” because once the claims of the creditors and the preferred shareholders are satisfied, the common shareholders own whatever is left.

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PROBLEM 13-1B 1.

Limited liability of shareholders. If the company was operated as a sole proprietorship or a partnership, Kevin might have to satisfy the business liabilities from his personal assets if there not sufficient assets in the business to pay the lawsuit claim.

Separate legal existence. Salik can negotiate a borrowing agreement on behalf of the corporation as an agent of the corporation. If the business was operated as a sole proprietorship or a partnership, only the business owner or partner could negotiate a borrowing agreement on behalf of the company since there is no separate legal existence.

Income tax. The corporation is taxed as a separate legal entity on its own earnings. Income that is distributed to the shareholders is then taxed on their personal income tax returns. If Ping Yu had organized her business as a sole proprietorship, all the profit from the business would be taxed directly on her personal income tax return at her top personal tax bracket.

Continuous life and transferable ownership rights. The corporation can continue with Marion’s daughter as President since the business is a separate legal entity. Marion can also transfer her ownership in the corporation by selling or bequeathing her shares to her daughter. If the business operated as a sole proprietorship or partnership, the business ceases to exist when Marion dies.

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PROBLEM 13-1B (Continued) 5.

Ability to acquire capital. The division of ownership into shares and the possibility of selling shares to the public through a public offering allow a corporation to acquire significant amounts of capital. A partnership or sole proprietorship is not as attractive to investors and does not allow business owners to attract significant amounts of investment capital.

Taking It Further: Investors in the secondary market want to limit their exposure to liability risk. The characteristic of limited liability means that the most investors can lose is the amount that they have paid to purchase their shares. Their personal assets are not at risk from liabilities of the corporation. This characteristic makes investments in corporations very attractive to investors.

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PROBLEM 13-2B (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Jan. 10 Cash (100,000 × $2) ........................ Common Shares ........................

200,000

Mar.

1 Cash (10,000 × $42) ........................ Preferred Shares ........................

420,000

Mar. 31 Cash (75,000 × $3) .......................... Common Shares ........................

225,000

Apr.

3 Land ................................................ Common Shares ........................

74,000

July 24 Cash ............................................... Equipment....................................... Common Shares ........................

60,000 12,000

Nov.

96,000

1 Cash (2,000 × $48) .......................... Preferred Shares ........................

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Credit

200,000

420,000

225,000

74,000

72,000 96,000

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PROBLEM 13-2B (Continued) (b) Preferred Shares Date Mar. Nov.

Explanation

Ref.

Debit

J1 J1

1 1

Credit

Balance

420,000 420,000 96,000 516,000

Common Shares Date Jan. 10 Mar. 31 Apr. 3 July 24

Explanation

Ref. J1 J1 J1 J1

Debit

Credit

Balance

200,000 225,000 74,000 72,000

200,000 425,000 499,000 571,000

(c) Number of preferred shares = 10,000 + 2,000 = 12,000 shares Average cost per preferred share = $516,000 ÷ 12,000 shares = $43.00 Number of common shares = 100,000 + 75,000 + 25,000 + 20,500 = 220,500 shares Average cost per common share = $571,000 ÷ 220,500 shares = $2.59 (d) The company is authorized to issue an additional 38,000 preferred shares (50,000 shares authorized – 12,000 shares issued) and an unlimited number of common shares.

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PROBLEM 13-2B (Continued)

(e) Yes. Features can be added to preferred shares to make them more attractive to potential investors. The cumulative feature assures investors that dividends not currently declared may be paid out at some point in the future. With non-cumulative preferred shares, if no dividends are declared, the dividend entitlement lapses and is lost to the investor. Since the cumulative feature makes the shares more attractive, it also results in a higher price for the shares.

Taking It Further: April 3 and July 24 are examples of issuing share for services or noncash assets. If Highland was a public corporation, the transactions would be valued at the fair value of the assets or services received. In this case, the fair value of the land received and of the equipment received are the only amounts the company has to value the transactions. This is typical for private companies where the shares are not widely traded and the fair value of the shares given in exchange cannot be determined. For Highland, the journal entries would be the same.

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PROBLEM 13-3B (a)

(b)

Dividend Noncumulative Cumulative Paid Preferred Year Common Preferred Common 1 $15,000 $15,000 $ 0 $15,000 $ 0 2 12,000 12,000 0 12,000 0 3 27,000 15,000 12,000 18,000 9,000 4 35,000 15,000 20,000 15,000 20,000 1. Regular dividend is $5 × 3,000 = $15,000 2b. Arrears = $15,000 − $12,000 = $3,000 3b. Preferred dividend = $15,000 (regular) + $3,000 (arrears) = $18,000 Taking It Further: Common shares have voting rights which allow investors some degree of influence over the company depending on how many shares are owned. Also, if the company is successful, the common shareholders will benefit more than the preferred shareholders from an increase in the value of the shares.

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PROBLEM 13-4B

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

2013 Jan. 10 Cash Dividends—Preferred ................. 12,000 Cash................................................

12,000

2014 Jan. 10 Cash Dividends—Preferred* ................ 28,000 Cash Dividends—Common ................... 4,000 Cash................................................

32,000

* Arrears from 2010: 2013 Dividend: (5,000 × $4) .............. $20,000 Less Dividend paid in 2013 .............. 12,000 Current year dividend (5,000 × $4) ........... Cash Dividend to Preferred.......................

$ 8,000 20,000 $28,000

Mar. 1 Preferred Shares (5,000 shares) .........400,000 Common Shares (20,000 shares).. (5,000 × $80)

400,000

(b) The company needs to disclose dividends in arrears of $8,000 in 2013 in the notes to the financial statements.

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PROBLEM 13-4B (Continued) (c) A preferred shareholder will usually convert preferred shares to common shares to participate in the growth of the market value of the common shares. Since preferred shares usually have no voting rights and carry a fixed dividend amount, their market price tends to remain fairly stable and is not subject to significant growth. Shareholders that own preferred shares can choose to keep their shares and receive stable, predictable dividends, but they can also choose to participate in the growth potential of common shares through conversion. If the market value of the common shares received exceed the market value of the preferred shares given up in the conversion, this would be a strong motivator to the preferred shareholder to convert, particularly if the shareholder intends to sell his investment. Taking It Further: The conversion option allows a preferred shareholder to convert their shares to common shares and to participate in the growth of the market value of the common shares. Since preferred shares usually have no voting rights and carry a fixed dividend amount, their market price tends to remain fairly stable and is not subject to significant growth. Shareholders that own preferred shares can choose to keep their shares and receive stable, predictable dividends, but they can also choose to participate in the growth potential of common shares through conversion. This additional choice and the possibility for additional returns on their investment makes the convertible preferred shares more attractive to investors.

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PROBLEM 13-5B (a)

GENERAL JOURNAL

Date

Debit

Credit

2014 June 26 Cash Dividends—Common ............... 80,000 Dividends Payable .........................

80,000

July

Account Titles and Explanation

9 Dividends Payable.............................. 80,000 Cash................................................

80,000

Dec. 26 Cash Dividends—Common ............... 80,000 Dividends Payable .........................

80,000

HYPERCHIP LIMITED Income Statement Year Ended December 31, 2014 Net sales ..........................................................................$1,425,000 Cost of goods sold......................................................... 950,000 Gross profit .................................................................... 475,000 Operating expenses ....................................................... 270,000 Profit from operations.................................................... 205,000 Other revenues .................................................. $45,000 Other expenses ................................................. 30,000 15,000 Profit before income tax ................................................ 220,000 Income tax expense ($220,000 × 20%) .......................... 44,000 Profit ............................................................................... $ 176,000

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PROBLEM 13-5B (Continued) (b) HYPERCHIP LIMITED Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1.................................................. Add: Profit ............................................................... Less: Cash dividends declared * ........................... Retained earnings, December 31 ...........................

$1,150,000 176,000 1,326,000 160,000 $1,166,000

* $80,000 + $80,000 Taking It Further: A statement of retained earnings shows increases from profit and decreases from distributions to owners through dividends. It does not show investments by owners through the sale of shares or repurchases of shares. In contrast, a statement of owner’s equity shows investments by owner in addition to increases from profit and distributions to owners through withdrawals.

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PROBLEM 13-6B (a) HAYDEN INC. Income Statement Year Ended November 30, 2014 Service revenue.............................................................. Operating expenses: Depreciation expense ................................... $51,650 Insurance expense .................................... 10,350 Rent expense ............................................. 43,500 Salaries expense.......................................... 220,000 Profit from operations.................................................... Interest expense............................................................. Profit before income tax ................................................ Income tax expense ($92,000 × 15%) ............................ Profit................................................................................ 2014 Nov. 30 Income Tax Receivable .......................... 1,200 Income Tax Expense ..................... ($15,000 – $13,800)

$425,000

325,500 99,500 7,500 92,000 13,800 $ 78,200

1,200

(b) HAYDEN INC. Statement of Retained Earnings Year Ended November 30, 2014 Balance, December 1 ........................................... Add: Profit............................................................. Less: Cash dividends .......................................... Retained earnings, November 30 ........................

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$ 339,500 78,200 417,700 120,000 $ 297,700

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-6B (Continued) GENERAL JOURNAL

Account Titles and Explanation

Debit

Credit

Nov. 30 Service Revenue ................................. 425,000 Income Summary ...........................

425,000

30 Income Summary ............................... 346,800 Depreciation Expense ................... Income Tax Expense ..................... Insurance Expense ........................ Interest Expense ............................ Rent Expense ................................. Salaries Expense ...........................

51,650 13,800 10,350 7,500 43,500 220,000

30 Income Summary ............................... 78,200 Retained Earnings .........................

78,200

30 Retained Earnings .............................. 120,000 Cash Dividends—Common ...........

120,000

(d) Income Summary Date

Explanation

Ref.

Debit

Nov. 30 30 30

Closing entry Closing entry Closing entry

J1 J1 J1

346,800 78,200

Debit

Credit

Balance

425,000

425,000 78,200 0

Retained Earnings Date

Explanation

Ref.

Nov. 30 30 30

Balance Closing entry Closing entry

J1 J1 J1

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Credit 78,200

120,000

Balance 339,500 417,700 297,700

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Accounting Principles, Sixth Canadian Edition

PROBLEM 13-6B (Continued) Taking It Further: The calculation of income tax expense involves the final amounts for the remainder of the income statement, so the calculation must be prepared after all adjustments have been considered. The company also has to calculate the difference between the income tax expense and the instalments remitted earlier in the year. In addition, certain opportunities for tax planning exist and managers need to calculate the profit before income tax before finalizing the income tax expense for the year.

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PROBLEM 13-7B (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 2 Cash (100,000 × $66) ...................... 6,600,000 Preferred Shares ......................... 6,600,000 Mar. 31

Cash Dividends—Preferred ........... Cash............................................. (100,000 × $6  4)

150,000

Cash (250,000 × $1.30) ................... Common Shares .........................

325,000

June 30 Cash Dividends—Preferred ........... Cash.............................................

150,000

Sep. 30

Cash Dividends—Preferred ........... Cash.............................................

150,000

Income Summary ........................... Retained Earnings ......................

160,000

Retained Earnings .......................... Cash Dividends—Preferred........

450,000

Apr. 18

Dec. 31

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150,000

325,000

150,000

160,000 450,000

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PROBLEM 13-7B (Continued) (b) Preferred Shares Date Jan.

Explanation 2

Ref.

Debit

Credit

Balance

6,600,000 6,600,000

Common Shares Date

Explanation

Ref.

Jan. 1 Apr. 18

Balance

 J1

Debit

Credit

Balance

325,000

1,650,000 1,975,000

Balance

Cash Dividends—Preferred Date Mar. 31 June 30 Sep. 30 Dec. 31

Explanation

Ref.

Debit

Credit

150,000 150,000 150,000

Closing entry

J1 J1 J1 J1

150,000 300,000 450,000 450,000 0

Retained Earnings Date Jan. 1 Dec. 31 31

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Explanation Balance Closing entry Closing entry

Ref.  J1 J1

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Debit

450,000

Credit

Balance 400,000 560,000 160,000 110,000

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PROBLEM 13-7B (Continued) (c) CONWAY LTD. Balance Sheet (Partial) December 31, 2014 Shareholders' equity Share capital* $6 noncumulative preferred shares, 100,000 issued ................................................. $6,600,000 Common shares, 1,750,000** issued ............... 1,975,000 Total share capital ....................................... 8,575,000 Retained earnings................................................. 110,000 Total shareholders' equity ........................................ $8,685,000 * Under ASPE, not required to show number of shares authorized. ** 1,500,000 + 250,000 = 1,750,000 shares No disclosure of arrears is required since the preferred shares are noncumulative. Taking It Further: The conditions to declare and pay dividends include (1) having sufficient cash to pay for ongoing operations and not make the company insolvent by paying a dividend; (2) maintain legal capital; and (3) a decision by the board of directors of the corporation. Also, the full dividend must be declared on the preferred shareholders before a common share dividend is declared. Since that did not happen, no dividend could have been declared for the common shares.

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PROBLEM 13-8B

(a)

GENERAL JOURNAL

Date

Account Titles and Explanation

Debit

Jan.

1 Cash ................................................. Preferred Shares ..........................

600,000

Apr. 14 Cash ................................................. Common Shares ..........................

560,000

June 30 Cash Dividend—Preferred Shares . Cash.............................................. (8,000 + 10,000) × ($4.00 ÷ 2)

36,000

Credit

600,000

560,000 36,000

Aug. 22 Building .................................................150,000 Common Shares .......................... 150,000 Dec

31 Income Summary ............................ Retained Earnings........................

582,000

31 Retained Earnings ........................... Cash Dividend—Preferred Shares

36,000

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582,000 36,000

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PROBLEM 13-8B (Continued) (b) Preferred Shares Date Jan. Jan.

1 1

Explanation

Ref.

Balance

 J1

Debit

Credit

Balance

440,000 600,000 1,040,000

Common Shares Date

Explanation

Ref.

Debit

Jan. 1 Apr. 14 Aug. 22

Balance

 J1 J1

Credit

Balance

1,050,000 560,000 1,610,000 150,000 1,760,000

Cash Dividends—Preferred Date June 30 Dec. 31

Explanation

Ref.

Debit 36,000

Closing entry

J1 J1

Credit

Balance

36,000

36,000 0

Retained Earnings Date

Explanation

Ref.

Debit

Jan. 1 Dec. 31 Dec. 31

Balance Closing Entry Closing Entry

 J1 J1

800,000 582,000 1,382,000 1,346,000 36,000

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PROBLEM 13-8B (Continued) (c)

LARGENT CORPORATION Balance Sheet (Partial) December 31, 2014

Shareholders' equity Share capital* Preferred shares, $4 cumulative, 18,000** issued ................................................. $1,040,000 Common shares, 120,000*** issued ...................... 1,760,000 Total share capital ....................................................... 2,800,000 Retained earnings ...................................................... 1,346,000 Total shareholders' equity ............................................. $4,146,000 * Under ASPE, not necessary to show number of authorized shares. ** 8,000 + 10,000 = 18,000 shares *** 70,000 + 40,000 + 10,000 = 120,000 shares Dividends of $36,000 [18,000 × ($4 ÷ 2)] are in arrears. Taking It Further: Under ASPE, shares issued in exchange for noncash assets are recorded at the fair value of whatever can more reasonably be determined — the fair value of the assets or the fair value of the shares. For a company applying ASPE, the fair value of the shares given in exchange can be particularly difficult to determine if there are no recent share transactions to provide a reliable fair value of the shares. For companies applying ASPE, the fair value of the noncash asset or service received can be used to value the transaction. The remaining challenge is determining how many shares to issue if a fair value per share cannot be determined. This will usually be resolved by negotiation between the company and the supplier of the noncash asset or service.

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PROBLEM 13-9B (a) RUPERT ENGINEERING CORP. Income Statement Year Ended March 31, 2014 Consulting revenue........................................................ $315,500 Operating expenses: Depreciation expense..................................... 14,800 Rent expense .................................................. 36,000 Salaries expense .......................................... 140,300 Supplies expense ........................................ 15,900 207,000 Profit from operations.................................................... 108,500 Other expenses: Interest expense ........................................................ 2,400 Profit before income tax ................................................ 106,100 Income tax expense ....................................................... 21,200 Profit................................................................................ $ 84,900 RUPERT ENGINEERING CORP. Statement of Retained Earnings Year Ended March 31, 2014 Balance, April 1 .................................................... Add: Profit.............................................................

$ 65,000 84,900 149,900

Less: Preferred share dividends ......................... $ 1,875 Common share dividends .......................... 53,125 55,000 Retained earnings, March 31 .............................. $ 94,900

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PROBLEM 13-9B (Continued) (a) (continued) RUPERT ENGINEERING CORP. Balance Sheet March 31, 2014 Assets Current assets Cash ..................................................................... Accounts receivable............................................. Supplies ................................................................ Total current assets....................................... Property, plant, and equipment Equipment .............................................. $148,000 Less: Accumulated depreciation..........(29,600) Total property, plant, and equipment Total assets.................................................... Liabilities and Shareholders’ Equity Current liabilities Accounts payable................................................. Income tax payable .............................................. Unearned revenue ................................................ Current portion of note payable .......................... Total current liabilities .................................. Long-term debt Long-term note payable ....................................... Total liabilities................................................ Shareholders’ equity Share capital* $3.75 cumulative preferred shares, 500 issued Common shares, 35,000 issued ......................... Total share capital ................................................... Retained earnings ...................................................... Total shareholders’ equity........................................... Total liabilities and shareholders’ equity ..........

$ 65,400 31,150 7,300 103,850

118,400 $222,250

$ 14,200 1,900 2,500 10,000 28,600 30,000 58,600 18,750 50,000 68,750 94,900 163,650 $222,250

* Under ASPE, not required to show the number authorized. Solutions Manual .

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PROBLEM 13-9B (Continued) (b) Dec. 31 Consulting revenue ............................ 315,500 Income Summary ...........................

315,500

31 Income Summary ............................... 230,600 Depreciation Expense ................... Rent Expense ................................. Salaries Expense ........................... Supplies Expense .......................... Interest Expense ............................ Income Tax Expense .....................

14,800 36,000 140,300 15,900 2,400 21,200

31 Income Summary ............................... 84,900 Retained Earnings ......................... ($315,500 – $230,600) 31 Retained Earnings .............................. 54,000 Cash Dividends—Preferred........... Cash Dividends—Common ...........

84,900

1,875 53,125

Taking It Further: The owner’s capital for proprietorships and retained earnings for corporations both track the cumulative profits net of distributions to owners. However, the owner’s capital account also contains investments by owners. This information is contained in the share capital account for corporations. In addition, corporate owners can choose to receive salaries which are expenses on the income statement as well as dividends that are closed directly to retained earnings. In a sole proprietorship, payments to the owner consist only of drawings that are closed directly to the owner’s capital account. The capital account of a sole proprietor or partner is an accumulation of profit that has not been taxed, plus any investments, less any drawings.

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PROBLEM 13-9B (Continued) Taking It Further (Continued): Transactions flowing through the retained earnings account such as dividends and share repurchases, must abide by the Business Corporations Act, whereas there is no such legislation for transactions flowing through the owner’s capital account.

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PROBLEM 13-10B (a) CARLOTTA’S CAKES INC. Income Statement Year Ended May 31, 2014 Sales revenue ................................................................. $504,500 Cost of goods sold......................................................... 277,475 Gross profit..................................................................... 227,025 Operating expenses: Depreciation expense.................................... 42,000 Insurance expense ........................................ 7,500 Rent expense ................................................. 24,500 Salaries expense............................................ 67,800 Supplies expense .......................................... 5,875 147,675 Profit from operations.................................................... 79,350 Other expenses: 4,500 Interest expense ........................................................ Profit before income tax ................................................ 74,850 Income tax expense ....................................................... 11,230 Profit................................................................................ $ 63,620 CARLOTTA’S CAKES INC. Statement of Retained Earnings Year Ended May 31, 2014 Balance, April 1 .................................................... Add: Profit............................................................. Less: Preferred share dividends ....................... $7,500 Common share dividends ........................ 50,000 Retained earnings, May 31 ..................................

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$ 73,000 63,620 136,620 57,500 $ 79,120

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PROBLEM 13-10B (Continued) (a)

(Continued) CARLOTTA’S CAKES INC. Balance Sheet May 31, 2014 Assets

Current assets Cash ......................................................................... Accounts receivable ................................................ Inventory .................................................................. Total current assets ............................................ Property, plant, and equipment: Equipment ............................................. $420,000 Less: Accumulated depreciation ......... (126,000) Total property, plant, and equipment .. ............. Total assets..............................................................

$ 20,600 15,300 70,220 106,120

294,000 $400,120

Liabilities and Shareholders’ Equity Current liabilities Accounts payable .................................................... Dividends payable ................................................... Total current liabilities ........................................ Long-term note payable............................................... Total liabilities ..................................................... Shareholders’ equity Share capital* $3 cumulative preferred shares, 2,500 issued .. Common shares, 50,000 issued ......................... Total share capital ................................................... Retained earnings ...................................................... Total shareholders’ equity........................................... Total liabilities and shareholders’ equity ..........

$ 38,500 7,500 46,000 75,000 $121,000

$150,000 50,000 200,000 79,120 279,120 $400,120

* Under ASPE, not required to show the number authorized. Solutions Manual .

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PROBLEM 13-10B (Continued) (b) Return on equity = Profit ÷ Average shareholders’ equity $63,620 ($273,000* + $279,120) ÷ 2

= 23.05%

* $273,000 = Beginning Retained Earnings + Share Capital = $73,000 + $200,000

Taking It Further: If the company is generating a loss, the return on equity is still a useful measurement since it will show a negative return on shareholders’ equity. If however, total shareholders’ equity is in a deficit position (a negative balance), the formula is no longer useful as a measurement.

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PROBLEM 13-11B (a) 2011

2010

Husky Energy Inc. Return on assets Return on equity

7.35% (1) 13.75% (3)

3.54% (2) 6.69% (4)

Suncor Energy Inc. Return on assets Return on equity

6.00% (5) 11.67% (7)

5.61% (6) 11.32% (8)

(1) (2) (3) (4) (5) (6) (7) (8)

7.35% = $2,224 ÷ (($32,426 + $28,050) ÷ 2) 3.54% = $947 ÷ (($28,050 + $25,508) ÷ 2) 13.75% = $2,224 ÷ (($17,773 + $14,574) ÷ 2) 6.69% = $947 ÷ (($14,574 + $13,716) ÷ 2) 6.00% = $4,304 ÷ (($74,777 + $68,607) ÷ 2) 5.61% = $3,829 ÷ (($68,607 + $67,799) ÷ 2) 11.67% = $4,304 ÷ (($38,600 + $35,192) ÷ 2) 11.32% = $3,829 ÷ (($35,192 + $32,485) ÷ 2)

Husky Energy Inc.: The Return on assets ratio has improved substantially as has the return on equity. Suncor Energy Inc.: The Return on assets and return on equity ratios have improved slightly. (b) Husky Energy`s return on assets and return on equity ratios both underperformed those of Suncor Energy in 2010. In 2011, the two ratios improved substantially for Husky Energy and outperformed Suncor Energy. During the same year, Suncor Energy`s two ratios increased slightly, but not to the same extent as those for Husky.

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PROBLEM 13-11B (Continued)

(c) Both companies outperformed the industry average for return on equity in 2011. Suncor Energy has outperformed the industry average for both 2010 and 2011, whereas Husky Energy underperformed in 2010 and increased its performance in 2011 to exceed the industry average.

Taking It Further: Comparisons can be made using intracompany (comparing within a company with prior years), intercompany (comparing with a competing company) and industry averages. In evaluating ratios, different bases of comparison allow the user to extract additional information. Intracompany comparisons allow the user to determine significant trends in financial relationships over time. Intercompany comparisons allow users to evaluate a company`s competitive position. Comparison with industry averages allows users to examine the performance of a company within its industry. Using Husky Energy and Suncor Energy results, the intracompany comparison allows us to examine the change in the relationship of profit to shareholders’ equity and assets from 2010 to 2011 and determine whether an improvement or deterioration is occurring. In this case, the performance of both companies is improving. The intercompany comparison allows us to examine each company`s performance by comparison to its competitor. In this case, the comparison allows us to note that Husky’s improvement is substantially better than Suncor’s. Finally, the industry average comparison allows us to compare how each firm is performing within its industry and to note that both companies outperform the industry but that Husky’s improvement is greater than Suncor’s.

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PROBLEM 13-12B (a) Jan. 1 Cash ................................................. Common Shares ..........................

60,000 60,000

Jan. 2 Cash (1,000 × $62.50) ...................... Preferred Shares ..........................

62,500

Dec. 10 Cash Dividends—Preferred*........... Cash Dividends—Common ............ Dividends Payable ....................... *(1,000 × $5.00) (b) 1. Cash ................................................. Consulting Revenue ....................

5,000 12,000

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62,500

17,000

268,000 268,000

Salaries Expense ............................. Rent Expense .................................. Office Expense ................................ Cash..............................................

164,000 42,000 12,000

Equipment........................................ Cash..............................................

130,000

Depreciation Expense ..................... Accumulated Depreciation ..........

13,000

Accounts Receivable ...................... Consulting Revenue ....................

22,000

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

4,200

Income Tax Expense ....................... Income Tax Payable..................... See part (d)

8,220

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130,000

13,000

22,000

4,200

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PROBLEM 13-12B (Continued) (c) Cash Date Jan. Jan. 1. 2. 3.

Explanation 1 2

Ref.

Debit

J1 J1 J1 J1 J1

60,000 62,500 268,000

Credit

218,000 130,000

Balance 60,000 122,500 390,500 172,500 42,500

(d) NYGREN CORPORATION Income Statement Year Ended December 31, 2014 Consulting revenue ($268,000 + $22,000) ..................... $290,000 Operating expenses: Salaries expense ($164,000 + $4,200)........ $168,200 Rent expense .................................................. 42,000 Office expense ................................................ 12,000 Depreciation expense .................................. 13,000 235,200 Profit from operations before income tax .................... 54,800 Income tax expense (15% × $54,800) ............................ 8,220 Profit................................................................................ $ 46,580 NYGREN CORPORATION Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1............................................... Add: Profit............................................................. Less: Preferred share dividends ....................... $5,000 Common share dividends ........................ 12,000 Retained earnings, December 31 ........................ Solutions Manual .

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0 46,580 46,580

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PROBLEM 13-12B (Continued) (d) (Continued) NYGREN CORPORATION Balance Sheet December 31, 2014 Assets Current assets Cash ......................................................................... $ 42,500 Accounts receivable ................................................ 22,000 Total current assets ............................................ 64,500 Property, plant, and equipment: Equipment .................................... $130,000 Less: Accumulated depreciation . (13,000) Total property, plant, and equipment 117,000 Total assets.............................................................. $181,500 Liabilities and Shareholders’ Equity Current liabilities Dividends payable ................................................... $ 17,000 Salaries payable....................................................... 4,200 Income tax payable.................................................. 8,220 Total current liabilities ........................................ 29,420 Total liabilities.......................................................... 29,420 Shareholders’ equity Share capital* $5 cumulative preferred shares, 1,000 issued ..... 62,500 Common shares, 6,000 issued .............................. 60,000 Total share capital.................................................. 122,500 Retained earnings.................................................... 29,580 Total shareholders’ equity.................................. 152,080 Total liabilities and shareholders’ equity ............... $181,500 * Under ASPE, not required to show the number authorized.

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PROBLEM 13-12B (Continued) Taking It Further: Common shareholders are referred to as “residual owners” because once the claims of the creditors and the preferred shareholders are satisfied, the common shareholders own whatever is left.

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CONTINUING COOKIE CHRONICLE GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Cash Dividends—Common ............ Dividends Payable .......................

85,000

July 30 Dividends Payable .......................... Cash..............................................

85,000

(a) July 15

Credit

85,000 85,000

Since only Janet and Brian own all of the common shares at the date the dividend is declared they would receive the full $85,000 on a pro-rata basis. This means that Janet would receive $42,500 ($85,000 / 2) and Brian would receive $42,500 since they both own 100 common shares. (b) KOEBEL’S FAMILY BAKERY LTD. Statement of Retained Earnings Year Ended July 31, 2014 Balance, August 1 ................................................ Add: Profit ($255,823 × [1 – 18%]) ....................... Less: Cash dividends .......................................... Retained earnings, July 31 ..................................

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$116,251 209,775 326,026 85,000 $241,026

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CONTINUING COOKIE CHRONICLE (Continued) (c) KOEBEL’S FAMILY BAKERY LTD. Balance Sheet (Partial) July 31, 2014 Shareholders' Equity Share capital Common shares, 200 shares issued................................ $ 200 Retained earnings .............................................................. 241,026 Total shareholders' equity .................................. $241,226 Note: Under ASPE, a firm is not required to show the number of authorized shares. Also, it would not include the preferred shares on the balance sheet, as none are issued. (d) Aug.

1 Cash ................................................. Accounts Receivable ...................... Merchandise Inventory ................... Supplies ........................................... Equipment ....................................... Common Shares ..........................

8,050 800 1,200 450 1,500 12,000

(e)

Balance before transaction Shares issued Balance after transaction

Number of shares 200 10 210

Dollar amount $200 $12,000 $12,200

Average $1.00 $1,200.00 $58.10

There is a significant change in value of the common shares because of relatively low number of shares issued to Natalie for the fair value of her assets.

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CONTINUING COOKIE CHRONICLE (Continued) (f) Janet and Brian likely determined the price of $1,200 per share by dividing the shareholders’ equity amount by the number of shares issued ($241,026 ÷ 200 shares = $1,205). By using the value of $1,200 per share to value Natalie’s contribution in assets, they obtained a quantity of 10 shares of common shares. This value is likely not fair to Natalie. The low number of shares given to Natalie means that she will receive only 4.8% (10 / 210 based on her number of shares over the total number of shares issued) of any dividends paid out. Natalie’s parents assume that Natalie will become the fulltime administrator, but she would receive a very low proportion of the profits and have no voting control over the operations of the business.

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BYP 13-1 FINANCIAL REPORTING PROBLEM (a) Per note 16 to the financial statements, Reitmans (Canada) Limited has 2 classes of shares. There is an unlimited number of Class A non-voting shares authorized and 52,146 issued; and an unlimited number of common shares authorized and 13,440 issued. (b) Both classes of shares rank equally with respect to the right to receive dividends and for distribution of assets. Class A non-voting shares have the right to receive Class A non-voting shares in the case of share dividends and common shares have the right to receive common shares in the case of share dividends. (c)

During the 2012 fiscal year, Reitmans issued 722 Class A non-voting shares for $11,056,000 from a share option program. The share option program is granted to key management and employees at the discretion of the board of directors.

(d) The average cost of the common shares is $35.86 ($482,000 ÷ 13,440). The average cost of the Class A nonvoting shares is $755.72 ($39,408,000 ÷ 52,146). (e)

Reitmans declared and paid $52,654,000 in dividends to common shares and Class A non-voting shares during fiscal 2012.

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BYP 13-1 (Continued) (f)

Return on equity = Profit ÷ Average shareholders’ equity (figures in thousands) Return on equity for 2011 = $88,985 ÷ ($512,800 + $498,252) 2 = 17.6% The company’s return on equity has deteriorated significantly over the past year from 17.6% in fiscal 2011 to 9.5% in fiscal 2012.

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BYP 13-2 INTERPRETING FINANCIAL STATEMENTS (a) Talisman’s profitability has declined from 2010 to 2011. Its profit margin has suffered a large decrease. Its return on assets and return on equity have also decreased in the same time period. (b) The fair value of Talisman’s shares depends on a number of factors, including the company's anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the stock market. Consistent with the decline in profitability, the market price of the common shares has declined significantly from 2010 to 2011. (c) Issuing preferred shares does not dilute the voting percentages of existing common shareholders. It allows the company to raise funds from new shareholders without affecting the voting control of common shareholders. (d) Underwriting fees do not meet the definition of an expense. They are not incurred to generate revenues but rather to increase owners’ capital and relate to a transaction with owners. They are therefore recorded as a reduction in the proceeds from the issue of the shares. (e) The dividend rate of 4.2% is equivalent to $1.05 per preferred share (4.2% × $25 per share = $1.05). This rate is higher than the interest rate on savings in a bank account because the rate has to be sufficiently high to attract investors. An investment in preferred shares is considerably riskier for an investor than a savings account. The payment of the dividends is at the discretion of the board of directors, and is dependent on the financial performance of the company and the company’s ability to pay the dividends. Interest on a savings account is a liability of the bank and is paid on a regular basis.

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BYP 13-2 (Continued)

(f)

Talisman may choose to redeem the shares in order to stop paying dividends and reduce its cash outflows. The commitment to pay dividends continues as long as the shares are outstanding, so the company may choose to repurchase the shares to conserve its cash for the future.

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BYP 13-3

Accounting Principles, Sixth Canadian Edition

COLLABORATIVE LEARNING ACTIVITY

All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resources site accompanying this textbook.

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BYP 13-4 COMMUNICATION ACTIVITY Memorandum To: XXX, Shareholder of Ghost River Back Country Limited From: Accountant Re: Purchase of land and building You are currently considering purchasing land and a building and trying to determine whether to pay for the purchase by using debt or shares. You have also indicated that you currently do not have excess cash in your business. A common method of paying for large purchases is to use debt. If you finance the purchase with a lender such as a bank, the seller of the property will not be involved in your business. This is an advantage as you would continue to exercise 100% control over the day to day operations of your business. This alternative usually requires that you provide a down payment, and this may not be possible because of your cash situation. You may also be able to finance the purchase directly with the seller. In this case, he may be willing to accept no down payment in exchange for security on the property. You would need to determine if your cash situation would allow for regular payments of interest and/or principal. Interest payments are taxdeductible and would reduce your taxable income. This transaction would increase the assets and the debt on your balance sheet. It would also increase your debt ratio. You are also considering paying for the purchase by issuing shares of your company. Issuing shares does not require any cash to complete the transaction. If you pay by issuing common shares, you will be issuing voting shares. It is unlikely that the seller will want to be a minority shareholder (own less than 50%), since he will exercise no control over business and

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BYP 13-4 (Continued) dividend decisions. This would be very risky for the seller since you would then own the land and building, he would receive no cash, and have no control over cash payments to himself. You may be required to issue more than 50% of the voting control and would therefore lose control of your company. In addition, it would be difficult for him to sell his shares in your company because it is a private corporation. Alternatively, you may be able to structure the exchange by giving preferred shares. The shares would be subject to a fixed dividend rate. The negotiations with the seller would likely involve various features on the preferred shares to make the exchange more attractive. For example, the seller would likely require that the preferred shares be cumulative and redeemable or retractable. If the shares are redeemable, you can terminate the relationship with the seller at a predetermined point in the future. The dividend payments are not tax-deductible and are paid with after-tax funds. Accepting shares in exchange for his property, is riskier for the seller since he is not receiving cash, and is dependent on the profitability of your business to receive dividends. This transaction would increase the assets and the shareholders’ equity on your balance sheet. If you use preferred shares and the features make the shares similar to debt financing, the shares would be reclassified as debt on the balance sheet. In conclusion, I recommend that you carefully consider the advantages and disadvantages outlined above. If the seller is willing to consider financing the purchase with preferred shares, this would be most advantageous to you considering your current cash situation.

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BYP 13-5 ETHICS CASE (a) The stakeholders in this situation are: The directors of the Simplex companies. The president of Simplex. The shareholders of the Simplex companies. Those who live in the environment to be sprayed by the new (un-tested) chemical. (b) The president is taking exceptional risks by allowing exposure to this new chemical, in order to enhance his company's sales and to preserve his job. Presidents and entrepreneurs frequently take risks in performing their leadership functions, but this action is both irresponsible and unethical. (c) A parent company may protect itself against loss and most reasonable business risks by establishing separate subsidiary corporations, but whether it can insulate itself against this type of action is a matter of international corporate law and criminal law.

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BYP 13-6 “ALL ABOUT YOU” ACTIVITY

(a)

The benefits of incorporating at the federal level include: 1. Heightened name protection 2. Right to carry on business anywhere in Canada 3. Recognition 4. Excellence in Client Service 5. Visitor service 6. Fully bilingual staff to answer your inquiries

(b)

Almost any type of business may incorporate under the Canada Business Corporations Act (CBCA). However, mortgage, banking, insurance, loan and trust companies, and other Financial Institutions, cooperative, Chambers of Commerce as well as not-for-profit corporations are incorporated under different statutes. There are no restrictions, such as minimum company size, on the businesses that may incorporate under the CBCA.

(c)

One or more individuals who are 18 years of age or older, are not of unsound mind and who are not a bankrupt may form a corporation under the Canada Business Corporations Act (CBCA). Similarly, one or more companies or "bodies corporate" may incorporate a company.

(d)

Federal corporations are formed when you file articles of incorporation with Corporations Canada and a certificate of incorporation is issued. Form 1 provides in the application, the main information concerning the corporation such as its name, the name of the incorporators, the classes of shares etc. Form 2 provides all of the necessary information about the initial registered office address and the names and addresses of the members of the first board of directors.

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BYP 13-6 (Continued) (e)

Filing online offers the following distinct advantages: 1. Convenience 2. Reduced delivery costs 3. Immediate acknowledgement of filing 4. Prompt articles processing 5. Reduced filing fee

(f) 1. A corporation must prepare financial statements and provide copies of your financial statements to your shareholders at least 21 days before your corporation's annual meeting each year. 2. Generally Accepted Accounting Principles are set out in the Canadian Institute of Chartered Accountants Handbook. 3. Shareholders may decide by a unanimous resolution (voting and non-voting shares) not to appoint an auditor. 4. A corporation must keep certain corporate records at its registered office or at some other location elsewhere in Canada as set out by the directors. Upon request, a corporation's shareholders and creditors (such as suppliers) may examine the following records: 

  

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Articles of Incorporation, by-laws and their amendments and any unanimous shareholder agreements; Minutes of meetings and resolutions of shareholders; Copies of certain forms that have been filed, A share register showing the names and addresses of all shareholders and details of shares held.

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CHAPTER 14 Corporations: Additional Topics and IFRS ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Problems Set A

Problems Set B

1. Account for stock dividends and stock splits, and compare their financial impact.

1, 2, 3,

1, 2, 3

1, 2, 7, 8, 9

1, 2, 4, 8

2. Account for the reacquisition of shares.

4, 5, 6, 7

4, 5

3, 7, 10

2, 3, 4, 6, 7, 8

3. Prepare an income statement showing continuing and discontinued operations, and prepare a statement of comprehensive income.

8, 9, 10, 11

6, 7, 8, 12

4, 5, 7, 9, 10

3, 4, 5, 6, 8

4. Explain the accounting difference for different types of accounting changes and account for corrections of prior period errors.

12, 13, 14

9, 10

6, 7, 8

4, 5, 6, 7, 8, 12

5. Prepare a statement of changes in shareholders’ equity.

15 , 16

11, 12

8, 9, 10

7, 8, 9

6. Evaluate earnings and dividend performance.

17, 18, 19, 20

13, 14, 15

11, 12, 13

10, 11, 12

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Exercises

Chapter 14

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compare impact of cash dividend, stock dividend, and stock split.

Simple

20-25

Record and post transactions; prepare shareholders’ equity section.

Moderate

25-30

Determine impact of reacquired shares.

Moderate

25-30

Record stock dividends, splits, and reacquisition of shares. Show impact of transactions on accounts.

Moderate

30-40

Prepare income statement with EPS and statement of comprehensive income.

Moderate

25-30

Correct error from prior period; prepare statement of comprehensive income—all-inclusive format; show presentation of retained earnings.

Moderate

30-35

Record and post transactions; prepare a statement of changes in shareholders’ equity.

Complex

30-40

Record and post transactions; prepare financial statements.

Complex

60-70

Prepare statement of changes in shareholders’ equity.

Complex

25-35

10A

Calculate earnings per share.

Moderate

30-35

11A

Calculate ratios and comment.

Moderate

25-30

12A

Calculate and evaluate ratios with discontinued operations.

Moderate

30-35

Compare impact of cash dividend, stock dividend, and stock split.

Simple

20-25

Record and post transactions; prepare shareholders’ equity section.

Moderate

25-30

Determine impact of reacquired shares.

Moderate

25-30

Record stock dividends, splits, and reacquisition of shares. Show impact of transactions on accounts.

Moderate

30-40

Prepare income statement with EPS and statement of comprehensive income.

Moderate

25-30

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Correct error from prior period; prepare statement of comprehensive income—all-inclusive format; show presentation of retained earnings.

Moderate

30-35

Record and post transactions; prepare a statement of changes in shareholders’ equity.

Complex

30-40

Record and post transactions; prepare financial statements.

Complex

60-70

Prepare statement of changes in shareholders’ equity.

Complex

25-35

10B

Calculate earnings per share.

Moderate

30-35

11B

Calculate ratios and comment.

Simple

25-30

12B

Calculate and evaluate ratios with discontinued operations.

Moderate

30-35

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Accounting Principles, Sixth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objectives 1.Account for stock dividends and stock splits, and compare their financial impact.

Knowledge Comprehension Q14-1 Q14-2 Q14-3

2. Account for the reacquisition of shares

Q14-5 Q14-6 Q14-7 Q14-8

3. Prepare an income statement showing continuing and discontinued operations, and prepare a statement of comprehensive income.

Q14-8 Q14-9 Q14-10 Q14-11

4. Explain the accounting difference for different types of accounting changes and account for corrections of prior period errors 5. Prepare a statement of changes in shareholders’ equity

Q14-12 Q14-13 Q14-14

Q14-15 Q14-16

6. Evaluate earnings and dividend performance.

Q14-17 Q14-18 Q14-20

Broadening Your Perspective

BYP14-1

Solutions Manual .

Application BE14-1 P14-1A BE14-2 P14-2A BE14-3 P14-4A E14-1 P14-8A E14-2 P14-1B E14-7 P14-2B E14-8 P14-4B E14-9 P14-8B BE14-4 P14-6A BE14-5 P14-7A E14-3 P14-8A E14-4 P14-2B E14-7 P14-3B E14-10 P14-4B P14-2A P14-6B P14-3A P14-7B P14-4A P14-8B BE14-6 P14-5A BE14-7 P14-6A BE14-8 P14-8A BE14-12 P14-5B E14-5 P14-6B E14-9 P14-8B E14-10

BE14-9 BE14-10 E14-6 E14-7 E14-8

BE14-11 BE14-12 E14-7 E14-8 E14-9 E14-10 Q14-19 BE14-13 BE14-14 BE14-15 E14-11 E14-12

P14-6A P14-7A P14-8A P14-12A P14-6B P14-7B P14-8B P14-12B

P14-7A P14-8A P14-9A P14-7B P14-8B P14-9B E14-13 P14-5A P14-10A P14-12A P14-5B P14-10B P14-12B Continuing Cookie Chronicle

14-4

Analysis Synthesis Evaluation

P14-11A P14-11B

BYP 14-2 BYP14-3

BYP14-4

BYP14-5 BYP14-6

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Accounting Principles, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

(a) When a stock dividend is declared, at the declaration date, the entry is Dr. Stock Dividend and Cr. Stock Dividend Distributable. (b) There is no entry on the record date and (c) at the date of distribution, the entry is Dr. Stock Dividend Distributable and Cr. Common Shares.

Freddy is not better off after the stock split. A stock split signifies that additional shares are issued in a multiple, such as 2-for-1, in exchange for old shares. The effect of the stock split is to adjust the fair value of the shares. For example, in a 2-for-1 stock split, the fair value normally will decrease by half and the number of shares doubles so that the total value of the investment stays the same.

3. (a) (b) (c) (d) (e)

Assets Liabilities Share capital Retained earnings Number of shares

Cash Dividend Decrease N/E N/E Decrease N/E

Stock Dividend N/E N/E Increase Decrease Increase

Stock Split N/E N/E N/E N/E Increase

A company would repurchase its shares for the following reasons: 1. To increase trading of the company’s shares in the securities market in the hope of increasing the company’s fair value. 2. To reduce the number of shares issued, which will increase earnings per share. 3. To eliminate hostile shareholders by buying them out. 4. To have additional shares available so that they can be reissued to officers and employees through bonus and stock compensation plans, or used to acquire other companies.

This transaction: (a) decreases total assets, (b) has no effect on total liabilities and, (c) decreases total shareholders' equity.

If the reacquisition price is less than the average cost, the difference is considered contributed to the remaining shareholders. This amount is reported as contributed surplus from share reacquisition in the share capital section of shareholders’ equity. If the reacquisition price is more than the average cost, the difference is debited to Contributed Surplus from the same class of shares to the extent of any pre-existing balance in the contributed surplus account, and then debited to Retained Earnings.

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Questions (Continued) 7.

If there have been gains from similar transactions in the past, the resulting credit balance of the contributed surplus account is available to absorb some or all of the loss on reacquisition. However, the balance of the contributed surplus account cannot go below zero. If the loss exceeds the balance in the contributed surplus account, the excess amount is debited to retained earnings.

Intraperiod tax allocation is the allocation of income tax within the accounting period, to items or categories that attracted the tax. For example, the tax associated with continuing operations is shown separately from the tax associated with discontinued operations. Allocating the tax to these specific items is important because it allows those items or sub-totals to show the after tax results, which is more relevant to the financial statement user.

Discontinued operations refer to the disposal or reclassification to “held for sale” of a component of an entity. It is important to report discontinued operations separately because they represent atypical items. Investors trying to get a picture of the company’s future growth potential should not include discontinued operations in their analysis of future earnings potential because they will not exist in the future.

10.

Comprehensive income includes all changes to shareholders’ equity during a period except those resulting from changes that result from the sale or repurchase of shares and from the payment of dividends. This includes not only the profit presented in a traditional income statement, but also other comprehensive income. Other comprehensive income includes certain gains and losses that are not included in profit, such as unrealized gains and losses from some long-term strategic equity investments and foreign currency translation. Other comprehensive income is reported on the comprehensive income statement in an all-inclusive format with the income statement or as a separate financial statement. Other comprehensive income is closed to Accumulated Other Comprehensive Income, which appears in the equity section of the balance sheet, immediately after Retained Earnings.

11.

Other comprehensive income is reported on the comprehensive income statement in an all-inclusive format with the income statement or as a separate financial statement.

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Questions (Continued) 12.

A company is allowed to change an accounting policy when the change is required by generally accepted accounting principles or when the resulting financial statements will provide more reliable and relevant information. When there is a change in accounting policy, companies are required to retroactively apply the new standards except if it is impractical to do so. This means the company must recalculate and restate all of the related accounts as if it had always followed the new policy. But, if significant estimates are required, or if the required information is not available, then it is not possible for prior financial statements to be restated for comparative purposes. Whether or not the prior periods are restated, companies must disclose the details of the change to the new policy in their notes to the financial statements.

13.

A company can make a change in accounting estimate on an as needed basis, whenever circumstances, conditions and events change and a better estimate is established. Changes in estimates are common and are not a result of an error. Consequently, the change in estimate is not applied retroactively but implemented prospectively to the current and future accounting periods.

14.

Since revenue and expense accounts are closed at the end of each fiscal year, corrections related to a previous period cannot be made to those accounts. However, the balances in the permanent accounts must be restored to what they would have been, had the error not been made. If the error affected an income statement account, retained earnings will be adjusted for the after-tax impact of the error. Prior year statements that are issued with the current statement will be restated to eliminate the error, if needed. Restated financial statements are labelled as restated and notes to the financial statements explain the nature and effect of the restatement caused by the prior period error.

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Questions (Continued) 15. Contributed Capital Profit Loss Issue shares Share reacquisition Other comprehensive gains Other comprehensive losses Dividend declaration Stock dividend Correction of prior period errors Cumulative effect of a change in accounting policy

Increase Decrease

Contributed Surplus

Retained Earnings Increase Decrease

Increase or Decrease

Decrease

Accum. Other Comp. Income

Increase Decrease Decrease Decrease Increase or Decrease Increase or Decrease

Increase

16.

Comprehensive income includes profit (or loss) and other comprehensive income (or loss). The profit or loss is reported in the retained earnings section of the statement of changes in shareholders’ equity. Other comprehensive income (or loss) is reported in the accumulated other comprehensive income section of the statement of changes in shareholders’ equity.

17.

Earnings per share is calculated by dividing profit less preferred dividends by the weighted-average number of common shares outstanding. The fully diluted earnings per share adjusts earnings per share for the maximum possible dilution that would occur if securities were converted into common shares.

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Questions (Continued) 18.

(a) When calculating earnings per share, the amount of profit available to common shareholders is not always the same as profit because preferred shareholders rank ahead of common shareholders for dividends. Preferred shareholders dividend entitlement must be satisfied before dividends can be declared on common shares. The preferred share dividend declared will reduce profit available to common shareholders. Also, the annual dividend entitlement of the preferred shares will not be available to common shareholders if the shares are cumulative. (b) Weighted average number of shares is used in the earnings per share calculation and not simply the number of shares at the end of the year because the profit available for common shareholders has been generated over the period of the year. The numbers of shares issued and outstanding during the fiscal year may vary tremendously and affect the company’s ability to generate profit. Using the weighted average number of shares in the calculation provides a less biased and fairer measure of performance.

19.

Company B would be a better choice. The price-earnings ratio indicates investors’ assessment of the company’s future earnings. A price-earnings ratio of 22 times means that investors are willing to pay 22 times earnings per share to purchase a share of Company B. If Company A and Company B are in the same industry, investors are more optimistic are Company B’s future earnings. There are potentially higher capital gains for a share of Company B. A very high price-earnings ratio may also mean that a company’s share price has reached its maximum.

20.

(a) Unfavourable (b) Favourable (c) Either favourable or unfavourable depending on the interpretation of the investor. That is, a decrease in the PE ratio makes the shares more affordable to purchase. An increase in the PE ratio means the shares will sell at a higher price and there exists more risk that the price will increase even further. (d) Favourable from the perspective of a shareholder receiving the dividend.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 (a) Mar. 1 Stock Dividends (400,000 × 5% × $5) ...100,000 Stock Dividends Distributable..........

100,000

31 Stock Dividends Distributable .............. 100,000 Common Shares................................

100,000

(b) Wei Tse’s percentage ownership would not change as a result of a stock dividend. Prior to the stock dividend, Wei Tse’s ownership percentage was 0.5% (2,000 ÷ 400,000). After the stock dividend, Wei Tse’s ownership percentage remains 0.5% (2,100 ÷ 420,000).

BRIEF EXERCISE 14-2 (a) (b) (c) (d)

Share capital Retained earnings Total shareholders’ equity Number of shares

Before $2,000,000 600,000 $2,600,000 225,000

After $2,270,000* 330,000* $2,600,000 247,500

* Number of shares issued: 225,000 × 10% = 22,500 shares Stock dividend: 22,500 shares × $12 = $270,000 Retained earnings will decrease and share capital will increase by this amount.

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BRIEF EXERCISE 14-3 Transaction (a) Declared a cash dividend (b) Paid the cash dividend declared in (a) (c) Declared a stock dividend (d) Distributed the stock dividend declared in (c) (e) Split stock 2-for-1

Shareholders’ Assets Liabilities Equity

Number of Shares

–

BRIEF EXERCISE 14-4 (a) Dec. 31

(b) Dec. 31

Common Shares (8,000 × $6.25*) ...... 50,000 Contributed Surplus— Reacquisition of Common Shares Cash .............................................

5,000 45,000

Common Shares (8,000 × $6.25*) ...... 50,000 Retained Earnings.............................. 10,000 Cash .............................................

60,000

*Average share price = $250,000 ÷ 40,000 shares = $6.25

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BRIEF EXERCISE 14-5 (a) Average cost per share: $12.60 ($50,000 + $265,000) ÷ (10,000 + 15,000) (b) Feb.

Dec. 22

Solutions Manual .

Common Shares (1,000 × $12.60) ... 12,600 Contributed Surplus— Reacquisition of Common Shares Cash .............................................

2,600 10,000

Common Shares (2,000 × $12.60) ... 25,200 Contributed Surplus— Reacquisition of Common Shares .. 2,600 Retained Earnings............................ 200 Cash .............................................

28,000

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BRIEF EXERCISE 14-6 (a)

Income tax expense on continuing operations = Profit before income tax × income tax rate = $320,000 × 20% = $64,000

(b)

Income tax savings on loss from operations = $(85,000) × 20% Income taxes on gain on disposal of assets = $60,000 × 20% Income tax savings on discontinued operations

(c)

$(17,000) 12,000 $ (5,000)

Profit before income tax $320,000 Income tax expense 64,000 Profit from continuing operations 256,000 Discontinued operations: Loss from operations of discontinued operations, net of $17,000 income tax savings $68,000 Gain on disposal of assets of discontinued operations, net of $12,000 income tax expense 48,000 20,000 Profit $236,000

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BRIEF EXERCISE 14-7 OLIVIER CORPORATION Statement of Income Year Ended August 31, 2014

Revenues ................................................. Operating expenses ................................. Profit before income taxes ...................... Income tax expense ................................. Profit from continuing operations ....... Discontinued operations: Loss from operations of discontinued operations, net of $17,000 income tax savings $68,000 Gain on disposal of assets of discontinued operations, net of $12,000 income tax expense 48,000 Profit..........................................................

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$500,000 180,000 320,000 64,000 256,000

20,000 $236,000

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BRIEF EXERCISE 14-8 (a) JET SET AIRLINES Statement of Comprehensive Income Year Ended December 31, 2014 Profit ............................................................... Other comprehensive income Gain on equity investments, net of $19,8001 income tax expense ........ Comprehensive income ................................ 1 $66,000 × 30% = $19,800

$920,000

(b) Accumulated other comprehensive income [$(31,550) + $46,200]

$14,650

46,200 $966,200

BRIEF EXERCISE 14-9 Jan. 1 Inventory ..................................................... 110,000 Income Tax Payable .............................. 27,500 Retained Earnings [$110,000 × (1 − 25%)] 82,500

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BRIEF EXERCISE 14-10 BROADFOOT BAKERIES, INC. Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1, 2011 as previously reported ......... $394,000 Add: Correction for overstatement of cost of goods 82,500 sold in 2013, net of $27,500 income tax expense Balance, January 1, 2011 as restated ............................ 476,500 Add: Profit ..................................................................... 128,000 604,500 Less: Dividends.............................................................. 44,000 Balance, December 31 .................................................... $560,500

BRIEF EXERCISE 14-11 (a) 525,000 = 500,000 beg. balance + 50,000 shares issued − 25,000 shares reacquired (b) $600,000 = balance at December 31, 2013 (c) $(28,750) = $603,750 − $600,000 − $32,500 (d) $23,000 = $15,000 + $8,000 (e) $(21,000) = $181,000 − $179,500 − $22,500 (f) $17,000 = $68,000 − $51,000 (g) $875,750 = $603,750 + $23,000 (from (d) above) + $181,000 + $68,000 (h) $19,500 = $179,500 − ($190,000 − $30,000) (i) $54,000 = $51,000 + $3,000 (j) $845,500 = $600,000 + $15,000 + $179,500 + $51,000

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BRIEF EXERCISE 14-12 (a) PENINSULA SUPPLY CORPORATION Statement of Comprehensive Income Year Ended December 31, 2014 Profit .......................................................................... Other comprehensive income ................................. Comprehensive income ...........................................

$22,500 17,000 $39,500

(b) PENINSULA SUPPLY CORPORATION Partial Balance Sheet December 31, 2014 Shareholders' equity Share capital Common shares, unlimited shares authorized, 525,000 shares issued ................... Contributed surplus—reacquired common shares. Total contributed capital .............................................. Retained earnings ........................................................ Accumulated other comprehensive income............... Total shareholders' equity....................................

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$603,750 23,000 626,750 181,000 68,000 $875,750

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 14-13 (a)

20,000 − 5,000 + 6,000 + 10,000 = 31,000 shares

(b)

Weighted average number of shares: Date Jan. 1 Mar. 1 June 1 Sep. 30

Actual Number 20,000 (5,000) 6,000 10,000 31,000

Fraction of Year × 12/12 = × 9/12 = × 7/12 = × 3/12 =

Weighted Average 20,000 (3,750) 3,500 2,500 22,250

BRIEF EXERCISE 14-14 (a) Earnings per share = $1.81 [($454,000 – $55,000*)  220,000] * 22,000 × $2.50 = $55,000 (b)

Same as in (a) above $1.81. Since the preferred shares are cumulative, their dividend needs to be paid before any of the earnings become available to the common shareholders. Therefore, cumulative preferred dividends must be deducted from profit in calculating earnings per share, whether they are declared and paid or not.

(c)

Same as in (a) above $1.81

(d) Earnings per share = $2.06 ($454,000  220,000)

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BRIEF EXERCISE 14-15 Price-earnings ratio = Market price per share ÷ Earnings per share = $24.00 ÷ $4.00 = 6 times Payout ratio

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= Cash dividends per share ÷ Earnings per share = $0.80 ÷ $4.00 = .20 or 20%

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SOLUTIONS TO EXERCISES EXERCISE 14-1 Before Action Total assets

After Cash After Stock After Stock Dividend Dividend Split

$1,875,000 $1,851,000

$1,875,000 $1,875,000

Total liabilities $ 75,000 $ 75,000 Common shares 1,200,000 1,200,000 Retained earnings 600,000 576,000 Total shareholders' equity 1,800,000 1,776,000 Total liabilities and shareholders’ equity $1,875,000 $1,851,000

$ 75,000 $ 75,000 1,242,000* 1,200,000 558,000 600,000 1,800,000 1,800,000

Number of common shares

60,000

$1,875,000 $1,875,000 63,000

120,000

* $1,200,000 + (60,000 shares × 5% × $14) = $1,242,000

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EXERCISE 14-2 1. Dec. 31 Cash Dividends—Preferred (20,000 × $4 ÷ 4) ..................... Dividend Expense.................. 2.

31 Stock Dividends—Common ...... Dividends Payable ..................... Common Stock Dividend Distributable ........ Retained Earnings .................

20,000 20,000 12,000 12,000 12,000 12,000

31 Preferred Shares ........................ 1,400,000 Retained Earnings ................. 1,400,000

31 Dividends Payable ..................... 20,000 Cash Dividends—Preferred .. (40,000 × $2 ÷ 4 = $20,000, not $40,000)

20,000

Before split: Annual dividend = 20,000 × $4 = $80,000 After split: Annual dividend = 40,000 × $2 = $80,000

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EXERCISE 14-3 (a) Jan. 6 Cash ............................................. 300,000 Common Shares ................. (200,000 shares × $1.50)

300,000

12 Cash ......................................... Common Shares ................. (50,000 shares × $1.75)

87,500

Mar. 17 Cash ............................................. 105,000 Preferred Shares ................. (1,000 shares × $105)

105,000

July 18 Cash .......................................... 2,000,000 Common Shares ................. 2,000,000 Nov. 17 Common Shares (200,000 × $1.91*) ................ Retained Earnings ................... Cash (200,000 × $1.95) ........

382,000 8,000

Dec. 30 Common Shares (150,000 × $1.91*) ................ 286,500 Contributed Surplus— Reacquisition of Common Shares Cash (150,000 × $1.80) ........ *Average Cost per Common Share: Number of Transaction Common Shares Date Issued January 6 200,000 January 12 50,000 July 18 1,000,000 Total 1,250,000

390,000

16,500 270,000

Proceeds of Issue $ 300,000 87,500 2,000,000 $2,387,500

$2,387,500  1,250,000 = $1.91

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EXERCISE 14-3 (Continued) (b) There are 900,000 common shares remaining, at an average cost of $1.91**. **Average Cost per Common Share: Transaction Date January 6 January 12 July 18 Nov. 17 Dec. 30 Total

Number of Common Shares Issued 200,000 50,000 1,000,000 (200,000) (150,000) 900,000

Proceeds of Issue $ 300,000 87,500 2,000,000 (382,000) (286,500) $1,719,000

$1,719,000  900,000 = $1.91

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EXERCISE 14-4 TOP BRANDS LIMITED Income Statement Year Ended March 31, 2014 Revenues Fees earned........................................... Rent revenue......................................... Operating expenses Advertising expense............................. Depreciation expense........................... Training programs expense ................. Profit from operations.............................. Other revenues Gain on disposal of equipment............ Other expenses Interest expense ................................... Profit before income taxes ...................... Income tax expense ($74,000 × 30%) ...... Profit from continuing operations........... Discontinued operations Loss on discontinued operations, net of $5,400 in income tax savings ..... Profit..........................................................

$62,000 34,000 $ 7,000 3,000 8,000

$96,000

18,000 78,000 1,500 5,500 74,000 22,200 51,800

12,600 $39,200

TOP BRANDS LIMITED Statement of Comprehensive Income Year Ended March 31, 2014 Profit.......................................................... Other comprehensive income (loss) Loss on equity investments, net of $900 in income tax savings ........ Comprehensive income ...........................

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$39,200

2,100 $37,100

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EXERCISE 14-5 SHRINK LTD. Partial Statement of Comprehensive Income Year Ended December 31, 2014 Profit from continuing operations........... Discontinued operations Profit on discontinued component operations, net of $27,000* income tax expense $63,000 Loss on disposal of discontinued operations, net of $9,000** income tax savings . 21,000 Profit.......................................................... Other comprehensive income (loss) Gain on equity investments, net of $6,000*** in income tax savings. Comprehensive income ...........................

$320,000

42,000 362,000

14,000 $376,000

* $90,000 × 30% = $27,000 ** $30,000 × 30% = $9,000 *** $20,000 × 30% = $6,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-6 (a) Jan. 1 Land ............................................................... 75,000 Income Tax Payable .............................. 18,750 Retained Earnings [$75,000 × (1 − 25%)] 56,250

(b) SILVER FOX ENTERPRISES INC. Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1 as previously reported ........ Add: Correction of error in recording purchase of land in 2013, net of $18,750 income tax expense ............................................................. Balance, January 1 as adjusted .......................... Add: Profit............................................................. Less: Cash dividends .......................................... Retained earnings, December 31 ........................

$ 573,500

56,250 629,750 193,000 822,750 216,000 $606,750

(c) If Silver Fox uses IFRS, instead of using a statement of retained earnings, it will use a statement of changes in shareholders’ equity.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-7 (a) FYRE LITE CORPORATION Statement of Retained Earnings Year Ended December 31, 2014 Balance, January 1, as previously reported .................... $650,000 Add: Correction for understatement of 2013 profit due to error, net of $21,2501 income tax expense 63,750 Balance, January 1, as adjusted ........................................ 713,750 Add: Profit ...................................................................... 562,5002 1,276,250 Less: Excess cost of reacquired shares ........ $ 50,000 Cash dividends ....................................... 245,000 295,000 Balance, December 31 ...................................................... $981,250 1 2

$85,000 × 25% = $21,250 $750,000 × (1 − 25%) = $562,500

(b) Note X: During the year, the corporation completed a 3-for-1 stock split on its common shares. On the balance sheet, the number of common shares outstanding will have tripled in number.

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EXERCISE 14-8

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

Contributed Capital Share Capital Additional NE NE NE NE I NE NE NE I NE NE NE NE NE NE NE D I NE NE

Solutions Manual

Retained Earnings D NE NE NE D NE I NE NE I

Accumulated Other Comprehensive Income NE NE NE NE NE NE NE I NE I

14-28 Copyright .

Total Shareholders’ Equity D NE I NE NE NE I I D I

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-9 (a) Journal entries not required: July 1

Cash (60,000 × $15) ................................ 900,000 Common Shares .............................. 900,000

Sep. 30 Memo entry: 3 for 2 split, 90,000 shares issued (120,000 + 60,000) × 3/2 = 270,000 total shares less previously issued 180,000 = 90,000 Dec. 9 Stock Dividends (13,500* × $22)............ 297,000 Stock Dividends Distributable ........ 297,000 * (120,000 + 60,000) × 3/2 × 5% = 13,500 HOPKINS CORPORATION Statement of Comprehensive Income Year ended December 31, 2014 Profit.......................................................... Other comprehensive income Loss on equity investments, net of $16,800* in income tax savings.. Comprehensive income ...........................

$390,000

31,200 $358,800

* ($48,000 × 35% = $16,800)

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-9 (Continued) (b) HOPKINS CORPORATION Statement of Changes in Shareholders’ Equity Year ended December 31, 2014 Share capital, common shares Balance, January 1, 120,000 shares issued .......... $1,200,000 Issued for cash, 60,000 shares.......................... 900,000 Stock split, 90,000 shares.................................. 0 Balance, December 31, 270,000 shares issued .... 2,100,000 Stock dividends distributable Balance, January 1 ................................................. Common stock dividend declared ...................... Balance, December 31 ..............................................

0 297,000 297,000

Retained earnings Balance, January 1 ................................................. Profit ................................................................... Stock dividends.................................................. Balance, December 31............................................

750,000 390,000 (297,000) 843,000

Accumulated other comprehensive income Balance, January 1 ................................................. Other comprehensive income (loss)................. Balance, December 31............................................

17,000 (31,200) (14,200)

Total shareholders' equity .......................................... $3,225,800

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-10 RUBY RED RENTAL CORPORATION Statement of Changes in Shareholders’ Equity Year ended December 31, 2014 Share capital, common shares Balance, January 1, 32,000 shares issued ............ $800,000 Reacquired 1,000 shares (1) .............................. (25,000) Issued for cash, 2,000 shares .............................. 104,000 Balance, December 31, 33,000 shares issued ......... 879,000 Contributed surplus—reacquired shares Balance, January 1 ................................................. Reacquired common shares (1) .......................... Balance, December 31 ..............................................

540,000 (19,500) 520,500

Retained earnings Balance, January 1 ................................................. Profit ($425,000 − $40,000)................................. Dividends ............................................................ Balance, December 31............................................

1,500,000 385,000 (70,000) 1,815,000

Accumulated other comprehensive income Balance, January 1 ................................................. Other comprehensive income ........................... Balance, December 31............................................

(25,000) 40,000 15,000

Total shareholders' equity .......................................... $3,229,500 (1) ($800,000 ÷ 32,000) × 1,000 = $25,000 $44,500 – $25,000 = $19,500

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-11 (a)

Profit available to common shareholders = Profit − Preferred share dividends = $465,325 − $65,000 = $400,325

(b) Weighted average number of shares December 1, 2013 Feb. 28, 2014 May 31, 2014 Nov. 1, 2014

(c)

60,000 × 12/12 10,000 × 9/12 (5,000) × 6/12 15,000 × 1/12

= = = =

60,000 7,500 (2,500) 1,250 66,250

Earnings per share = Profit available to common shareholders ÷ Weighted average number of common shares = $400,325 ÷ 66,250 = $6.04

(d) Earnings per share — preferred shares are non-cumulative = Profit available to common shareholders ÷ Weighted average number of common shares = $465,325 ÷ 66,250 = $7.02

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-12 (a)

Weighted average number of shares Jan. 1, 2014 March 31, 2014 June 1, 2014 Dec. 1, 2014

100,000 × 12/12 12,000 × 9/12 (14,000) × 7/12 24,000 × 1/12

= = = =

100,000 9,000 (8,167) 2,000 102,833

(b) 1. (i) Earnings per share = $4.49 [($478,000 − $16,000*)  102,833] *(3,000 + 1,000) × $4 = $16,000 1. (ii) Same as in [(b) 1. (i)] above: $4.49. Since the preferred shares are cumulative, their dividends need to be paid before any of the earnings become available to the common shareholders. Therefore, cumulative preferred dividends must be deducted from profit in calculating earnings per share, whether they are declared and paid or not. 2. (i) Same as in [(b) 1. (i)] above $4.49 2. (ii) Earnings per share = $4.65 ($478,000  102,833)

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-13 (a) Earnings per share Price-earnings ratio Payout ratio

2014

2013

2012

$3.79 11.3 X .660

$4.18 11.9 X .538

$5.26 10.7 X .399

Calculations: Earnings per share (in thousands) 2014: ($1,978 − $73) ÷ 502 = $3.79 2013: ($2,131 − $43) ÷ 500 = $4.18 2012: ($2,663 − $30) ÷ 501 = $5.26 Price-earnings ratio 2014: $43.00 ÷ $3.79 = 11.3 times 2013: $49.75 ÷ $4.18 = 11.9 times 2012: $56.25 ÷ $5.26 = 10.7 times Payout ratio 2014: $2.50 ÷ $3.79 = .660 2013: $2.25 ÷ $4.18 = .538 2012: $2.10 ÷ $5.26 = .399

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Accounting Principles, Sixth Canadian Edition

EXERCISE 14-13 (Continued) (b) Earnings per share have deteriorated substantially over the past three years, moving from $5.26 to $3.79, a 28% decrease. This indicates that the company is earning less profit per common share. This decrease occurred primarily because profit has decreased. The 2014 earnings per share is also lower because preferred share dividends have increased over the three year period. This leaves less profit for common shareholders. The price-earnings ratio increased substantially in 2013, and then declined in 2014. There are many factors affecting priceearnings ratios but one possible reason for the decline could be that investors are not anticipating as high a level of income in the future. The price-earnings ratio should be compared to other companies in the industry to see if a multiple of around eleven is good for this type of business. The company’s dividends have increased each year and the payout ratio has increased substantially as a percentage of earnings per share over the three year period. The increase is due to the increase in dividends paid as well as the decrease in earnings per share.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 14-1A (a) Cash Dividend

Stock Dividend

3-for-2 Stock Split

(1)

Assets

$12,000,000 − No effect = $600,000a = $12,000,000 $11,400,000

No effect = $12,000,000

(2)

Liabilities

No effect = $4,000,000

(3)

Common shares

No effect = $2,000,000

$2,000,000 + $600,000b = $2,600,000

No effect = $2,000,000

(4)

Retained earnings

$6,000,000 − $600,000 = $5,400,000

$6,000,000 − $600,000 = $ 5,400,000

No effect = $6,000,000

(5)

Total $8,000,000 − shareholders’ $600,000 = $7,400,000 equity

No effect ($8,000,000 + $600,000 − $600,000 = $8,000,000)

No effect = $8,000,000

(6)

Number of shares

20,000 increase (20,000 + 400,000 = 420,000)

200,000 increase (400,000 × 3 ÷ 2 = 600,000)

a b

No effect = 400,000

400,000 × $1.50 = $600,000 400,000 × 5% × $30 = $600,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-1A (Continued) (b) 1. Cash dividend Cash dividend 1,000 × $1.50 = $1,500 Fair value of shares 1,000 × $28.501 = $28,500 1

Assumed that fair value of the shares would likely drop by the amount of the cash dividend ($30 − $1.50 = $28.50)

2. Stock Dividend Stock dividend 1,000 × 5% = 50 shares Fair value of shares 1,050 × $28.57142 = $30,000 2

Assumed that fair value of the shares would drop accordingly ($30 ÷ 105% = $28.5714), the same amount as the stock dividend.

3. Stock Split Stock split 1,000 × 3 ÷ 2 = 1,500 shares Fair value of shares = 1,500 × $203 = $30,000 3

Assumed that fair value of the shares would likely decrease by one-third because of the stock split ($30 × 2/3 = $20)

In terms of final value, the shareholder would be in the same position having received a cash dividend, a stock dividend or a stock split. However, a stock dividend or split would allow the shareholder to control the receipt of the cash and the related tax payment. Since the shareholder can control when the shares are sold, they can control when the income tax would have to be paid on any gains. Stock dividends and stock splits also provide the shareholder with an increased number of shares on which to generate future gains and dividends. Alternatively, some shareholders may prefer to receive a cash dividend since they do not have to sell the shares to obtain the cash. As well, there are often brokerage fees associated with selling shares. Solutions Manual .

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-1A (Continued) Taking It Further Advantages:  Increases marketability of a company’s shares by reducing the fair value. This makes it easier for the company to sell additional shares since the fair value per share has been decreased.  Makes it easier for investors to trade their shares since the fair value per share is decreased.  Frequently seen as a good sign to investors and is frequently accompanied by an increase above split value.  A reverse split can increase fair value per share and allow a company to continue trading its shares on a stock exchange; this increases marketability of the shares for investors and allows a company to continue accessing the secondary market. Disadvantages:  A reverse split can be seen as a negative sign to investors and can be accompanied by a further decline in fair value below the split value.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-2A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 15 Cash Dividends—Common................... 90,000 Dividends Payable (90,000 × $1) ......

90,000

Feb. 15 Dividends Payable ................................. 90,000 Cash ...................................................

90,000

July 1 Memo: 3-for-2 stock split increases the number of shares to 135,000 (90,000 × 3 ÷ 2) Dec. 15 Common Stock Dividends .....................135,000 Common Stock Dividends Distributable (135,000 × 10% × $10). 135,000 31 Income Summary....................................315,000 Retained Earnings ............................ 315,000 [($450,000 × (1 – 30%)] 31 Retained Earnings ..................................225,000 Cash Dividends—Common .............. 90,000 Common Stock Dividends................ 135,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-2A (Continued) (b) Common Shares Date Jan.

Explanation 1 Balance

Ref.

Debit

Credit



Balance 1,100,000

Common Stock Dividends Distributable Date

Explanation

Dec. 15

Ref.

Debit

Credit

Balance

135,000

Credit

Balance

90,000

90,000 0

Credit

Balance

135,000

135,000 0

Cash Dividends—Common Date

Explanation

Jan. 15 Dec. 31 Closing entry

Ref.

Debit

J1 J1

90,000

Ref.

Debit

J1 J1

135,000

Ref.

Debit

Common Stock Dividends Date

Explanation

Dec. 15 31 Closing entry Retained Earnings Date

Explanation

Jan. 1 Balance Dec. 31 Closing entry 31 Closing entry

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Credit

 J1 315,000 J1 225,000

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Balance 540,000 855,000 630,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-2A (Continued)

(c) LEBLANC CORPORATION Partial Balance Sheet December 31, 2014 Shareholders' equity Share capital Common shares, no par value, unlimited number of shares authorized, 135,000 shares issued... $1,100,000 Common stock dividend distributable ............... 135,000 Total share capital................................................ 1,235,000 Retained earnings..................................................... 630,000 Total shareholders' equity .............................. $1,865,000

Taking It Further: The share price will usually change in inverse proportion to the split or dividend so that the total fair value of the shares in circulation remains the same. For example, with a 2-for-1 stock split, the fair value of an individual share will reduce by half, but there are twice as many shares after the split as before. The total fair value of all shares outstanding remains the same. This reflects the lack of change in the company’s total assets. In practice, the share price will rise above the split value, or the decreased value due to the stock dividend, as a result of investor interest.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-3A (a) Shares authorized Shares issued

1,000,000 437,000

(b) Common shares Contributed Surplus—reacquisition of Common shares Retained earnings

$1,351,330 $6,750 $719,420

Calculations:

Bal 1. 2. 3. 4. 5.

Common shares (a)

Average Cont. surplus —reacq. of Number issue of shares price common (b) shares (a) ÷ (b)

$1,500,000 147,000 1,647,000 (30,800) 1,616,200 22,500 1,638,700 (55,620) 1,583,080 (231,750) $1,351,330

500,000 35,000 535,000 (10,000) 525,000 5,000 530,000 (18,000) 512,000 (75,000) 437,000

Retained earnings

$3.00

$15,000

$720,000

3.08

15,000 (1) 800 15,800

720,000

15,800 (2) (15,800) 0 (3) 6,750 $ 6,750

720,000 (580) 719,420

3.08 3.09 3.09 3.09

720,000

$719,420

(1) (10,000 × $3.08) − (10,000 × $3) = $30,800 − $30,000 = $800 (2) (18,000 × $3.09) − (18,000 × $4) = $55,620 − $72,000 = $(16,380). A maximum of $15,800 is deducted from contributed surplus; the remainder, $580, is deducted from retained earnings. (3) (75,000 × $3.09) – (75,000 × $3) = $231,750 − $225,000 = $6,750

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PROBLEM 14-3A (Continued) Taking It Further: Reporting the number of shares authorized and issued allows shareholders to determine how many additional shares can be sold and how much their share ownership can potentially be diluted. If there are a maximum number of shares authorized, this would also determine how many additional shares can be issued to raise capital.

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PROBLEM 14-4A (a) and (b)

Date Jan. 1, Feb. 11 Subtotal Mar. 2 May 3 Subtotal June 14 Subtotal Sept. 16 Subtotal Dec. 13 Bal.

Common Shares (1) (2) (3) No. of Shares Total Cost Average Cost 150,000 $2,400,000 $16.00 50,000 1,000,000 200,000 3,400,000 17.00 (20,000) (340,000) 17.00 4,000 75,000 184,000 17.04 3,135,000 184,000 368,000 3,135,000 8.52 (50,000) (426,000) 318,000 2,709,000 8.52 15,900 302,100 333,900 3,011,100 9.02

Date Jan. 1, May 3 July 25 Bal.

Preferred Shares (1) (2) (3) No. of Shares Total Cost Average Cost 5,000 $375,000 $75.00 (1,000) (75,000) 75.00 (500) (37,500) 75.00 3,500 262,500 75.00

(b) Feb. 11 Cash ................................................... 1,000,000 Common Shares ......................... 1,000,000 (50,000 shares × $20)

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-4A (Continued) (b) (Continued) Mar. 2 Common Shares (20,000 × $17.00) .................................... 340,000 Contributed Surplus— Reacquisition of Common Shares ....... 30,000 Retained Earnings ................................. 70,000 Cash (20,000 × $22)......................... 440,000 May

3 Preferred Shares.................................... 75,000 Common Shares .............................

75,000

July 25 Preferred Shares (500 × $75) ................ 37,500 Contributed Surplus— Reacquisition of Preferred Shares Cash (500 × $70)..............................

2,500 35,000

Sept. 16 Common Shares (50,000 × $8.52) ..........426,000 Retained Earnings ..................................424,000 Cash (50,000 × $17)......................... 850,000 Oct. 27 Stock Dividends (15,900 × $19)..............302,100 Stock Dividends Distributable ....... 302,100 Dec. 13 Stock Dividends Distributable ...............302,100 Common Shares ............................. 302,100 (c) Share capital Preferred shares $4 cumulative, convertible, 100,000 authorized, 3,500 shares issued Common shares, unlimited number of shares authorized, 333,900 shares issued

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$ 262,500 3,011,100

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-4A (Continued) Taking It Further: Branch Inc. may have split the common shares to make the price more affordable. As for the stock dividend, it might have been declared to give a return to shareholder but without having to reduce cash. Another reason for the stock dividend may be to permanently increase share capital and make the amount transferred from retained earnings unavailable for cash dividends.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-5A (a) PORT HOPE CORPORATION Income Statement Year Ended November 30, 2014 Net sales ........................................................................ $9,124,000 Cost of goods sold........................................................ 7,280,000 Gross profit.................................................................... 1,844,000 Operating expenses............................. $1,120,000 Depreciation expense .......................... 355,000 1,475,000 Profit from operations................................................... 369,000 Other revenues .............................................................. 48,000 Profit before income taxes ........................................... 417,000 Income tax expense* ..................................................... 104,250 Profit from continuing operations................................ 312,750 Discontinued operations Profit on discontinued operations of communication device division net of $5,000** income taxes ............. $15,000 Loss on disposal of discontinued communication device division net of $18,750*** income tax savings 56,250 41,250 Profit.......................................................... $271,500 Earnings per share Profit ....................................................................

$1.23

$271,500 – $25,000 = $1.23 200,000 * ($417,000 × 25%) = $104,250 ** ($20,000 × 25%) = $5,000 *** ($75,000 × 25%) =$18,750

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PROBLEM 14-5A (Continued) (b) PORT HOPE CORPORATION Statement of Comprehensive Income Year Ended November 30, 2014 Profit.......................................................... Other comprehensive loss Loss, net of $20,750* in income tax savings ...................................... Comprehensive income ...........................

$271,500

62,250 $209,250

*($83,000 × 25%) = $20,750 Taking It Further: It is important to report gains and losses from discontinued operations separately from continuing operations because they represent atypical items. Investors trying to get a picture of the company’s future growth potential should not include discontinued operations in their analysis of future earnings potential because they will not exist in the future. Profit from continuing operations is a better indication of ongoing performance of the business on a comparative basis.

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PROBLEM 14-6A

(a) 2014 Mar. 17 Note Payable .................................... Income Taxes Payable................ Retained Earnings ...................... ($57,000 × 25% = $14,250)

57,000 14,250 42,750

(b) ZUG LIMITED Statement of Comprehensive Income Year Ended October 31, 2014 Fees earned ................................................................... $1,476,000 Operating expenses................................ $929,000 Depreciation expense ............................ 87,000 1,016,000 Profit from operations................................................... 460,000 Interest expense............................................................ 54,000 Profit before income taxes ........................................... 406,000 Income tax expense* ..................................................... 101,500 Profit............................................................................... 304,500 Other comprehensive income Gain net of $12,000** income taxes ..................... 36,000 Comprehensive income ................................................ $340,500 * ($406,000 × 25%) = $101,500 ** ($48,000 × 25%) = $12,000

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PROBLEM 14-6A (Continued) (c) The changes in retained earnings would include the following details: Balance, November 1, 2013 as previously reported Add: Correction of error in recording payment on notes payable in 2014, net of $18,750 income tax expense........................................ Balance, November 1 as adjusted....................... Add: Profit............................................................. Less: Reacquired common shares $ 22,500* Cash dividends ................... 120,000 Retained earnings, November 30 ........................ * $97,500 – $75,000

$ 575,000

42,750 617,750 304,500 922,250 142,500 $779,750

Taking It Further: Financial statements are generally presented on a comparative basis to help the user of the financial statements make comparisons and assess trends in performance. In order for the information to be comparable, the financial statement of the prior period must be corrected to rectify the information affected by the prior year error.

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PROBLEM 14-7A (a), (b) and (c) Preferred Shares Date

Explanation

Ref.

Jan.

1 Balance (10,000)



Debit

Credit

Balance 1,100,000

Common Shares Date

Explanation

Ref.

Jan.

1 Balance (320,000) 15 Reacquisition of shares (20,000) Oct. 1 Issue of shares (100,000)

Debit

Credit

 J1

Balance 1,280,000

80,000 J1

1,200,000 800,000 2,000,000

Contributed Surplus—Reacquisition of Common Shares Date

Explanation

Ref.

Jan.

1 Balance 15 Reacquisition of shares

Debit

Credit

 J1 30,000

Balance 30,000 0

Retained Earnings Date Jan.

1 15 July 1 Dec. 31 31

Explanation Balance Reacquisition of shares Prior period error Income Summary Dividends

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Ref.

Debit

 J1 30,000 J1 J1 J1 25,000

14-51

Credit

Balance

2,443,500 2,413,500 187,500 2,601,000 570,000 3,171,000 3,146,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 14-7A (Continued) (b) GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Credit

Jan. 15 Common Shares ($4(1) × 20,000) ........... 80,000 Contributed Surplus—Reacquisition of Shares ................................................ 30,000 Retained Earnings ................................. 30,000 Cash (20,000 × $7)............................. 140,000 (1)

$1,280,000 ÷ 320,000 = $4

Mar. 31 Cash Dividends—Preferred .................. 12,500 Cash (10,000 × $5 × ¼)......................

12,500

Jun. 30 Cash Dividends—Preferred .................. 12,500 Cash (10,000 × $5 × ¼)......................

12,500

Jul. 1 Long-Term Investments ......................... 250,000 Income Tax Payable ($250,000 × 25%) 62,500 Retained Earnings 187,500 [$250,000 × (1 − 25%)] ....................... Oct. 1 Cash (100,000 × $8) ................................ 800,000 Common Shares ............................... 800,000 (c) Dec. 31 Income Summary [$760,000 × (1 − 25%)] .......................... 570,000 Retained Earnings ......................... 570,000 31 Retained Earnings ...................................25,000 Cash Dividends—Preferred ..........

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25,000

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PROBLEM 14-7A (Continued) (d) JAJOO CORPORATION Statement of Changes in Shareholders’ Equity Year Ended December 31, 2014 Share capital, preferred shares Balance, Jan. 1, 10,000 shares issued ..................... $1,100,000 Share capital, common shares Balance, Jan. 1, 10,000 shares issued................... Reacquired 20,000 shares................................. Issued for cash, 100,000 shares ....................... Balance, December 31, 400,000 shares issued.....

1,100,000 (80,000) 800,000 2,000,000

Contributed surplus – reacquired shares Balance, January 1 ................................................. Reacquired common shares............................. Balance, December 31, ...........................................

30,000 (30,000) 0

Retained earnings Balance, January 1, as previously reported .............. 2,443,500 Add: Correction for understatement of investment, net of $62,500 income tax expense .............................................. 187,500 Balance, January 1, as adjusted ............................ 2,631,000 Profit ..................................................................... 570,000 Cash dividends—preferred .................................. (25,000) Reacquisition of shares ....................................... (30,000) Balance, December 31 ................................................ 3,146,000 Shareholders’ equity December 31 ............................ $6,246,000 (e) The balances in the general ledger account, after the posting of closing entries, will match the balances reported on the statement of changes in shareholders’ equity.

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PROBLEM 14-7A (Continued) Taking It Further: Corrections of prior period errors are recorded in the retained earnings account because they relate to revenues and expenses of prior periods. These revenues and expenses have been transferred to the retained earnings account through the closing entries of prior periods. To record them in current year accounts would misstate current year results. In addition, comparative figures are restated to adjust for the error. This enhances comparability and usefulness of the information.

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PROBLEM 14-8A (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 20 Stock Dividend Distributable ................ 400,000 Common Shares ............................... 400,000 Feb. 12 Cash (50,000 × $5) ................................. 250,000 Common Shares ............................... 250,000 Mar. 31 Inventory ................................................ 60,000 Income Tax Payable.......................... Retained Earnings ............................ Nov.

18,000 42,000

2 Common Shares (25,000 × $3.17*)........ 79,250 Contributed Surplus— 16,750 Reacquired Common Shares ........... Cash (25,000 × $2.50) ........................ 62,500 *($3,000,000 + $400,000 + $250,000) ÷ (1,000,000 + 100,000 + 50,000) = $3.17

Dec. 31 Cash Dividends—Common ....................562,500 Dividends Payable (1,125,000* × $0.50) 562,500 *(1,000,000 + 100,000 + 50,000 − 25,000) 31 Income Summary....................................280,000 Retained Earnings ............................ 280,000 31 Retained Earnings ..................................562,500 Cash Dividends—Common .............. 562,500 31 Accumulated Other Comprehensive Income (Loss) ...........................................19,600 Other Comprehensive Income – Loss* *[$28,000 × (1 – 30%)]

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PROBLEM 14-8A (Continued) (b) Common Shares Date

Explanation

Ref.

Debit

Credit

 J1 400,000 J1 250,000 J1 79,250

Jan.

1 Balance 20 Feb. 12 Nov. 2

Balance 3,000,000 3,400,000 3,650,000 3,570,750

Stock Dividends Distributable Date Jan.

Explanation 1 Balance 20

Ref.

Debit

Credit

Balance

 400,000 J1 400,000

400,000 0

Contributed Surplus—Reacquired Common Shares Date

Explanation

Ref.

Debit

 J1

Jan. 1 Balance Dec. 31

Credit

Balance

5,000 16,750

5,000 21,750

Credit

Balance

562,500

562,500 0

Cash Dividends—Common Date

Explanation

Dec. 31 Dec. 31 Closing entry

Ref.

Debit

J1 J1

562,500

Retained Earnings Date

Explanation

Jan. 1 Balance Mar. 31 Dec. 31 Closing entry Dec. 31 Closing entry

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Ref.

Debit

Credit

Balance

 1,200,000 J1 42,000 1,242,000 J1 280,000 1,522,000 J1 562,500 959,500

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PROBLEM 14-8A (Continued) (b) (Continued) Accumulated Other Comprehensive Income (Loss) Date

Explanation

Dec. 31 Closing entry

Ref.

Debit

19,600

Credit

Balance 19,600Dr

(c) CEDENO INC. Statement of Comprehensive Income Year ended December 31, 2014 Profit.......................................................... Other comprehensive loss Loss, net of $8,400* in income tax savings ...................................... Comprehensive income ...........................

$280,000

19,600 $260,400

*($28,000 × 30%) = $8,400

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PROBLEM 14-8A (Continued) (d) CEDENO INC. Statement of Changes in Shareholders’ Equity Year ended December 31, 2014 Share capital, common shares Balance, January 1, 1,000,000 shares issued ....... $3,000,000 Stock dividend, 100,000 shares ........................ 400,000 Issued for cash, 50,000 shares.......................... 250,000 Reacquired 25,000 shares ................................. (79,250) Balance, December 31, 1,125,000 shares issued . 3,570,750 Stock dividends distributable 400,000 Balance, January 1 ................................................. Common stock dividend distributed ................ (400,000) Balance, December 31............................................ 0 Contributed surplus—reacquired shares Balance, January 1 ................................................. 5,000 Reacquired common shares ................................ 16,750 Balance, December 31 ............................................... 21,750 Retained earnings Balance, January 1, as previously reported ......... 1,200,000 Correction for overstatement of cost of goods sold in 2013, net of $18,000 income tax expense ...................................................... 42,000 Balance, January 1, as restated............................. 1,242,000 Profit ................................................................... 280,000 Cash dividends................................................... (562,500) Balance, December 31............................................ 959,500 Accumulated other comprehensive income (loss) Balance, January 1 ................................................. 0 Other comprehensive income (loss) .................. (19,600) Balance, December 31 ............................................. (19,600) Total shareholders' equity ............................................ $4,532,400

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PROBLEM 14-8A (Continued) (e) CEDENO INC. Partial Balance Sheet December 31, 2014 Shareholders' equity Contributed capital Share capital Common shares, no par value, unlimited number of shares authorized, 1,125,000 shares issued ................................................ $3,570,750 Other contributed capital Contributed surplus—reacquired common shares......................................... 21,750 Total contributed capital ....................................... 3,592,500 Retained earnings.................................................. 959,500 Accumulated other comprehensive income (loss) (19,600) Total shareholders' equity .................................... $4,532,400 Taking It Further: The first of two methods of preparing the statement of comprehensive income is to combine the income statement with the comprehensive income statement on an all-inclusive basis. The second method is to prepare the statement of comprehensive income on its own, starting with profit taken for the income statement. Neither format is better. The choice of which format to use depends on the nature and amount of information that a company needs to present on its statement for its users. For example, if a company has several material transactions to disclose in other comprehensive income, it may choose the separate statement format. A company may also choose a separate statement format if it wants to emphasize the profit amount rather than comprehensive income.

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PROBLEM 14-9A TMAO INC. Statement of Changes in Shareholders’ Equity Year Ended December 31, 2014 Share capital, preferred shares Balance, January 1, 4,000 shares issued .............. $400,000 Stock split, 4,000 shares ..................................... 0 Balance, December 31, 8,000 shares issued .......... 400,000 Share capital, common shares Balance, January 1, 160,000 shares issued ............ 800,000 Balance, December 31, 160,000 shares issued ....... 800,000 Stock dividends distributable Balance, January 1 ................................................. 0 Common stock dividend declared .................... 192,000 2 Balance, December 31 .............................................. 192,000 Retained earnings Balance, January 1, as previously reported ......... 450,000 Correction for understatement of cost of goods sold in 2013, net of $24,500 income tax savings.... (45,500) Cumulative effect of change in accounting policy, net of $10,500 income tax expense ...... (19,500) Balance, January 1, as restated............................. 385,000 Profit ................................................................... 227,500 1 Stock dividend—common ................................. (192,000) Cash dividends—preferred................................ (12,000) 3 Balance, December 31............................................ 408,500 Accumulated other comprehensive income (loss) Balance, January 1 ................................................. (50,000) Other comprehensive income (loss), net of $35,000 income tax expense ........................... 65,000 Balance, December 31............................................ 15,000 Total shareholders' equity .......................................... $1,815,500 1 $350,000 × (1 − 35%) = $227,500 2 160,000 × 10% × $12 = 16,000 × $12 = $192,000 3 4,000 × 2 from split × ($3 ÷ 2) = $12,000

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PROBLEM 14-9A (Continued)

Taking It Further: Comprehensive income is closed at the end of the year to accumulated other comprehensive income. In turn, accumulated other comprehensive income is an element of shareholders’ equity on the balance sheet. For companies following ASPE, there is no comprehensive income and consequently no accumulated other comprehensive income either.

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PROBLEM 14-10A (a)

Weighted Average Number of Shares

Date Apr. 1 June 1 July 1 Sept. 30 Jan. 31 Mar. 31

Beginning Balance Reacquired shares Issued 50,000 shares Reacquired shares Issued 60,000 shares Ending balance

Actual Fraction number of Year 500,000 12/12 (12,000) 10/12 50,000 9/12 (8,000) 6/12 60,000 2/12 590,000

Weighted Average 500,000 (10,000) 37,500 (4,000) 10,000 533,500

(b) Earnings per Share 1. Preferred dividend cumulative but not declared = Income available to common shareholders ÷ Weighted average number of common shares = [$973,600 – (20,000 × $6)] ÷ 533,500 = $1.60 2. Preferred dividend cumulative and declared for 2 years = Income available to common shareholders ÷ Weighted average number of common shares = ($973,600 − $120,000) ÷ 533,500 = $1.60 Note: When the preferred dividend is cumulative it must be subtracted from profit whether or not it is declared. As well, profit is only reduced by the amount of the current year’s preferred dividend. Therefore, the earnings per share will be the same regardless of whether the preferred dividend declared is for one or more years.

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PROBLEM 14-10A (Continued) (c)

1. Preferred dividend not cumulative or declared = Income available to common shareholders ÷ Weighted average number of common shares = $973,600 ÷ 533,500 = $1.82 2. Preferred dividend noncumulative with partial ($80,000) dividend paid to preferred = Income available to common shareholders ÷ Weighted average number of common shares = ($973,600 − $80,000) ÷ 533,500 = $1.67

Taking It Further: Preferred shareholders usually have the return (or dividend rate) on their investment fixed by the terms of the share issue. They do not share in additional income. The concept of “earnings per share” for preferred shareholders therefore has no meaning. Common shareholders however, do not have a dividend rate and “own” all of the company’s profit after the preferred shareholders receive their dividend.

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PROBLEM 14-11A (a) ($ in millions except for market price per share) Canadian Pacific Railway Limited Ratio 1. Earnings per share 2. Price-earnings ratio 3. Payout ratio

2011 $570 − $0 = $3.36 169.5 $67.67 = 20.14 times $3.36 $198 = .347 $570

2010 $651 − $0 = $3.86 168.8 $64.81 = 16.79 times $3.86 $179 = .275 $651

2009 $550 − $0 = $3.31 166.3 $54.00 = 16.31 times $3.31 $166 = .302 $550

2010 $2,104 − $0 = $4.51 466.3 $66.47 = 14.74 times $4.51 $503 = .239 $2,104

2009 $1,854 − $0 = $3.95 469.2 $54.36 = 13.76 times $3.95 $474 = .256 $1,854

Canadian National Railway Company Ratio

2011 $2,457 − $0 1. Earnings per share = $5.45 451.1 $78.56 = 14.41 2. Price-earnings ratio times $5.45 $585 3. Payout ratio = .238 $2,457

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Problem 14-11A (Continued) (a) (Continued) In order to comment on whether a particular ratio has improved or deteriorated, one must take on a role of a user of that ratio. If the user is management, earnings per share improved in 2010 then deteriorated in 2011 for Canadian Pacific. On the other hand, for Canadian National, the improvement in earnings per share is constant from year to year. From a potential investor’s point of view, a lower the priceearnings ratio is an indicator of lower risk. From that perspective, Canadian Pacific’s price-earnings ratio keeps increasing and therefore is perceived as deteriorating. On the other hand, Canadian National’s price-earnings ratio deteriorated in 2010 then improved in 2011. Finally, for the dividend payout ratio, if one takes the perspective of a current shareholder who receives dividends, Canadian Pacific’s ratio deteriorated in 2010 then improved in 2011 while Canadian National’s ratio deteriorated in 2010 and again, but only slightly in 2011. (b) Canadian National’s earnings per share are consistently higher than Canadian Pacific’s earning per share but it is difficult to compare earnings per share without also considering the market price of each share. Therefore it is more useful to compare price earnings ratios. The price earnings ratio of Canadian National is better than Canadian Pacific, from the perspective of a potential shareholder. If a current shareholder is interested in receiving regular dividends, Canadian Pacific’s dividend payout ratio would be considered more favoured as it pays out a higher proportion of its profits compared to Canadian National. If a shareholder has purchased the shares for capital appreciation they would likely prefer Canadian National’s lower dividend payout ratio. Solutions Manual .

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Problem 14-11A (Continued) Taking It Further: The presentation of earnings per share and fully diluted earnings per share is required. The fully diluted earnings per share shows the “worst-case” scenario if all possible securities are converted into common shares. This allows users to assess the impact of management decisions on their share holding and its potential dilution.

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PROBLEM 14-12A (a) Before Discontinued Operations Ratio 2014 $1,160 − $20 1. Return on equity = 33.53% $3,400 $1,160 − $20 2. Earnings per = $3.80 share 300 $45.50 3. Price-earnings = 11.97 ratio times $3.80

2013 $810 − $20 = 32.92% $2,400 $810 − $20 = $2.72 290 $33.65 = 12.37 times $2.72

2012 $570 − $15 = 30.83% $1,800 $570 − $15 = $1.98 280 $44.80 = 22.63 times $1.98

After Discontinued Operations Ratio 2014 $710 − $20 1. Return on equity = 20.29% $3,400 $710 − $20 2. Earnings per = $2.30 share 300 $45.50 3. Price-earnings = 19.78 ratio times $2.30

2013 $730 − $20 = 29.58% $2,400 $730 − $20 = $2.45 290 $33.65 = 13.73 times $2.45

2012 $500 − $15 = 26.94% $1,800 $500 − $15 = $1.73 280 $44.80 = 25.90 times $1.73

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PROBLEM 14-12A (Continued) (b) Before Discontinued Operations: Highlander’s return on equity increased slightly from 2012 to 2014 due to a larger increase in profit from continuing operations than the increase in shareholders’ equity. The earnings per share from continuing operations increased substantially due to a large increase in profit from continuing operations. The price-earnings ratio showed a substantial decrease due to the large increase in earnings per share from continuing operations. After Discontinued Operations: The return on equity shows a substantial decrease in 2014 because the losses from discontinued operations offset most of the increase in profit from continuing operations. The slight increase in profit is offset by the substantial increase in shareholders’ equity. Earnings per share increased due to increased profit, but not as substantially as the earnings per share from continuing operations. The price-earnings ratio decreased due to the increase in earnings per share from continuing operations. Again, the decrease was not as substantial as the amount calculated before discontinued operations. (c)

Performing the analysis for results before discontinued operations reflects financial results as if the discontinued operations were not there. This is a better indication of ongoing performance and will lead to better comparability with years after 2014. The results before discontinued operations show substantial increases for return on equity and earnings per share caused by a substantial increase in profits from continuing operations. The losses from the discontinued operations in 2014 change this trend for all three ratios.

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PROBLEM 14-12A (Continued) Taking It Further: The purpose of reporting separately the discontinued operations of a component of an entity is to allow analysis of continuing operations. To be considered a component, operations must constitute a separate major line of business, or geographical area of operations, with its own cash flows separately identifiable from those of the continuing business.

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PROBLEM 14-1B (a) Cash Dividend

Stock Dividend

2-for-1 Stock Split

(1)

Assets

$9,000,000 − $750,000a = $8,250,000

No effect = $9,000,000

(2)

Liabilities

No effect = $2,500,000

(3)

Common shares No effect = $3,000,000

$3,000,000 + $750,000b = $3,750,000

No effect = $3,000,000

(4)

Retained earnings

$3,500,000 − $750,000 = $2,750,000

$3,500,000 − $750,000 = $ 2,750,000

No effect = $3,500,000

(5)

Total shareholders’ equity

$6,500,000 − $750,000 = $5,750,000

No effect ($6,500,000 + $750,000 − $750,000 = $6,500,000)

No effect = $6,500,000

(6)

Number of shares

No effect = 500,000

25,000 increase (25,000 + 500,000 = 525,000)

500,000 increase (500,000 × 2 = 1,000,000)

a b

500,000 × $1.50 = $750,000 500,000 × 5% × $30 = 25,000 × $30 = $750,000

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PROBLEM 14-1B (Continued) (b) 1. Cash Dividend Cash dividend 2,000 × $1.50 = $3,000 Fair value of shares 2,000 × $28.501 = $57,000 1

Assumed that fair value of the shares would likely drop by the amount of the cash dividend ($30 − $1.50 = $28.50)

2. Stock Dividend Stock dividend 2,000 × 5% = 100 shares Fair value of shares 2,100 × $28.57142 = $60,000 2

Assumed that fair value of the shares would drop accordingly ($30 ÷ 105% = $28.5714), the same amount as the stock dividend

3. Stock Split Stock split 2,000 × 2 = 4,000 shares Fair value of shares 4,000 × $153 = $60,000 3

Assumed that fair value of the shares would likely drop by half because of the stock split ($30 × ½ = $15)

In terms of final value, the shareholder would be in the same position having received either a cash or a stock dividend. However, a stock dividend would allow the shareholder to control the receipt of the cash and the related tax payment. Since shareholders can control when the shares are sold, they can control when the income tax would have to be paid on any gains. Alternatively, some shareholders may prefer to receive a cash dividend since they do not have to sell the shares to obtain the cash. As well, there are often brokerage fees associated with selling shares.

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PROBLEM 14-1B (Continued) (b) (Continued) The decision as to whether a cash or stock dividend would be more beneficial really depends on the preferences of the shareholder and their tax situation. A stock split would leave the investor in exactly the same position before and after the split. The investor would own twice as many shares but each share should be worth about half as much. Therefore, on an overall basis, the shareholder’s financial position should not have changed. Taking It Further Advantages:  Increases marketability of a company’s shares by reducing the fair value. This makes it easier for the company to sell additional shares since the fair value per share has been decreased.  Makes it easier for investors to trade their shares since the fair value per share is decreased.  Frequently seen as a good sign to investors and is frequently accompanied by an increase above split value.  A reverse split can increase fair value per share and allow a company to continue trading its shares on a stock exchange; this increases marketability of the shares for investors and allows a company to continue accessing the secondary market. Disadvantages:  A reverse split can be seen as a negative sign to investors and can be accompanied by a further decline in fair value below the split value.

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PROBLEM 14-2B (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Feb. 1 Cash Dividends—Common (75,000 × $1) ........................................... 75,000 Dividends Payable—Common .........

75,000

Mar. 1 Dividends Payable—Common .............. 75,000 Cash...................................................

75,000

April 1 No entry required—Memo only to increase the number of common shares to 150,000 (75,000 × 2) Dec. 1 Stock Dividends—Common (150,000 × 5% × $16) .............................. 120,000 Common Stock Dividends Distributable 120,000 31 Income Summary [$400,000 × (1 − 25%)] ........................... 300,000 Retained Earnings ............................ 300,000 31 Retained Earnings .................................. 195,000 Cash Dividends—Common .............. 75,000 Stock Dividends—Common ............. 120,000

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PROBLEM 14-2B (Continued) (b) Common Shares Date Jan.

Explanation 1 Balance

Ref.

Debit

Credit



Balance 1,700,000

Common Stock Dividends Distributable Date Dec.

Explanation 1

Ref.

Debit

Credit

Balance

120,000

Credit

Balance

75,000

75,000 0

Credit

Balance

120,000

120,000 0

Cash Dividends—Common Date

Explanation

Feb. 1 Dec. 31 Closing entry

Ref.

Debit

J1 J1

75,000

Ref.

Debit

J1 J1

120,000

Ref.

Debit

Stock Dividends—Common Date Dec.

Explanation 1 31 Closing entry

Retained Earnings Date

Explanation

Jan. 1 Balance Dec. 31 Closing entry 31 Closing entry

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Credit

 J1 300,000 J1 195,000

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PROBLEM 14-2B (Continued) (c) ASAAD CORPORATION Partial Balance Sheet December 31, 2014 Shareholders' equity Share capital Common shares, no par value, unlimited number of shares authorized, 157,500 shares issued............................................. $1,700,000 Stock dividends distributable ..................... 120,000 Total share capital ..................................... 1,820,000 Retained earnings............................................. 705,000 Total shareholders' equity......................... $2,525,000 Taking It Further: The share price will usually change in inverse proportion to the split or dividend so that the total fair value of the shares in circulation remains the same. For example, with a two-for-one stock split, the fair value of an individual share will reduce by half, but there are twice as many shares after the split as before. The total fair value of all shares outstanding remains the same. This reflects the lack of change in the company’s total assets. In practice, the share price will rise above the split value, or the decreased value due to the stock dividend, because of investor interest.

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PROBLEM 14-3B (a) Shares authorized Shares issued

150,000 15,300

(b) Common shares Contributed surplus—reacquisition of Common shares Retained earnings

$597,292 $4,560 $203,848

Calculations:

Bal 1. 2. 3. 4. 5.

Common shares (a)

Number Average of issue shares price (b) (a) ÷ (b)

$490,000 (21,000) 469,000 169,200 638,200 64,500 702,700 (46,848) 655,852 (58,560) $597,292

14,000 (600) 13,400 3,600 17,000 1,000 18,000 (1,200) 16,800 (1,500) 15,300

$35.00 35.00

Cont.surplus —reacq. of common shares

Retained earnings

$12,000 (1) (5,400) 6,600

$220,000

6,600 (2) (6,600) 0 (3) 4,560 $ 4,560

220,000 (16,152) 203,848

37.54 39.04 39.04 39.04

$203,848

(1) (600 × $35) − (600 × $44) = $21,000 − $26,400 = $5,400 (2) (1,200 × $39.04) − (1,200 × $58) = $46,848 − $69,600 = $(22,752). A maximum of $6,600 is deducted from contributed surplus; the remainder, $16,152, is deducted from retained earnings. (3) (1,500 × $39.04) – (1,500 × $36) = $58,560 − $54,000 = $4,560

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PROBLEM 14-3B (Continued) Taking It Further: Reporting the number of shares authorized and issued allows shareholders to determine how many additional shares can be sold and how much their share ownership can potentially be diluted. If there are a maximum number of shares authorized, this would also determine how many additional shares can be issued to raise capital.

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PROBLEM 14-4B (a) and (b)

Date Jan. 1, Jan. 17 Sub. Feb. 27 Mar. 31 Sub. Apr. 14 Sub. Aug. 16 Sub. Dec. 3 Bal.

Common Shares (1) (2) (3) No. of Shares Total Cost Average Cost 500,000 $4,000,000 $8.00 50,000 500,000 550,000 4,500,000 8.18 (20,000) (163,600) 8.18 20,000 300,000 550,000 8.43 4,636,400 550,000 1,100,000 4,636,400 4.215 (100,000) (421,500) 1,000,000 4,214,900 4.215 50,000 500,000 1,050,000 4,714,900 4.49

Date Jan. 1, Mar. 31 June 25 Bal.

Preferred Shares (1) (2) (3) No. of Shares Total Cost Average Cost 4,000 $600,000 $150.00 (2,000) (300,000) 150.00 (500) (75,000) 150.00 1,500 225,000 150.00

(b) Jan. 17 Cash ................................................. Common Shares ......................... (50,000 shares × $10)

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PROBLEM 14-4B (Continued) (b) (Continued) Feb. 27 Common Shares (20,000 × $8.18) .......... 163,600 Contributed Surplus— Reacquisition of Common Shares ....... 2,000 Retained Earnings ....................................74,400 Cash (20,000 × $12)......................... 240,000 Mar. 31 Preferred Shares..................................... 300,000 Common Shares ............................. 300,000 June 25 Preferred Shares (500 × $150) .............. 75,000 Contributed Surplus— Reacquisition of Preferred Shares Cash (500 × $145)............................

2,500 72,500

Aug. 16 Common Shares (100,000 × $4.125) ...... 421,500 Retained Earnings .................................. 678,500 Cash (100,000 × $11)....................... 1,100,000 Oct. 17 Stock Dividends (50,000 × $10).............. 500,000 Stock Dividends Distributable ....... 500,000 Dec. 3

Stock Dividends Distributable ............... 500,000 Common Shares ............................. 500,000

(c) Share capital Preferred shares $9 cumulative, convertible, 100,000 authorized, 1,500 issued Common shares, unlimited number of shares authorized, 1,050,000 issued

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PROBLEM 14-4B (Continued) Taking It Further: Talty may have split the common shares to make the price more affordable. As for the stock dividend, it might have been declared to give a return to shareholder but without having to reduce cash. Another reason for the stock dividend may be to permanently increase share capital and make the amount distributed unavailable for cash dividends.

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PROBLEM 14-5B (a) PORT HOPE CORPORATION Income Statement Year Ended December 31, 2014 Net sales ........................................................................ $1,750,000 Cost of goods sold........................................................ 888,000 Gross profit.................................................................... 862,000 Operating expenses ..................................................... 451,000 Profit from operations................................................... 411,000 Other expenses ............................................................. 18,000 Profit before income taxes ........................................... 393,000 Income tax expense*..................................................... 98,250 Profit from continuing operations................................ 294,750 Discontinued operations Loss on discontinued operations of ceramics division net of $37,500** income taxes...................... $112,500 Gain on disposal of discontinued ceramics division net of $17,500*** income tax savings 52,500 60,000 Profit.......................................................... $234,750 Earnings per share Profit ....................................................................

$ 0.90

$234,750 – $55,000 = $0.90 200,000 * ($393,000 × 25%) = $98,250 ** ($150,000 × 25%) = $37,500 *** ($70,000 × 25%) = $17,500

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PROBLEM 14-5B (Continued) (b) PORT HOPE CORPORATION Statement of Comprehensive Income Year Ended December 31, 2014 Profit.......................................................... Other comprehensive loss Gain, net of $11,750* in income tax savings ...................................... Comprehensive income ...........................

$234,750

35,250 $270,000

*($47,000 × 25%) = $11,750 Taking It Further: It is important to report gains and losses from discontinued operations separately from continuing operations because they represent atypical items. Investors trying to get a picture of the company’s future growth potential should not include discontinued operations in their analysis of future earnings potential because they will not exist in the future. Profit from continuing operations is a better indication of ongoing performance of the business on a comparative basis.

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PROBLEM 14-6B

(a) 2014 Jul. 9

Note Payable.................................... Income Taxes Payable................ Retained Earnings ...................... ($61,500 × 25% = $14,250)

61,500 15,375 46,125

(b) WEATHER VANE LIMITED Statement of Comprehensive Income Year Ended September 30, 2014 Fees earned ................................................................... $1,647,000 Operating expenses................................ $971,000 Depreciation expense ............................ 74,000 1,045,000 Profit from operations................................................... 602,000 Other revenue................................................................ 65,000 Profit before income taxes ........................................... 667,000 Income tax expense*..................................................... 166,750 Profit............................................................................... 500,250 Other comprehensive income Loss net of $9,500** income taxes ....................... 28,500 Comprehensive income ................................................ $471,750 * ($667,000 × 25%) = $166,750 ** ($38,000 × 25%) = $9,500

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PROBLEM 14-6B (Continued) (c) The changes in retained earnings would include the following details: Balance, October 1, 2013 as previously reported Add: Correction of error in recording payment on notes payable in 2014, net of $15,375 income tax expense........................................ Balance, October 1 as adjusted .......................... Add: Profit............................................................. Less: Reacquired common shares $ 32,500 Cash dividends ................... 150,000 Retained earnings, September 30 .......................

$ 845,000

46,125 891,125 500,250 1,391,375 182,500 $1,208,875

Taking It Further: Financial statements are generally presented on a comparative basis to help the user of the financial statements to make comparisons and assess trends in performance. In order for the information to be comparable, the financial statement of the prior period must be corrected to rectify the information affected by the prior year error.

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PROBLEM 14-7B (a), (b) and (c) Preferred Shares Date

Explanation

Ref.

Jan.

1 Balance (15,000)



Debit

Credit

Balance 850,000

Common Shares Date

Explanation

Ref.

Jan. Mar. July

1 Balance (255,000) 1 Issue of shares (20,000) 1 Reacquisition of shares (25,000)

 J1 J1

Debit

Credit

Balance

3,210,000 310,000 3,520,000 3,200,000

320,000

Contributed Surplus—Reacquisition of Common Shares Date

Explanation

Ref.

Jan. July

1 Balance 1 Reacquisition of shares

 J1

Debit

Credit

Balance

20,000

20,000 40,000

Credit

Balance

Retained Earnings Date Jan. 1 Sept. 1 Dec. 31 31

Explanation

Ref.

 980,000 938,000 J1 42,000 J1 525,000 1,463,000 1,418,000 J1 45,000

Balance Correction of error Income Summary Dividends

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PROBLEM 14-7B (Continued) (b)

GENERAL JOURNAL

Date

Account Titles and Explanation

J1 Debit

Credit

Mar. 1 Cash (20,000 × $15.50) ........................... 310,000 Common Shares ............................... 310,000 Mar. 31 Cash Dividends—Preferred (15,000 × $4 × ¼).................................... 15,000 Cash...................................................

15,000

Jun. 30 Cash Dividends—Preferred (15,000 × $4 × ¼).................................... 15,000 Cash...................................................

15,000

July 1 Common Shares (25,000 × $12.801) ....... 320,000 Contributed Surplus—Reacquisition 20,000 of Common Shares ........................... Cash (25,000 × $12)........................... 300,000 1

($3,210,000 + $310,000) ÷ (255,000 + 20,000) = $12.80

Sep. 1 Retained Earnings [$60,000 × (1 − 30%)] ............................. 42,000 Income Tax Payable (Recoverable) ($60,000 × 30%)...................................... 18,000 Accounts Receivable ........................

60,000

Sep. 30 Cash Dividends—Preferred (15,000 × $4 × ¼).................................... 15,000 Cash................................................... 15,000 (c) Dec. 31 Income Summary [$750,000 × (1 − 30%)] ........................... 525,000 Retained Earnings ............................ 525,000 31 Retained Earnings ....................................45,000 Cash Dividends—Preferred.............. Solutions Manual .

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PROBLEM 14-7B (Continued) (d) MICHAUD CORPORATION Statement of Changes in Shareholders’ Equity Year Ended December 31, 2014 Share capital, preferred shares Balance, Jan. 1, 15,000 shares issued ....................... $ 850,000 Share capital, common shares Balance, Jan. 1, 255,000 shares issued................. Reacquired 25,000 shares................................. Issued for cash, 20,000 shares ......................... Balance, December 31, 250,000 shares issued.....

3,210,000 (320,000) 310,000 3,200,000

Contributed surplus—reacquired shares Balance, January 1 ................................................. Reacquired common shares............................. Balance, December 31, ...........................................

20,000 20,000 40,000

Retained earnings Balance, January 1, as previously reported ......... Add: Correction for overstatement of sales, net of $18,000 income tax saving ................................................. Balance, January 1, as adjusted ............................ Profit ..................................................................... Cash dividends—preferred .................................. Balance, December 31 ................................................

980,000 42,000 938,000 525,000 (45,000) 1,418,000

Shareholders’ equity December 31 ............................ $5,508,000

Note X: $15,000 of preferred dividends are in arrears. (e) The balances in the general ledger account, after the posting of closing entries, will match the balances reported on the statement of changes in shareholders’ equity. Solutions Manual .

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PROBLEM 14-7B (Continued) Taking It Further: Corrections of prior period errors are recorded in the retained earnings account because they relate to revenues and expenses of prior periods. These revenues and expenses have been transferred to the retained earnings account through the closing entries of prior periods. To record them in current year accounts would misstate current year results. In addition, comparative figures are restated to adjust for the error. This enhances comparability and usefulness of the information.

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PROBLEM 14-8B (a) Date Aug.

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

1 Income Tax Payable (Recoverable) ...... 13,500 Retained Earnings ................................. 31,500 Inventory............................................

Credit

45,000

Oct. 15 Stock Dividends .................................... 450,000 Stock Dividends Distributable ......... 450,000 (250,000 × 10% × $18) Nov. 10 Stock Dividends Distributable .............. 450,000 Common Shares ............................... 450,000 Dec. 15 Cash Dividends—Preferred .................. 48,000 Dividends Payable ............................ (12,000 × $4) 31 Other Comprehensive Income—Gain .. Income Taxes Payable......................

48,000

3,600 3,600

31 Income Summary.................................... 395,000 Retained Earnings ............................ 395,000 31 Retained Earnings .................................. 498,000 Cash Dividends—Preferred.............. 48,000 Stock Dividends ................................ 450,000 31 Other Comprehensive Income—Gain .. Accumulated Other Comprehensive Income (Loss) .................................

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PROBLEM 14-8B (Continued) (b) Preferred Shares Date Jan.

Explanation

Ref.

Debit

Credit



1 Balance

Balance 800,000

Common Shares Date

Explanation

Ref.

Debit

 J1

Jan. 1 Balance Nov. 10

Credit

Balance

450,000

500,000 950,000

Contributed Surplus—Reacquired Common Shares Date Jan.

Explanation

Ref.

Debit

Credit



1 Balance

Balance 100,000

Stock Dividends Distributable Date

Explanation

Ref. J1 J1

Oct. 15 Nov. 10

Debit

Credit

Balance

450,000

450,000 0

450,000

Stock Dividends Date

Explanation

Oct. 15 Dec. 31 Closing entry

Ref.

Debit

Credit

J1 450,000 J1 450,000

Balance 450,000 0

Cash Dividends—Preferred Date

Explanation

Dec. 15 31 Closing entry

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Debit

J1 J1

48,000

14-90

Credit 48,000

Balance 48,000 0

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PROBLEM 14-8B (Continued) (b) (Continued)

Retained Earnings Date

Explanation

Jan. 1 Balance Aug. 1 Dec. 31 Closing entry 31 Closing entry

Ref.

Debit

Credit

Balance

 900,000 868,500 J1 31,500 J1 395,000 1,263,500 J1 498,000 765,500

Accumulated Other Comprehensive Income (Loss) Date

Explanation

Jan. 1 Balance Dec. 31 Closing entry

Ref.

Debit

 J1

Credit

Balance

50,000Dr 8,400 41,600Dr

(c) FRYMAN LTD. Statement of Comprehensive Income Year ended December 31, 2014 Profit.......................................................... Other comprehensive loss Gain, net of $3,600* in income tax savings ...................................... Comprehensive income ...........................

$395,000

8,400 $403,400

*($12,000 × 30%) = $3,600

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PROBLEM 14-8B (Continued) (d) FRYMAN LTD. Statement of Changes in Shareholders’ Equity Year ended December 31, 2014 Share capital, preferred shares Balance, January 1, 12,000 shares issued .............. $800,000 Balance, December 31, 12,000 shares issued ........ 800,000 Share capital, common shares Balance, January 1, 250,000 shares issued .......... 500,000 Stock dividend, 25,000 shares ........................... 450,000 Balance, December 31, 275,000 shares issued ...... 950,000 Contributed surplus—reacquired shares Balance, January 1 .................................................. 100,000 Balance, December 31 ............................................. 100,000 Retained earnings Balance, January 1, as previously reported ......... 900,000 Correction for understatement of cost of goods sold in 2010, net of $13,500 income tax expense ...................................................... (31,500) Balance, January 1, as restated............................. 868,500 Profit ................................................................... 395,000 Stock dividends—common ............................... (450,000) Cash dividends—preferred................................ (48,000) Balance, December 31............................................ 765,500 Accumulated other comprehensive income (loss) (50,000) Balance, January 1 ................................................. Other comprehensive income ........................... 8,400 Balance, December 31............................................ (41,600) Total shareholders' equity .......................................... $2,573,900

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PROBLEM 14-8B (Continued) (e)

FRYMAN LTD. Partial Balance Sheet December 31, 2014 Shareholders' equity Contributed capital Share capital Preferred shares, $4-noncumulative, no par value, unlimited number authorized, 12,000 shares issued......... $ 800,000 Common shares, no par value, unlimited number authorized, 275,000 shares issued........................... 950,000 Total share capital............................... 1,750,000 Additional contributed capital Contributed surplus—reacquired common shares..................................... 100,000 Total contributed capital..................... 1,850,000 Retained earnings ............................................ 765,500 Accumulated other comprehensive loss ........ (41,600) Total shareholders' equity.................. $2,573,900

Taking It Further: The first of two methods of preparing the statement of comprehensive income is to combine the income statement with the comprehensive income statement on an all-inclusive basis. The second method is to prepare the statement of comprehensive income on its own, starting with profit taken from the income statement. Neither format is better. The choice format depends on the nature and amount of information that a company needs to present on its statement. For example, if a company has several material transactions to disclose in other comprehensive income, it may choose the separate statement format. A company may also choose a separate statement format if it wants to emphasize the profit amount rather than comprehensive income.

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PROBLEM 14-9B KANADA INC. Statement of Changes in Shareholders’ Equity Year Ended September 30, 2014 Share capital, preferred shares Balance, October 1, 6,000 shares issued ................. $465,000 Balance, September 30, 6,000 shares issued ......... 465,000 Share capital, common shares Balance, October 1, 25,000 shares issued ............ 900,000 Stock dividend, 1,000 shares ............................ 10,000 1 Stock split, 26,000 shares.................................. 0 Balance, September 30, 52,000 shares issued ..... 910,000 Retained earnings Balance, October 1, as previously reported ......... 540,000 Correction for overstatement of bad debts expense, net of $9,900 income tax expense 23,100 Correction for overstatement of cost of goods sold in 2013, net of $16,200 income 37,800 tax expense .................................................... Balance, October 1, as restated............................. 600,900 Profit ................................................................... 227,500 2 Stock dividend—common ................................. (10,000) Cash dividends—preferred................................ (30,000) 3 Balance, September 30........................................... 788,400 Accumulated other comprehensive income (loss) Balance, October 1 ................................................. 95,000 Other comprehensive income, net of $8,100 income tax expense ......................................... 18,9004 Balance, September 30........................................... 113,900 Total shareholders' equity .......................................... $2,277,300 1

25,000 × 4% = 1,000 × $10 = $10,000 $325,000 × (1 − 30%) = $227,500 3 6,000 × $5 = $30,000 4 $27,000 × (1 − 30%) = $18,900 2

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PROBLEM 14-9B (Continued) Taking It Further: Comprehensive income is closed at the end of the year to accumulated other comprehensive income. In turn, accumulated other comprehensive income is an element of shareholders’ equity on the balance sheet. For companies following ASPE, there is no comprehensive income and consequently no accumulated other comprehensive income either.

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PROBLEM 14-10B (a)

Weighted Average Number of Shares

Date Aug. 1 Nov. 30 Feb. 1 Mar. 1 July 31

Beginning balance Issued 37,500 shares Reacquired shares Issued 30,000 shares Ending balance

Actual Fraction Weighted number of Year Average 350,000 12/12 350,000 37,500 8/12 25,000 (6,000) 6/12 (3,000) 30,000 5/12 12,500 411,500 384,500

(b) Earnings per Share 1. Preferred dividend cumulative but not declared = Income available to common shareholders ÷ Weighted average number of common shares = [$1,022,800 − (25,000 × $4)] ÷ 384,500 = $2.40 2. Preferred dividend cumulative and declared for 2 years = Income available to common shareholders ÷ Weighted average number of common shares = ($1,022,800 − $100,000) ÷ 384,500 = $2.40 Note: When the preferred dividend is cumulative it must be subtracted from profit whether or not it is declared. As well, profit is only reduced by the amount of the current year’s preferred dividend. Therefore, the earnings per share will be the same regardless of whether the preferred dividend declared is for one or more years.

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PROBLEM 14-10B (Continued)

(c)

1. Preferred dividend not cumulative or declared = Income available to common shareholders ÷ Weighted average number of common shares = $1,022,800 ÷ 384,500 = $2.66 2. Preferred dividend noncumulative with partial ($60,000) dividend paid to preferred shareholders = Income available to common shareholders ÷ Weighted average number of common shares = ($1,022,800 − $60,000) ÷ 384,500 = $2.50

Taking It Further: A weighted average number of shares is used in the earnings per share calculation because the issue of shares and other activity affecting the number of shares issued during the period changes the amount of net assets upon which income can be earned.

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PROBLEM 14-11B (a)

($in millions except for market price per share)

Husky Energy Inc. Ratio 1. Earnings per share 2. Price-earnings ratio 3. Payout ratio

2011 $2,224 − $10 = $2.40 923.8 $24.55 = 10.23 times $2.40 $1,109 = .50 $2,224

2010 $947 − $0 = $1.11 852.7 $26.55 = 23.92 times $1.11 $1,020 = 1.08 $947

2011 $4,304 −$0 = $2.74 1,571 $29.38 = 10.72 times $2.74 $664 = .154 $4,304

2010 $3,829 − $0 = $2.45 1,562 $38.28 = 15.62 times $2.45 $611 = .160 $3,829

Suncor Energy Inc. Ratio 1. Earnings per share 2. Price-earnings ratio 3. Payout ratio

In order to comment on whether a particular ratio has improved or deteriorated, one must take on a role of a user of that ratio. Husky’s more than doubling in the increase of its profit in 2011 has translated into a corresponding increase in earnings per share, while Suncor’s has had more of a modest increase in profitability. From the point of view of management, Husky has improved more than Suncor.

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PROBLEM 14-11B (Continued) (a)

(Continued) From a potential investor’s point of view, the lower the price-earnings ratio the lower the risk. From that perspective, Husky’s price-earnings ratio which was very high in 2010 has now been brought in line, in comparison to Suncor’s and therefore has improved. The same can be said for Suncor, but on a much smaller scale. In terms of the dividend payout ratio, Husky’s ratio dropped by more than 50% from 2010 to 2011. This was caused by paying almost the same amount of dividends in both years even though profit was much higher in 2011. It is an indication that management felt the low 2010 profit would recover in future years, which it did. In this case maintaining the constant dividend would be considered a positive sign even though the ratio looks worse. Suncor’s dividend payout ratio was consistent between the two years indicating stability in its profit and dividends.

(b) Husky and Suncor have fairly similar earnings per share and price earnings ratios in 2011. Based on these ratios it would be difficult to say that one company is better than the other. Husky may be consider more favourable as it pays out a higher proportion of its profits compared to Suncor. On the other hand, Suncor is less volatile between the two years and therefore may be considered more favourable by investors looking for a less risky investment. Taking It Further: The presentation of earnings per share and fully diluted earnings per share is required. The fully diluted earnings per share ratio shows the “worst-case” scenario if all possible securities are converted into common shares. This allows users to assess the impact of management decisions on their share holding and its potential dilution.

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PROBLEM 14-12B (a) Before Discontinued Operations Ratio 2014 $1,250 − $80 1. Return on equity = 34.41% $3,400 $1,250 − $80 2. Earnings per = $2.60 share 450 $24.40 3. Price-earnings = 9.38 ratio times $2.60

2013 $1,130 − $80 = 43.75% $2,400 $1,130 − $80 = $2.23 470 $19.88 = 8.91 times $2.23

2012 $990 − $60 = 48.95% $1,900 $990 − $60 = $2.02 460 $21.60 = 10.69 times $2.02

After Discontinued Operations Ratio 2014 $430 − $80 1. Return on equity = 10.29% $3,400 $430 − $80 2. Earnings per = $0.78 share 450 $24.40 3. Price-earnings = 31.28 ratio times $0.78

2013 $980 − $80 = 37.50% $2,400 $980 − $80 = $1.91 470 $19.88 = 10.41 times $1.91

2012 $810 − $60 = 39.47% $1,900 $810 − $60 = $1.63 460 $21.60 = 13.25 times $1.63

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PROBLEM 14-12B (Continued)

(b) Before Discontinued Operations: All Care’s return on equity decreased from 2012 to 2014 due to a larger increase in shareholders’ equity than profit from continuing operations. The earnings per share increased due to larger profit from continuing operations and a decrease in the number of common shares outstanding. The price-earnings ratio showed a slight decrease; an increase in share price was offset by an increase in earnings per share from continuing operations. After Discontinued Operations: The return on equity shows a sharp decrease from in 2014 due to losses from discontinued operations. The same loss also causes a large decrease in earnings per share for 2014. This shows a different trend than earnings per share before discontinued operations. The sharp decrease in earnings per share caused a large increase in the priceearnings ratio in 2014. This is also a different trend than the price-earnings ratio from continuing operations. (c)

Performing the analysis for results before discontinued operations reflects financial results as if the discontinued operations were not there. This is a better indication of ongoing performance and will lead to better comparability with years after 2014. The results before discontinued operations do not show the sharp decrease caused by the large losses in 2014 caused by the disposal of the discontinued operations.

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PROBLEM 14-12B (Continued) Taking It Further: The purpose of reporting separately the discontinued operations of a component of an entity is to allow analysis of continuing operations. To be considered a component, operations must constitute a separate major line of business, or geographical area of operations with its own cash flows, separately identifiable from those of the continuing business.

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CONTINUING COOKIE CHRONICLE

(a) 1.

Because Koebel’s Family Bakery Ltd. is not a public company with its shares traded on a stock exchange, the fair value of the common shares is not easily established. On the other hand, arriving at the fair value can be done the same way someone outside the business might go about coming up with the purchase price of a business. It would be advisable for a business valuation to be done by an expert valuator to arrive at a fair value per share that everyone involved can agree on.

The original purchase price paid for the shares will not necessarily correspond to the current fair value of the shares at the date of repurchase. Natalie’s investment in the business goes beyond the amount of cash invested in return for the 10 common shares she purchased.

If you assume that $1,200 will be paid for each share repurchased, and since the total number of shares to be repurchased is 180 shares (210 less 30), the amount of cash needed to repurchase the shares will be $216,000 (180 × $1,200).

The difference between the average cost of the shares held and the price paid for the reacquisition of the shares will reduce retained earnings. In this case the average cost per share is $58.10 ($12,200 ÷ 210). Since 180 shares will be repurchased, $10,458 will be debited to the account for common shares and the remainder $205,542, will be debited to retained earnings. Since the current balance of retained earnings is $241,026, the balance in retained earnings, after the shares repurchase would be $35,484 ($241,026 – $205,542).

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CONTINUING COOKIE CHRONICLE (Continued) (a) 4. (Continued) Although there is a sufficient balance of retained earnings to allow the share repurchase, with such as substantial reduction in its balance, it is unlikely that dividends could be paid for several years after the share repurchase. When dividends are declared subsequent to the share repurchase, the amount of dividends received by each of the three shareholders would be equal, as they each would own 10 common shares of the company. 5.

Janet and Brian must consider that the option for the business to repurchase the majority of their shares is limited to the amount of cash available to execute the transaction. Taking out significant amounts of cash from the business cannot be done without borrowing more funds and consequently crippling the operations of the business. It is very unlikely that a bank would lend money to Koebel’s Family Bakery Ltd. and let it use that cash to repurchase the common shares. The cash borrowed would be leaving the business and not be available to sustain and grow the operations, which would be needed in order to be able to repay the loan and the interest on the loan. The share reacquisition might not be possible under the current set of circumstances, nor would it be wise to do so while trying to ensure the future success of the business. An alternative available to reach the objective of an equal number of voting shares owned by each shareholder is for Janet and Brian to convert their excess common shares (90 shares each) into non-voting preferred shares. These new preferred shares could have a high dividend rate, giving Janet and Brian a continued return on their investment in the form of dividends. While Natalie would not be receiving these preferred share dividends, she would remain a one third owner of the business and would consequently be motivated to stay on with the business.

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CONTINUING COOKIE CHRONICLE (Continued) (b) Common Shares (180 × $58.10) ..................... 10,458 Retained Earnings .......................................... 205,542 Cash (180 × $1,200)........................... 216,000

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BYP 14-1 FINANCIAL REPORTING PROBLEM (a)

For the 2012 fiscal year Reitmans: (1) There were no stock dividends and stock splits. (2) Other comprehensive income changed due to the change in fair value of available-for-sale financial assets, net of taxes of $8,737,000. (3) There were no corrections of prior period errors.

(b) For the 2012 fiscal year, Reitmans repurchased Class A non-voting shares and spent $22,410,000 in cash on the repurchase. (c) The basic earnings per share ratio for 2011 was $1.33. The earnings per share weakened substantially in 2012. (d) Fully diluted earnings per share were reported in both years. In 2011, the fully diluted amount was one cent lower than the basic amounts, at $1.32 per share. For the 2012 fiscal year, the fully diluted was equal to the basic earnings per share ratio. (e) The price-earnings ratio increased from 13.8 times in 2011 to 20.3 times in 2012. From the perspective of potential investors, this is a weakening of the ratio, consistent with the declining earnings per share. Investors most likely believe that Reitmans is less likely to improve earnings in the future. (f)

Reitmans’ payout ratio for 2011 was 0.58 ($51,895 ÷ $88,985). The major cause for the difference between the 2011 of .58 and the 2012 of 1.11 payout ratio is the 46% decline in profit.

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BYP 14-2 INTERPRETING FINANCIAL STATEMENTS

(a)

A cash dividend would cause assets (cash) and shareholders’ equity (retained earnings) to decease by the amount of the dividend. There would be no impact on liabilities or on the number of shares issued. Stock dividends have no effect on assets or liabilities. What does change are elements of equity. Retained earnings are reduced and the common shares account increases by the amount of the stock dividend. A stock split would have no impact on assets, liabilities or shareholders’ equity. All that would change is that the number of shares issued would increase by a multiple.

(b) The most likely reason a 3-for-1 stock split was to decrease the market value of the shares that are split to a third of the pre-split price. This in turn will ensure that the share price remains at an optimal trading price, as a lower share price typically increases investor interest and makes it easier for the corporation to issue additional shares. The split market price is more in line with the market price of the shares of Potash’s competitors. (c)

The market reacted favourably to the stock split as evidenced by the fact that the stock’s market price post stock split was greater than one third of the market price pre stock split.

(d) If the dividend rate per share had remained the same after the stock split to what is was prior to the split, the amount of the dividend per share would be $0.133 ($0.40 ÷ 3). The actual cash dividend declared at $0.28 after the split is more than double the equivalent amount before the stock split.

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BYP 14-2 (Continued) (e) (in millions of US dollars, except per share data): 2011

Ratio Return on common shareholders' equity

Earnings per share

Payout ratio

2010

$3,081 = $7,847 + $6,685 2

42.4%

$1,775 = $6,685 + $6,305 2

27.3%

$3,081 855.7

= $3.60

$1,775 886.4

= $2.00

$240 $3,081

$118 $1,775

= 0.066

0.078

Potash’s profit increased 74% [($3,081 – $1,775) / $1,775] in 2011. This improvement in profit for the year 2011 led to a corresponding increase in the earning per share ratio and return on common shareholders’ equity.

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BYP 14-3 COLLABORATIVE LEARNING ACTIVITY

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BYP 14-4 COMMUNICATION ACTIVITY MEMORANDUM To: From: Re:

Student Earnings per Share and Price-Earnings Ratio

Earnings per share is an important ratio for shareholders because it provides investors with a measure of the income earned by each common share. Earnings per share is calculated as earnings available to common shareholders (profit – preferred dividends) divided by the weighted average number of common shares outstanding during the period. The price-earnings ratio is important to investors as it provides investors with a meaningful way of comparing different companies when there are wide variations in the number of shares issued and the share prices. The price-earnings ratio is calculated as the market price divided by the earnings per share. Therefore, the earnings per share must be calculated before the price-earnings ratio can be determined. The priceearnings ratio will vary according to changes in earnings per share. For example, increases in earnings per share without a corresponding increase in the market price of the share will cause the price earnings ratio to decrease. A high price-earnings ratio indicates that investors are willing to pay a higher price for the company’s shares given its level of earnings per share. A high price-earnings ratio may occur because investors are confident about the company’s potential to earn profit in the future. However, a high price-earnings ratio may also indicate that the company’s shares are currently overpriced. While a low price-earnings ratio may indicate the investors are not confident about the company’s future performance, it may also indicate the company’s shares are undervalued and signal that the shares may currently be a good investment opportunity.

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BYP 14-4 (Continued) For companies using ASPE, there is no requirement to present earnings per share. Since private companies do not have their shares traded on the stock market, the share values are not often tested for their market value. Consequently, shareholders are not able to compare earnings per share to the shares’ market value. This means that the usefulness of the earnings per share ratio is substantially diminished. As well, in the case of private enterprises, shareholders are usually limited in number and have more hands on access to the company’s financial information and are more familiar with its operations. They are therefore better equipped to assess profit performance, even though they might not have this ratio to refer to.

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BYP 14-5 ETHICS CASE

(a)

The stakeholders in this situation are: Vince Ramsey, president of Flambeau Corporation Janice Rahn, financial vice-president The shareholders of Flambeau Corporation

(b) There is nothing unethical in issuing a stock dividend. However, the president's order to write a press release convincing the shareholders that the stock dividend is just as good as a cash dividend is unethical. A stock dividend is not a cash dividend and does not necessarily place the shareholder in the same position. A stock dividend is not paid in cash, it is “paid” in shares. This does provide a future potential opportunity to receive cash if the additional shares can be profitably sold. (c)

As a shareholder, preference for a cash dividend versus stock dividend is dependent upon one's investment objective—income (cash flow) or growth (reinvestment). By not paying out the cash, the stock dividend leaves cash in the company, where it is reinvested and contributes to the growth of the company. As well, more shares provide an opportunity for future profitable resale of these shares, especially if the share price climbs.

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BYP 14-6 “ALL ABOUT YOU” ACTIVITY (a)

Canadian Tire’s four main business lines include: 1. Canadian Tire Retail 2. FGL Sports 3. Mark’s and 4. Financial Services Knowledge of the four main business lines will help investors interpret the financial statement information since the lines of business have different sources of revenue and operations.

(b)

The management discussion and analysis includes: 1. Company and industry overview, including key performance indicators and the competitive landscape. 2. Core capabilities. 3. Historical performance highlights. 4. Strategic objectives and initiatives and financial aspirations. 5. Economic environment. 6. Performance including details of business segments. 7. Tax matters. 8. Accounting policies and estimates. 9. Enterprise risk management. 10. Controls and procedures. 11. Social and environmental responsibility. 12. Other investor communication. The information contained in the “Management’s Discussion and Analysis” (MD&A), although delivered from management’s perspective, gives information that is not strictly financial reporting as is the case with the financial statements. The topics covered give a more in depth understanding of the company’s business model, its history and aspirations, which might affect you opinion concerning an investment decision.

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BYP 14-6 (Continued) (c)

Cash dividends per share in 2011 were $1.125 and $0.905 for 2010. This demonstrates an increasing dividend return on your investment. This increase may be an important consideration in your investment decision if the dividend is a substantial component of what the investment is expected to yield.

(d)

The basic earnings per share for 2011 was $5.73.

(e)

The web page for investors includes links to the following: 1. Company profile 2. Strategy 3. Corporate governance 4. Quarterly reports 5. Annual reports 6. Events and presentations 7. Shareholders 8. Debtholders 9. IFRS 10. FAQs 11. Investor contacts Canadian Tire’s close share price at December 30, 2011 was $65.90.

(f)

The price earnings ratio is $65.90 ÷ $5.73 = 11.5

(g)

Canadian Tire is listed on the TSX stock exchange under the symbol CTC.A and its auditors are Deloitte & Touche LLP.

(h)

Included on SEDAR are documents including: 1. Code of conduct 2. Interim financial statements 3. MD&A 4. News releases 5. Annual reports 6. Proxy forms and 7. Notices of meetings.

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BYP 14-6 (Continued) (i)

Solutions will vary depending on date retrieved: As of Oct. 5 2012 Price Earnings ratio is 10.46 and industry 13.27. At that date, from the perspective of a potential investor, Canadian Tire’s price earnings ratio is better (lower) than the industry average.

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CHAPTER 15 Non-Current Liabilities ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

1. Compare the impact of issuing debt instead of equity.

1, 2, 3

1, 16

2. Account for bonds payable.

4, 5, 6, 7, 8, 9, 10

2, 3, 4, 5, 6, 7, 8, 9

3. Account for instalment notes payable.

11, 12, 13, 14

4. Account for leases.

5. Explain and illustrate the methods for the presentation and analysis of non-current liabilities.

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Problems Set A

Problems Set B

2, 3, 4, 5, 6, 7, 8

1, 2, 3, 4, 5

10, 11, 12, 13

9, 10, 11, 12, 13

6, 7, 8

15, 16, 17, 18, 19

14, 15, 16

14, 15

9, 10

20, 21, 22, 23, 24

13, 17, 18, 19

15, 16, 17

4, 5, 6, 10, 11

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record bond transactions.

Simple

20-30

Record bond transactions; show balance sheet presentation.

Moderate

25-35

Record bond transactions and answer questions

Moderate

25-30

Fill in missing amounts in amortization schedule, record bond transactions, and show balance sheet presentation.

Moderate

20-30

Record bond transactions; show balance sheet presentation.

Moderate

30-40

Prepare instalment payment schedule and record note transactions and show balance sheet presentation.

Moderate

25-30

Record note transactions.

Moderate

25-30

Prepare instalment payment schedule and record note transactions. Show balance sheet presentation.

Moderate

25-30

Analyze lease situations. Discuss financial statement presentation.

Moderate

20-25

10A

Calculate and analyze solvency ratios.

Simple

15-20

11A

Prepare liability section of balance sheet and analyze leverage.

Moderate

25-35

Record bond transactions.

Simple

20-30

Record bond transactions; show balance sheet presentation.

Moderate

25-35

Record bond transactions and answer questions.

Moderate

25-30

Fill in missing amounts in amortization schedule, record bond transactions, and show balance sheet presentation.

Moderate

20-30

Record bond transactions; show balance sheet presentation.

Moderate

30-40

Prepare instalment payment schedule and record note transactions and show balance sheet presentation.

Moderate

25-30

Record note transactions.

Moderate

25-30

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare instalment payment schedule and record note transactions. Show balance sheet presentation.

Moderate

25-30

Analyze lease situations. Discuss financial statement presentation.

Moderate

20-25

10B

Calculate and analyze solvency ratios.

Simple

15-20

11B

Prepare liability section of balance sheet and analyze leverage.

Moderate

25-35

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objectives

Knowledge

Comprehension Q15-1 Q15-2 Q15-3

Application BE15-1 E15-1 E15-16

Q15-9

Q15-4 Q15-5 Q15-6 Q15-7 Q15-8 Q15-10

BE15-2 BE15-3 BE15-4 BE15-5 BE15-6 BE15-7 BE15-8 BE15-9 E15-2 E15-3 E15-4 E15-5

E15-6 E15-7 E15-8 P15-1A P15-2A P15-3A P15-4A P15-5A P15-1B P15-2B P15-3B P15-4B P15-5B

3. Account for instalment notes payable.

Q15-11 Q15-12

Q15-13 Q15-14 BE15-10 BE15-11 BE15-12 BE15-13 E15-9 E15-10

E15-11 E15-12 E15-13 P15-6A P15-7A P15-8A P15-6B P15-7B P15-8B

4. Account for leases.

Q15-15 Q15-16 Q15-17 Q15-19

Q15-18 BE15-14 BE15-15 BE15-16 E15-14 E15-15

P15-9A P15-9B

P15-10A P15-10B

Q15-23 Q15-24

BE15-13 BE15-17 BE15-18 BE15-19 E15-15 E15-16 E15-17

P15-4A P15-5A P15-6A P15-11A P15-4B P15-5B P15-6B P15-11B

P15-10A P15-10B

BYP15-5

BYP15-1 BYP15-4 Continuing Cookie Chronicle

1. Compare the impact of issuing debt instead of equity. 2. Account for bonds payable.

5. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. Broadening Your Perspective

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Q15-20 Q15-21 Q15-22

15-4

Analysis

Synthesis

Evaluation

BYP15-2 BYP15-3 BYP15-6

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ANSWERS TO QUESTIONS 1.

Current liabilities are obligations that are expected to be settled within one year from the balance sheet date, or the company’s normal cycle, whichever is longer. Examples include accounts payable and interest payable. Non-current liabilities are obligations that are expected to be settled after one year from the balance sheet date. Examples include noncurrent mortgage payable and bonds payable.

(a) The major advantages of debt over equity are: 1. Shareholder control is not affected—debt holders (lenders) do not have voting rights, so current shareholders retain full control over the company. 2. Income tax savings result—interest is deductible for tax purposes; dividends on shares are not. 3. Earnings per share may be higher—although interest expense will reduce profit, earnings per share will often be higher under debt financing, because no additional common shares are issued. 4. Return on equity may be higher—although profit is lower, return on equity is often higher because shareholders’ equity is proportionately lower than profit. (b) The major disadvantage of using debt is that it is riskier. Interest must be paid on a periodic basis and the principal (face value) of the debt must be repaid. These are binding legal obligations.

If a company increases its debt, its earnings per share will be higher under debt financing (even though interest expense will reduce profit), because no additional common shares are issued. Even though profit is reduced under debt financing because of the interest expense, as long as the company earns a higher rate of return on the borrowed money than they are paying in after-tax interest, return on equity will be higher.

4. (a) The contractual interest rate (also called the coupon rate) is set before the bonds are issued. It is used to determine the cash interest that will be paid on the bonds, and it does not vary during the time the bond is outstanding. The market rate of interest is the rate that investors demand for lending their money and it can vary during the term of the bond. (b) The contractual rate does not vary because it is the rate that was agreed to when the bond contract was drawn up. The market rate will vary due to such things as changes in the creditworthiness of the issuer, inflation, or the state of the economy.

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QUESTIONS (Continued) 5.

The legal documents, which state the contractual interest rate, are often prepared well in advance of the actual bond issue and the market rate of interest fluctuates on a daily basis. It is nearly impossible to predict, months in advance, what the market interest rate will be on the date of issue.

Investors paid $2,000 ($102,000 – $100,000) more than the face value. The market interest rate must have been lower than the contractual interest rate. These bonds are said to have been sold at a premium.

(a) When a bond is sold at a discount, the total cost of borrowing is higher than the bond interest paid. The bond discount is considered to be an additional cost of borrowing. In accordance with the expense recognition criteria, the additional cost of borrowing should increase interest expense over the life of the bonds. (b) When bonds are sold at a premium, the sale of the bonds for proceeds higher than the face value of the bonds reduces the cost of borrowing. The bond premium is considered a reduction in the cost of borrowing. In accordance with the expense recognition criteria, these savings should reduce interest expense over the life of the bonds.

When bonds are issued at a discount, the proceeds from the issuance of the bonds are lower than the face value and corresponding maturity amount of the bonds. The difference in these two amounts has to be absorbed as an expense to the business over the term of the bonds, using the effective interest method. When bonds are issued at a premium the proceeds of the bonds are higher than the face value and corresponding maturity amounts. The difference in these two amounts, in this case, reduces the amount of interest expense recognized over the life of the bond.

Under the effective-interest method, the interest payment is determined by multiplying the face value of the bonds by the contractual interest rate. Interest expense is determined by multiplying the amortized cost of the bonds at the beginning of the period by the market (effective) rate of interest in effect when the bonds were issued. The difference between the interest payment and the interest expense is the amount of discount or premium amortized each period.

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QUESTIONS (Continued) 10.

When a bond reaches maturity, any premium or discount will have been fully amortized, so the amortized cost of the bond will be equal to its face value. This will result in no gain or loss when the principal is repaid at maturity. When bonds are retired prior to maturity however, the amount paid will rarely equal the amortized cost of the bonds, which will cause a gain or loss to occur.

11.

This type of loan is a floating rate loan because the prime rate changes over time. Since the loan repayment period is typically several years in length, this reduces the risk for the financial institution by providing a proper return on the loan to the student.

12.

For notes payable with fixed principal payments each payment will reduce the principal by the same amount, and interest is added to that amount. Since the periodic interest will drop as the loan principal is repaid, the periodic payment will get smaller each time a payment is made. For notes payable with blended principal and interest payments, the periodic payments are the same each period. Since the periodic interest will drop as the loan principal is repaid, the amount of the principal repayment each period will increase.

13.

In order to calculate the annual fixed principal payment, the principal amount of the note of $15,000 must be divided by 3. The annual principal repayment is therefore $5,000.

14.

I disagree. Each payment made by Bob consists of (1) interest on the unpaid balance of the loan and (2) a reduction of loan principal. The interest portion of the payment decreases each period (as the principal owing is reduced) while the portion applied to the loan principal increases each period.

15.

(a) A lease agreement is a contract in which the lessor gives the lessee the right to use an asset for a specified period, in return for one or more periodic rental payments. The lessor is the owner of the property and the lessee is the renter or tenant. (b) The two major types of leases are operating leases and finance leases. In an operating lease, the property is rented by the lessee and the lessor retains all ownership risks and responsibilities. A finance lease transfers substantially all the benefits and risks of ownership from the lessor to the lessee, so that the lease effectively results in a purchase of the property.

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QUESTIONS (Continued) 16.

A company might choose to lease equipment instead of purchasing the equipment because of financing considerations. The lease transaction provides essentially 100% the financing for acquisition. No down payment is required, as would be the case in a financed purchase, and the interest rate on long-term leases is fixed. Another consideration is the elimination of any obsolescence risk. Many leases offer the possibility of upgrades to newer, more efficient equipment within the term of the lease. The company can take advantage of these opportunities and doesn’t have to deal with the resale of an obsolete asset which would be the case if it had purchased instead of leased the equipment. Finally, there can be income tax advantages to leasing, because the full amount of the lease payments is a deductible expense.

17.

Off-balance sheet financing refers to situations where a company has liabilities or obligations that are not recorded on the balance sheet. Offbalance sheet transactions arise when a company is able to structure its financing so that it does not meet the criteria under IFRS or ASPE that would require the transaction to be recorded as debt. For operating leases, no asset or liability is recorded on the balance sheet. Lease payments are recorded as expenses. Thus, even though the company may have a contractual obligation, no liability appears on the balance sheet.

18.

For operating leases, no asset or liability is recorded on the balance sheet. Lease payments are recorded as expenses on the income statement. For finance leases, the present value of the lease payments is recorded as an asset and as a liability on the balance sheet. The asset is depreciated during its life, the liability is paid down, and the interest portion of the lease payments is recorded as an expense on the income statement.

19.

While assets are not legally owned by a business, the substance of the lease contract is equivalent to the purchase of an asset. The accounting guidelines require that the substance of the transaction is the determining factor in accounting for the lease. If the asset is essentially being purchased by the lessee, the lease must be accounted as a financing lease and the asset must be included on the lessee’s balance sheet.

20.

The notes to the financial statements provide the user of the financial statements with additional relevant information concerning non-current liabilities such as the amount of the payments that will be due in each of the next five fiscal years and beyond. Other information such as interest rate, maturity date, redemption price, convertibility, and any assets pledged as collateral is also provided in the notes to the financial statements.

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QUESTIONS (Continued) 21.

Current liabilities include those principal payments on the mortgage note payable that are going to be due for payment within one year of the balance sheet date. The principal payments appearing under non-current debt are those amounts to be paid beyond one year of the balance sheet date. When looking at the balance owing on a mortgage note, care must be taken to disaggregate the balance to ensure that the current portion of the debt is properly classified as a current liability as this affects the liquidity position of the business.

22.

Liquidity ratios measure the short-term ability of a company to repay its maturing obligations. Ratios such as the current ratio, receivables turnover, and inventory turnover can be used to assess liquidity. Solvency ratios measure the ability of a company to repay its non-current debt and survive over a long period of time. Ratios that are commonly used to measure solvency include debt to total assets and times interest earned.

23.

The debt to total assets and interest coverage ratios help assess solvency by providing insight into the ability of a company to repay its non-current debt. Debt to total assets measures the percentage of total assets provided by creditors. The higher this is, the greater the risk that the company may be unable to meet its maturing obligations. The ability of the company to meet its interest obligations as they come due is measured by the interest coverage ratio. A company may have a high debt to total assets ratio and be still able to pay its interest payments. Alternatively, a company may have a low debt to total assets ratio and struggle to cover its interest payments. Therefore, the debt to total assets ratio should always be interpreted with reference to the interest coverage ratio.

24.

An increase in debt will cause an increase in the debt to total asset ratio. An increase in debt leads to an increase in interest expense. In the calculation of the interest coverage ratio, the denominator, interest expense will become larger and when divided into the profit available to pay interest, the ratio will reduce.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15-1 Profit before interest and income tax Interest expense ($4,000,000 × 6%) Profit before income tax Income tax expense (25%) Profit Number of shares Earnings per share (profit ÷ number of shares)

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Issue Equity $1,000,000 0 1,000,000 250,000 $ 750,000

Issue Debt $1,000,000 240,000 760,000 190,000 $ 570,000

700,000

500,000

$1.07

$1.14

Chapter 15

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 1511 (a)

($500,000 × 0.67297) + ($500,000 × 2.5% × 16.35143) = $540,878 Using a financial calculator: Yields $540,879 PV $? I 2% N 20 PMT $ (12,500) FV $ (500,000) Type 0

(b) ($500,000 × 0.61027) + ($500,000 × 2.5% × 15.58916) = $500,000 (rounded) Using a financial calculator: Yields $500,000 PV $? I 2.5% N 20 PMT $ (12,500) FV $ (500,000) Type 0

(c)

($500,000 × 0.55368) + ($500,000 × 2.5% × 14.87747) = $462,808 Using a financial calculator: Yields $462,806 PV $? I 3% N 20 PMT $ (12,500) FV $ (500,000) Type 0

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BRIEF EXERCISE 1512 (a)

Jan. 1 Cash .......................................... 2,000,000 Bonds Payable .................... 2,000,000

(b)

July 1 Interest Expense....................... Cash ($2,000,000 × 3% × 6/12) ......

30,000

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BRIEF EXERCISE 1513 (a)

Jan. 1 Cash ($1,000,000 × 98%) .......... Bonds Payable ..................... July 1 Interest Expense ($25,000 + $1,766) ................ Bonds Payable ..................... Cash ($1,000,000 × 5% × 1/2)

980,000 980,000

26,766 1,766 25,000

(b) Jan. 1 Cash ...........................................1,000,000 Bonds Payable ..................... 1,000,000 July 1 Interest Expense....................... Cash ($1,000,000 × 5% × 1/2) (c)

25,000 25,000

Jan. 1 Cash ($1,000,000 × 102%) .........1,020,000 Bonds Payable ..................... 1,020,000 July 1 Interest Expense ($25,000 – $1,804) ................ Bonds Payable.......................... Cash ($1,000,000 × 5% × 1/2)

23,196 1,804 25,000

(d) Regardless of whether the bonds were sold at face value, at a discount, or at a premium, at maturity on January 1, 2019, the amortized cost of the bonds will be $1,000,000.

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BRIEF EXERCISE 1514 (a)

Principal $120,000 × 0.61027 = Interest $120,000 × 3% × 15.58916 (2.5%, 20 periods)

$ 73,232 56,121 $129,353

Using a financial calculator: Yields $129,353 PV $? I 2.5% N 20 PMT $ (3,600) FV $ (120,000) Type 0

(b) 2014 May 1

Cash ............................................... 129,353 Bonds Payable........................

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3,234 366 3,600

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 1515 (a) 1.

Discount

Payment

Expense

Interest expense = $47,812 ($40,000 + $7,812)

Discount amortization = $8,007 ($48,007 – $40,000)

Bond amortized cost = $1,928,298 ($1,920,291 + $8,007)

(b) Face value = $2,000,000 (c) Contractual interest rate: $2,000,000 = 4%

($40,000 × 2) ÷ face value

Market interest rate = 5.0% [($47,812 ÷ $1,912,479) × 2] (d) Interest expense is greater than interest paid because the bonds sold at a discount. The bonds sold at a discount to satisfy the investors with a 5.0% market (or effective) interest rate, which was higher than the 4% contractual interest rate.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-7 ELSWORTH LTD. Bond Premium Amortization Table Effective Interest Method—Semi-annual Interest Payments 4% Bonds Issued at market rate of 3% (c) Date

(A) (B) (C) Interest Interest Premium Payment Expense $1,000,000 × (D) × 3% × Amortization (A) – (B) 4% × 6/12 6/12

May 1, 2014 Nov. 1, 2014 May 1, 2015 Nov. 1, 2015

$20,000 20,000 20,000

$15,692 15,627 15,561

$4,308 4,373 4,439

(D) Bond Amortized Cost (D) – (C) $1,046,110 1,041,802 1,037,429 1,032,990

BRIEF EXERCISE 15-8 (a)

The bond was issued at a discount. The amortization for each period is added to the bond’s amortized cost.

(b) 2014 July 1 Interest Expense .............................. 7,172 Bond Payable .......................... Cash ......................................... (c) 2014 Dec. 31 Interest Expense .............................. 7,201 Bond Payable .......................... Interest Payable ...................... (d) 2015 Jan. 1 Interest Payable ............................... 6,000 Cash .........................................

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1,172 6,000

1,201 6,000

6,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-9 (a)

2015 Jan. 1

(b) 2015 Jan. 1

(c)

2015 Jan. 1

Bonds Payable ............................. 289,245 Loss on Bond Redemption ($300,000 – $289,245).............. 10,755 Cash ($300,000 × 100%) ..........

300,000

Bonds Payable ............................. 289,245 Loss on Bond Redemption ($303,000 – $289,245).............. 13,755 Cash ($300,000 × 101%) ..........

303,000

Bonds Payable ............................. 289,245 Gain on Bond Redemption ($289,245 – $285,000).............. Cash ($300,000 × 95%)............

4,245 285,000

BRIEF EXERCISE 15-10

Monthly Interest Period Issue Date 1 2 3 4

Solutions Manual .

(A) Cash Payment $105.09 105.09 105.09 105.09

(B) Interest (C) (D) Expense Reduction Principal (D) × 4.8% × of Principal Balance 1/12 (A) – (B) (D) – (C) $10,000.00 $40.00 $65.09 9,934.91 39.74 65.35 9,869.56 39.48 65.61 9,803.95 39.21 65.87 9,738.08

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-11 (a) Monthly Interest Period Nov. 30, 2013 Dec. 31, 2013 Jan. 31, 2014

(B) Interest Expense (D) × 6% × 1/12

$4,800 4,785

$1,800 1,785

(D) (A) Principal Reduction Balance of Principal (D) – (A) $360,000 $3,000 357,000 3,000 354,000

2013 Nov. 30 Cash .................................................... 360,000 Mortgage Note Payable .................

360,000

Dec. 31 Interest Expense ..................................... 1,800 Mortgage Note Payable .......................... 3,000 Cash................................................

4,800

2014 Jan. 31 Interest Expense..................................... 1,785 Mortgage Note Payable .......................... 3,000 Cash................................................

4,785

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-11 (Continued) (b) Monthly (A) Interest Cash Period Payment Nov. 30, 2013 Dec. 31, 2013 $3,997 Jan. 31, 2014 3,997

(B) Interest (C) Expense Reduction (D) × 6% × of Principal 1/12 (A) – (B) $1,800 1,789

2013 Nov. 30 Cash .......................................... Mortgage Note Payable ....... Dec. 31 Interest Expense....................... Mortgage Note Payable ............ Cash...................................... 2014 Jan. 31 Interest Expense....................... Mortgage Note Payable ............ Cash......................................

$2,197 2,208

(D) Principal Balance (D) – (C) $360,000 357,803 355,595

360,000 360,000 1,800 2,197 3,997

1,789 2,208 3,997

BRIEF EXERCISE 15-12 (a) December 31, 2013 Current liabilities Interest payable .......................................................... Current portion of note payable ................................

$2,000 10,000

Non-current liabilities Note payable, 5%, due 2017, net of current portion .

$30,000

(b) December 31, 2016 Current liabilities Interest payable .......................................................... Current portion of note payable ................................

$500 10,000

There is no non-current portion on December 31, 2016 Solutions Manual .

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-20 (a) 2013 Mar. 31 Cash .......................................... Note Payable ........................ 2014 Mar. 31 Note Payable............................. Interest Expense ($600,000 × 4%)......................... Cash......................................

600,000 600,000

150,000 24,000 174,000

(b) ELBOW LAKE CORP. Balance Sheet (Partial) March 31, 2014 Current liabilities Current portion of note payable................................... $150,000 Non-current liabilities Note payable, net of current portion.............................. 300,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-14 Because the asset being leased is of such a specialized nature that only the lessee can use the asset, the leased asset should be recorded as an asset on Paget’s books. The lease should be accounted as a finance lease.

BRIEF EXERCISE 15-15 Rent Expense ................................................. 2,500 Cash........................................................

2,500

BRIEF EXERCISE 15-16 (a)

Lessor: Lessee:

Bracer Construction, Inc. Chang Corp.

(b) Leased Asset—Equipment ........................ 300,000 Lease Liability ........................................

300,000

BRIEF EXERCISE 15-17 COOKE INC. Balance Sheet (Partial) December 31, 2013 Current liabilities Interest payable .......................................................... Current portion of note payable ................................

$ 4,800 16,375*

Non-current liabilities Note payable, due 2023, net of current portion ............ 223,625 *$3,973 + $4,052 + $4,134 + $4,216 = $16,375 Alternately: $240,000 – $223,625

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 15-18 WAUGH CORPORATION Balance Sheet (Partial) December 31, 2014 Current liabilities Accounts payable ....................................................... Income tax payable..................................................... Interest payable .......................................................... Current portion of lease liability ................................ Current portion of notes payable .............................. Total current liabilities ...........................................

$ 48,000 8,000 26,000 25,000 25,000 132,000

Non-current liabilities Bonds payable, due 2028 ............................................ 1,035,000 Notes payable, net of current portion............................ 145,000 Lease liability, net of current portion ........................ 50,000 Total non-current liabilities .....................................1,230,000 Total liabilities .............................................. 1,362,000

BRIEF EXERCISE 15-19 ($ in U.S. millions) (a)

Debt to total assets = Total debt ÷ Total assets $4,733.6 $12,423.8

38.1%

(b) Interest coverage = EBIT ÷ Interest expense ($677.1 + $118.7 + $99.4) $118.7

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7.54 times

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 15-1 (a) Profit before interest and income tax Interest expense ($5,400,000 × 5%) Profit before income tax Income tax expense (30%) Profit Number of shares Shareholders’ equity ($12,000,000 + $5,400,000 + $840,000) ($12,000,000 + $651,000)

Issue Equity $1,200,000 0 1,200,000 360,000 $ 840,000

Issue Bonds $1,200,000 270,000 930,000 279,000 $ 651,000

320,000

200,000

$18,240,000 $12,651,000

(b) Earnings per share (profit ÷ number of shares)

$2.63

$3.26

Return on equity (profit ÷ shareholders’ equity)

4.61%

5.15%

(c)

Even though profit is lower, the debt alternative is better as earnings per share and return on equity are higher. However, the existing amount of debt should be considered as part of the decision.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-2 (a) (1)

Market interest rate 5% ($1,000,000 × 0.61027) + ($1,000,000 × 3% × 15.58916) = $1,077,945 Using a financial calculator: PV $ ? Yields $1,077,946 I 2.5% N 20 PMT $ (30,000) FV $ (1,000,000) Type 0

(2)

Market interest rate 6% Since the market rate is the same as the contractual rate of interest, the issue price will be the same as the face value of $1,000,000.

(3)

Market interest rate 7% ($1,000,000 × 0.50257) + ($1,000,000 × 3% × 14.21240) = $928,942 Using a financial calculator: Yields $928,938 PV $? I 3.5% N 20 PMT $ (30,000) FV $ (1,000,000) Type 0

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-2 (Continued) (b) (1)

Market interest rate 5% $1,077,945 × 5% × 6/12 = $26,949

(2)

Market interest rate 6% $1,000,000 × 6% × 6/12 = $30,000

(3)

Market interest rate 7% $928,938 × 7% × 6/12 = $32,513

(c)

The amount of interest payment will be the same for all three market rates as the amount of the payment is based on the contractual interest rate of 6% per year or 3% semiannual. The amount will be $1,000,000 × 3% = $30,000.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-3 (a)

The market rate of interest is higher than the contract rate of 3% interest, which explains why the bond can be sold at a discount.

(b) 2013 Sept. 1 Cash ($600,000 × 96%) ................ 576,000 Bonds Payable ........................ (c)

2014 Feb. 28 Interest Expense ............................ 10,014 Bonds Payable ........................ Interest Payable ($600,000 × 3% × 6/12) ...........

576,000

1,014 9,000

(d) PRIORA CORPORATOIN Balance Sheet (Partial) February 28, 2014 Current liabilities Interest payable ..........................................................

$9,000

Non-current liabilities Bonds payable, due 2023 ............................................. $577,014 ($576,000 + $1,014) = $577,014

(e) 2014 Mar. 1

Solutions Manual .

Interest Payable ............................... 9,000 Cash .........................................

15-26

9,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 1527 (a) The market rate of interest is lower than the contract rate of 4% interest, which explains why the bond can be sold at a premium. (b) 2013 July 31 Cash ($500,000 × 102%) .............. 510,000 Bonds Payable ........................ (c)

2014 Jan. 31 Interest Expense .............................. 9,077 Bond Payable............................... 923 Cash ($500,000 × 4% × 6/12)...

510,000

10,000

(d) MOONEY INC. Balance Sheet (Partial) January 31, 2014 Non-current liabilities Bonds payable, due 2018 ............................................. $509,077 ($510,000 – $923) = $509,077

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EXERCISE 15-5 (a)

The bonds were issued at a premium. Note that the amortized cost is decreasing from periods 1 through 6, and will continue to decrease until the maturity date in ten years time at which time the carrying amount will equal the face value of the bond.

(b) $400,000, as given in the description of the bonds. (c)

The bond amortized cost will be $400,000 at the maturity date.

(d) Contractual interest rate = 4% $8,000 ÷ $400,000 = 2% semi-annually, × 2 = 4% annually Market interest rate = 3% $6,277 ÷ $418,444 = 1.5% semi-annually, × 2 = 3% annually (e) BRIGHT CORPORATOIN Balance Sheet (Partial) March 31, 2013 Current liabilities Interest payable ..........................................................

$8,000

Non-current liabilities Bonds payable, due 2016 ............................................. $411,395 (f)

Total interest payment = $80,000 $400,000 × 4% × 5 years = $80,000 or $8,000 × 10 semi-annual periods = $80,000 Total interest expense = $61,556 $80,000 (interest payment) – $18,444 (premium) = $61,556

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-5 (Continued) (g)

The total interest payment of $80,000, would be unchanged if the bonds had been issued at a discount instead of a premium. However, the interest expense would be greater. It would be the total of the interest payment of $80,000 plus the amount of the discount. For a premium, as shown in (f), the interest expense is calculated as the total of the interest payments less the amount of the premium.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 1530 (a)

2013 July 1

Interest Expense.......................... 14,474 Bond Payable .......................... Cash .........................................

1,974 12,500

(b) 2013 Dec. 31 Interest Expense.......................... 14,533 Bond Payable .......................... Interest Payable ......................

2,033 12,500

(c)

2014 Jan. 1

(d) 2014 Jan. 1

(e)

2014 Jan. 1

Solutions Manual .

Interest Payable ........................... 12,500 Cash .........................................

12,500

Bonds Payable............................. 486,457 Loss on Bond Redemption ($500,000 – $486,457).............. 13,543 Cash ($500,000 × 100%) ..........

500,000

Bonds Payable............................. 486,457 Gain on Bond Redemption ($486,457 – $480,000).............. Cash ($500,000 × 96%)............

6,457 480,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-7 (a) ($800,000 × 0.61027) + ($800,000 × 2% × 15.58916) = $737,643 (2.5%, 20 periods) Discount = $800,000 – $737,643 = $62,357 Using a financial calculator: Yields $737,643 PV $? I 2.5% N 20 PMT $ (16,000) FV $ (800,000) Type 0 (b) 2013 Jan. 1 Cash ............................................. 737,643 Bonds Payable ........................ 737,643 (c) ONTARIO INC. Bond Discount Amortization Table Effective Interest Method—Semi-annual Interest Payments 4% Bonds Issued at market rate of 5%

Date

Jan. 1, 2013 July 1, 2013 Jan. 1, 2014 July 1, 2014 Jan. 1, 2015

Solutions Manual .

(A) Interest Payment $800,000 × 4% × 6/12 $16,000 16,000 16,000 16,000

(B) (C) Interest Discount Expense (D) × 5% × Amortization (B) – (A) 6/12 $18,441 18,502 18,565 18,629

15-31

$2,441 2,502 2,565 2,629

(D) Bond Amortized Cost (D) + (C) $737,643 740,084 742,586 745,151 747,780

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-7 (Continued) 2014 (d) Dec. 31 Interest Expense ............................ 18,629 Bond Payable .......................... Interest Payable ...................... (e)

ONTARIO INC. Balance Sheet (Partial) December 31, 2014 Current liabilities Interest payable ................................... Non-current liabilities Bonds payable, due 2023 ....................

(f)

2,629 16,000

2015 Jan. 1 Interest Payable ............................. 16,000 Cash .........................................

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$16,000 $747,780

16,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 1533 (a)

2014 Jan. 1

Cash ............................................. 642,637 Bonds Payable ........................

642,637

(b) TAGAWA CORPORATION Bond Premium Amortization Table Effective Interest Method—Semi-annual Interest Payments 8% Bonds Issued at market rate of 7% (c) Date

(A) Interest Payment $600,000 × 8% × 6/12

Jan. 1, 2014 July 1, 2014 Jan. 1, 2015 July 1, 2015 Jan. 1, 2016

(c)

2014 July 1

$24,000 24,000 24,000 24,000

(B) (C) Interest Premium Expense (D) × 7% × Amortization (A) – (B) 6/12 $22,492 22,440 22,385 22,328

$1,508 1,560 1,615 1,672

(D) Bond Amortized Cost (D) – (C) $642,637 641,129 639,569 637,954 636,282

Interest Expense ............................ 22,492 Bonds Payable........................... 1,508 Cash .........................................

24,000

(d) Dec. 31 Interest Expense ............................ 22,440 Bonds Payable ................................. 1,560 Interest Payable ......................

24,000

(e)

2015 Jan. 1

Solutions Manual .

Bonds Payable ............................. 639,569 Gain on Bond Redemption ($639,569 – $624,000).............. Cash ($600,000 × 104%) ..........

15-33

15,569 624,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-9 (a)

Semi-annual (A) Interest Cash Period Payment Dec. 31, 2014 June 30, 2015 $15,000 Dec. 31, 2015 14,813

(B) Interest (C) (D) Expense Reduction Principal (D) × 5% × of Principal Balance 1/2 (A) – (B) (D) – (C) $300,000 $7,500 $7,500 292,500 7,313 7,500 285,000 Issue of Note

2014 Dec. 31

Cash ................................................... 300,000 Mortgage Note Payable .................

300,000

First Instalment Payment 2015 June 30

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

7,500 7,500 15,000

Second Instalment Payment Dec. 31

Solutions Manual .

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

15-34

7,313 7,500 14,813

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-9 (Continued) (b) (B) Interest (C) Semi-annual (A) Expense Reduction Interest Cash (D) × 5% × of Principal Period Payment 1/2 (A) – (B) (D) – (C) Dec. 31, 2014 June 30, 2015 $11,951 $7,500 $4,451 Dec. 31, 2015 11,951 7,389 4,562

(D) Principal Balance $300,000 295,549 290,987

Issue of Note 2014 Dec. 31

Cash ................................................... 300,000 Mortgage Note Payable .................

300,000

First Instalment Payment 2015 June 30

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

7,500 4,451 11,951

Second Instalment Payment Dec. 31

Solutions Manual .

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

15-35

7,389 4,562 11,951

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-36 (a)

This is a blended payment loan as the payments are constant at $23,097 year.

(b) The interest rate is 5% ($5,000 ÷ $100,000). (c)

Interest Expense............................................. 5,000 Notes Payable ............................................... 18,097 Cash........................................................

23,097

(d) Current portion = $19,952 Non-current portion = $62,901 – $19,952 = $42,949

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-37 (a)

This is a fixed principal loan as principal is being reduced by $18,750 each year.

(b) The interest rate is 4% ($6,000 ÷ $150,000). (c)

The number of semi-annual payments for the instalment note will be ($150,000 ÷ $18,750 = 8) and so the maturity date of the note will be January 1, 2017.

(d) Interest Expense............................................. 6,000 Notes Payable ............................................... 18,750 Cash........................................................

24,750

(e) Current portion = $37,500 Non-current portion = $112,500 – $37,500 = $75,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-38 (a) Cash Payment

Period Jan. 1, 2014 Dec. 31, 2014 $5,612 Dec. 31, 2015 5,612 Dec. 31, 2016 5,612 * adjusted for rounding error

Interest Expense 6%

Reduction of Principal

$ 900 617 *319

$4,712 4,995 5,293

Principal Balance $15,000 10,288 5,293 0

(b) 2014 Jan. 1 Cash .......................................... Notes Payable ......................

(c)

15,000 15,000

Dec. 31 Interest Expense....................... Notes Payable ........................... Cash ......................................

900 4,712

Current liability........................................ Non-current liability ................................

$4,995 5,293

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EXERCISE 15-39 (a)

The amount of the annual principal payments will be $5,000 ($15,000 ÷ 3 years).

(b)

Period Jan. 1, 2014 Dec. 31, 2014 Dec. 31, 2015 Dec. 31, 2016

Cash Payment

Interest Expense 6%

Reduction of Principal

$5,900 5,600 5,300

$ 900 600 300

$5,000 5,000 5,000

Principal Balance $15,000 10,000 5,000 0

15,000 15,000

Dec. 31 Interest Expense....................... Notes Payable ........................... Cash ......................................

900 5,000

(d) Current liability........................................ Non-current liability ................................

$5,000 5,000

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EXERCISE 15-40 (a)

Dumfries has an operating lease. In an operating lease, the property is rented by the lessee and the lessor retains all ownership risks and responsibilities. A one year lease does not meet any of the criteria for a finance lease. InSynch Ltd. has a finance lease. A finance lease transfers substantially all the benefits and risks of ownership from the lessor to the lessee, so the lease effectively results in a purchase of the property. In this case, the present value of the lease payments is very near the fair value of the computers. This criteria having been met, the treatment of the lease is to record the computers as assets.

(b) 1. There is no journal entry to record the lease. However, the first rental payment would be recorded as follows: May 21 Equipment Rental Expense .......... Cash ...........................................

750 750

2. Jan. 1 Leased Asset—Equipment............ 118,000 Lease Liability ........................... 118,000

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EXERCISE 15-41 (a)

[dollar figures in millions] 2011 Debt to total assets =

Interest coverage = 2010 Debt to total assets =

Interest coverage =

$3,032.5 $7,300.3

41.5%

($613.9 + $64.0 + $232.9) = $64.0 $2,941.6 $7,044.2

14.23 times

41.8%

($591.9 + $60.6 + $244.8) = $60.6

14.81 times

The debt to total asset ratio has decreased slightly indicating a modest solvency improvement and the interest coverage has decreased indicating that Shoppers’ solvency deteriorated. Overall Shoppers’ solvency is very similar in 2011 to 2010. (b) The use of the operating leases improves the company’s solvency. If the operating leases were treated as finance leases, the debt to total assets ratio would be much worse as would the company solvency. Since operating leases are accounted for as rent expense, Shoppers Drug Mart can avoid reporting the lease obligations on its balance sheet. As well, because the company has less debt, its interest expense is lower, which causes its interest coverage ratio to be higher than it would have been had the leases been accounted for as finance leases.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-42 (a) Issue Debt $17,000,000 13,000,000 4,000,000

Assets Liabilities Shareholders’ Equity Profit ($2,000,000 + $315,000) ($2,000,000 + $525,000)

Issue Equity $17,000,000 8,000,000 9,000,000

$2,315,000 $2,525,000

Average Shareholder’s Equity ($4,000,000 + ($4,000,000 + $2,315,000))/2

$5,157,500 $10,262,500

(($4,000,000 + $5,000,000) + ($4,000,0000 + $5,000,000 + $2,525,000))/2

Debt to Assets ($13,000,000 ÷ $17,000,000) ($8,000,000 ÷ $17,000,000)

76.5%

Return on Equity ($2,315,000 ÷ $5,157,500) ($2,525,000 ÷ $10,262,500)

44.9%

47.1%

24.6%

(b) Utopia should issue debt. The existing shareholders maintain control, and they achieve a higher return on equity. There is more risk, however. Interest must be paid regularly, and the principal must eventually be repaid or refinanced. 76.5% debt is quite high. Perhaps a combination of debt and equity issue would be a better alternative.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 15-17 (a) RAY CORPORATION Balance Sheet (Partial) July 31, 2014 Non-current liabilities Bonds payable, due 2018....................................... $205,000 Note payable, net of current portion*................... 120,000 Lease liability, net of current portion** ................. 48,750 Total non-current liabilities .......................... $373,750 * ($140,000 – $20,000) = $120,000 ** ($65,000 – $16,250) = $48,750 (b) Accounts Payable and Interest Payable should be classified as a current liability. Unearned Revenue should likely be classified as a current liability depending on when the revenue will be earned. Similarly, the portion of the lease liability due within one year and the note payable due within one year should be classified as current liabilities. Accounts Receivable, and Note Receivable should be classified as current assets.

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SOLUTIONS TO PROBLEMS PROBLEM 15-1A (a) The contractual rate of interest on the bonds is 4% [($50,000 × 2) ÷ $2,500,000] (b) Jan. 1 Interest Payable ......................... Cash ......................................

50,000

625,000 12,500

50,000

637,500

(d) July 1 Interest Expense ........................ 37,500 Cash ....................................... [($2,500,000 – $625,000) × 4% × 6/12]

37,500

(e) Dec. 31 Interest Expense ........................ 37,500 Interest Payable..................... [($2,500,000 – $625,000) × 4% × 6/12]

37,500

(f)

Jan. 1 Bonds Payable ........................... 1,875,000 1,875,000 Cash ....................................... ($2,500,000 – $625,000)

Taking It Further: The bonds were initially issued at par. The market rate of interest at the time of the redemption was lower than when the bonds were issued because the bonds were trading at a premium ($625,000 × 102%) at the time of redemption.

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PROBLEM 15-2A 2013 (a) May 1 Cash ($900,000 × 103%) ............ Bonds Payable ...................... 2014 (b) Apr. 30 Interest Expense ........................ Bonds Payable ........................... Interest Payable..................... ($900,000 × 7%) (c) MEM Corp. Balance Sheet (Partial) April 30, 2014

927,000 927,000 58,237 4,763 63,000

Current liabilities Interest payable .......................................

$63,000

Non-current debt Bonds payable......................................... *($927,000 – $4,763) = $922,237

*922,237

(d) May 1 Interest Payable ......................... Cash .......................................

63,000

(e)

922,237

May 1 Bonds Payable ........................... Loss on Bond Redemption ($922,237 – $891,000) ............ Cash ($900,000 × 104%) ........

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63,000

13,763 936,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-2A (Continued)

Taking It Further: The market rate of interest on May 1, 2013 was 6.28%. Using a financial calculator: PV $ 927,000 I ? Yields 6.2823% N 5 PMT $(63,000) FV $(900,000) Type 0

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-3A (a) 2013 1. July

1 Cash ....................................... Bonds Payable ..................

Dec. 31 Interest Expense ($4,327,029 × 4% × 6/12)............. Bonds Payable............................ Interest Payable ($4,000,000 × 5% × 6/12) .......

2014 Jan.

July

4,327,029 4,327,029

86,541 13,459 100,000

1 Interest Payable .............................. 100,000 Cash....................................... 100,000 1 Interest Expense [($4,327,029 – $13,459) × 4% × 6/12] . 86,271 Bonds Payable.................................. 13,729 Cash............................................. 100,000

(b) 1.

Interest expense for 2013 is $86,541.

Interest expense for bonds issued at a premium as in this problem, is less than interest expense for bonds issued at a discount. When bonds are issued at a discount, the interest expense is more than the interest payment by the amount of the amortization. When bonds are issued at a premium, the interest expense is less than the interest payment by the amount of the amortization.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-3A (Continued) (b) (Continued) 3.

The total cost of borrowing will be the total interest payments less the premium. Total interest payments = $4,000,000 × 2.5% × 20 = Premium Total cost of borrowing

$2,000,000 327,029 $1,672,971

Interest expense for bonds issued at a premium is less than interest expense for bonds issued at a discount whether calculated annually (as explained in part (b) (2)), or in total. When bonds are issued at a discount, the interest expense is more than the interest payment by the amount of the discount. When bonds are issued at a premium, the interest expense is less than the interest payment by the amount of the premium.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-3A (Continued) 5.

$4,000,000 × 0.55368 = $ 2,214,720 $4,000,000 × 2.5% × 14.87747 = 1,487,747 (3%, 20 periods) $3,702,467 Using a financial calculator: PV $ ? Yields $3,702,451 I 3% N 20 PMT $ (100,000) FV $ (4,000,000) Type 0

The total cost of borrowing will be the total interest payments plus the discount. Total interest payments = $4,000,000 × 2.5% × 20 = Discount ($4,000,000 – $3,702,467) Total cost of borrowing

$2,000,000 297,533 $2,297,533

Taking It Further: Had the market rate of interest gone to 4.5% in December 2013, there would be no change in how the debt would be accounted for on the records of Webhancer Corp. The company would likely be happy that it managed to sell the bond before the market rate of interest increased.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-4A

(a) The bonds were issued at a discount. Note that the amortized cost is increasing and will continue to increase until the maturity date in ten years time, when the carrying amount will equal the face value of the bond of $1,400,000. (b) [1] [2] [3] [4] [5] (c)

$42,000. $42,000 + $3,518 = $45,518 or $1,300,514 × 3.5% (market rate (e) below = $45,518) $45,769 – $42,000 = $3,769 $45,900 – $42,000 = $3,900 $1,311,442 + $3,900 = $1,315,342

The face value of the bond is $1,400,000.

(d) Contractual interest rate = 6% $42,000 ÷ $1,400,000 = 3% semi-annually, × 2 = 6 % annually (e)

(f)

Market interest rate = 7% [2] $45,518 ÷ $1,300,514 = 3.5% semi-annually, × 2 = 7% annually 2013 Jan 1 Cash............................................ 1,300,514 Bonds Payable ...................... 1,300,514

2014 (g) July 1 Interest Expense ........................ Bonds Payable ...................... Cash ....................................... 2014 (h) Dec. 31 Interest Expense ........................ Bonds Payable ...................... Interest Payable.....................

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45,769 3,769 42,000 45,900 3,900 42,000

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PROBLEM 15-4A (Continued) (i) GLOBAL SATELLITES Balance Sheet (Partial) December 31, 2014 Current liabilities Interest payable .......................................................

$42,000

Non-current liabilities Bonds payable, due 2023 ...........................................$1,315,342 (j) (k)

2015 Jan. 1 Interest Payable ......................... Cash .......................................

42,000 42,000

Calculate the present value of the future payments of interest and maturity amount of $1,400,000 at the market rate of 5%, when there are 16 interest payments (initial 20 less 4 already paid) remaining as follows: ($1,400,000 × 0.67362) + ($42,000 × 13.05500) = $1,491,378 (2.5%, 16 periods) Using a financial calculator: PV $ ? Yields $1,491,385 I 2.5% N 16 PMT $ (42,000) FV $ (1,400,000) Type 0

(l)

2015 Jan. 1

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Bonds Payable .............................1,315,342 Loss on Bond Redemption ($1,491,378 – $1,315,342) ........ 176,036 Cash ......................................... 1,491,378 15-51

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PROBLEM 15-4A (Continued) Taking It Further: The legal documents, which state the contractual interest rate, are often prepared well in advance of the actual bond issue and the market rate of interest fluctuates on a daily basis. It is nearly impossible to predict, months in advance, what the market interest rate will be on the date of issue. In this case the market rate of interest increased after the contractual rate was set.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-5A

(a) ($8,000,000 × 0.67297) + ($8,000,000 × 2.5% × 16.35143) = $8,654,046 (2%, 20 periods) Using a financial calculator: PV $ ? Yields $8,654,057 I 2% N 20 PMT $ (200,000) FV $ (8,000,000) Type 0 (b) ALBERTA HYDRO LTD. Bond Premium Amortization Table Effective Interest Method—Semi-annual Interest Payments 5% Bonds Issued at market rate of 4% (c) Date

Jan. 1, 2013 July 1, 2013 Jan. 1, 2014 July 1, 2014 Jan. 1, 2015

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(A) (B) (C) Interest Interest Premium Payment Expense $8,000,000 × (D) × 4% × Amortization (A) – (B) 5% × 6/12 6/12 $200,000 200,000 200,000 200,000

$173,081 172,543 171,993 171,433

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$26,919 27,457 28,007 28,567

(D) Bond Amortized Cost (D) – (C) $8,654,046 8,627,127 8,599,670 8,571,663 8,543,096

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PROBLEM 15-5A (Continued) 2013 (c) Jan. 1 Cash............................................ 8,654,046 Bonds Payable ................... 8,654,046 July 1 Interest Expense .................... Bonds Payable ....................... Cash ....................................

173,081 26,919

Dec. 31 Interest Expense .................... Bonds Payable ....................... Interest Payable..................

172,543 27,457

200,000

(d) ALBERTA HYDRO LTD. Balance Sheet (Partial) December 31, 2013 Current liabilities Interest Payable ................................... Non-current liabilities Bonds payable, due 2023 ....................

2014 (e) Jan. 1 Interest Payable ............................ 200,000 Cash .......................................

(f)

2015 Jan. 1

2023 (g) Jan. 1

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$200,000 8,599,670

200,000

Bonds Payable .............................8,599,670 Gain on Bond Redemption ($8,599,670 – $8,160,000) ........ 439,670 Cash ($8,000,000 × 102%) ....... 8,160,000 Bonds Payable .............................8,000,000 Cash ......................................... 8,000,000

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PROBLEM 15-5A (Continued)

(h) The total amount of interest payment: Contractual rate (5% × $8,000,000 × 10 years)

$4,000,000

Total interest expense: Interest paid............................................. Less: premium ($8,654,046 – $8,000,000) Total interest expense ............................

$4,000,000 654,046 $3,345,954

Taking It Further: Because the bonds were issued at a premium, the additional proceeds from the issuance of the bond served to effectively reduce the amount of interest expense incurred by Alberta Hydro Ltd. over the term of the bond. The total amount of the interest payments is fixed to the contractual rate. On the other hand, the total interest expense is only the same as the contractual amount of interest paid if the bonds are issued at par.

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PROBLEM 15-6A (a) 2013 April 1 Cash .......................................... 1,000,000 Note Payable ...................... 1,000,000 (b) Annual fixed principal $1,000,000 ÷ 4 = $250,000 (c) (A) Cash Payment (B) + (C)

Period Apr. 1, 2013 Mar. 31, 2014 $300,000 Mar. 31, 2015 287,500 Mar. 31, 2016 275,000 Mar. 31, 2017 262,500 Total $1,125,500

(B) Interest Expense (D) × 5% $50,000 37,500 25,000 12,500 $125,000

(C)

Balance (D) – (C) $1,000,000 $ 250,000 750,000 250,000 500,000 250,000 250,000 250,000 0 $1,000,000

(d) 2013 Dec. 31 Interest Expense..................... Interest Payable ................. ($1,000,000 × 5% × 9/12) 2014 Mar. 31 Note Payable ........................... Interest Expense..................... Interest Payable ...................... Cash .................................... (e)

(D)

Principal Reduction

37,500 37,500

250,000 12,500 37,500 300,000

Current liabilities Interest payable .......................................................... $37,500 Current portion of instalment note payable.............. 250,000 Non-current liabilities Instalment note payable, net of current portion ....... 750,000

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PROBLEM 15-6A (Continued) (f)

2014 Dec. 31 Interest Expense..................... Interest Payable ................. ($750,000 × 5% × 9/12) 2015 Mar. 31 Note Payable ........................... Interest Expense..................... Interest Payable ...................... Cash ....................................

28,125 28,125 250,000 9,375 28,125 287,500

Taking It Further: (A)

(B) Interest Portion (D) × 5%

Date Payment Apr. 1, 2013 Mar. 31, 2014 $ 282,012 $50,000 Mar. 31, 2015 282,012 38,399 Mar. 31, 2016 282,012 26,219 Mar. 31, 2017 282,012 * 13,430 $1,128,048 *$128,048

(D) Note Payable Balance (D) – (C) $1,000,000 $ 232,012 767,988 243,613 524,375 255,793 268,582 * 268,582 0 $1,000,000

* rounded Where the note is repaid in fixed principal payments, the reduction of the principal is the same ($250,000) each period. Where the note is repaid in blended principal and interest payments, the reduction of the principal increases each period. Because the principal balance changes each period, the amount of interest expense changes each period. In both situations, the interest expense declines each period. In total, the payment is higher with blended payments, as the total interest cost is higher ($128,048 versus $125,000).

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PROBLEM 15-7A (a) 2013 Sept. 30 Equipment ................................. Mortgage Note Payable ....... Cash ......................................

900,000 750,000 150,000

(b) (A) Monthly Interest Period

Cash Payment

Oct. 31 Nov. 30

$13,677 13,677

(B) (C) (D) Interest Reduction Principal Expense (D) × 3.6% × of Principal Balance 1/12 (A) – (B) (D) – (C) $750,000 $2,250 $11,427 738,573 2,216 11,461 727,112

2013 Oct. 31 Interest Expense........................ Mortgage Note Payable ............. Cash ....................................... Nov. 30 Interest Expense........................ Mortgage Note Payable ............. Cash .......................................

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2,250 11,427 13,677 2,216 11,461 13,677

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PROBLEM 15-7A (Continued) (c) (A) Monthly Interest Period

Cash Payment (B) + (C)

Oct. 31 Nov. 30

$14,750 14,713

(B) (C) (D) Interest Expense Principal (D) × 3.6% × Reduction Balance 1/12 of Principal (D) – (C) $750,000 $2,250 $12,500 737,500 2,213 12,500 725,000

Oct. 31 Interest Expense........................ Mortgage Note Payable ............. Cash .......................................

2,250 12,500

Nov. 30 Interest Expense........................ Mortgage Note Payable ............. Cash .......................................

2,213 12,500

14,750

14,713

Taking It Further: With the fixed payment of principal each payment, a larger amount of principal is paid in the earlier portion of the loan, and so the principal balance reduces more quickly. As a result, the interest paid will be less if the instalments are fixed principal payments of $12,500.

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PROBLEM 15-8A (a) (A) Semi-annual Interest Period Dec. 31, 2013 June 30, 2014 Dec. 31, 2014 June 30, 2015 Dec. 31, 2015

(b)

Cash Payment

(B) (C) Interest Reduction Expense of Principal (D) × 3.5% (A) – (B)

$49,253 49,253 49,253 49,253

$24,500 23,634 22,737 21,809

$24,753 25,619 26,516 27,444

(D) Principal Balance (D) – (C) $700,000 675,247 649,628 623,112 595,668

2013 Dec. 31 Cash ............................................. 700,000 Mortgage Note Payable .......

700,000

(c) KINYAE ELECTRONICS Balance Sheet (Partial) December 31, 2013 Current liabilities Current portion of mortgage note payable* ............... $ 50,372 Non-current liabilities Mortgage note payable, net of current portion** .......... 649,628 * $24,753 + $25,619 = $50,372 ** $700,000 – $24,753 – $25,619 = $649,628 or see Dec. 31, 2014 balance.

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PROBLEM 15-8A (Continued) (d) 2014 June 30 Interest Expense ............................ 24,500 Mortgage Note Payable ................ 24,753 Cash .....................................

49,253

Dec. 31 Interest Expense ............................ 23,634 Mortgage Note Payable ................ 25,619 Cash .....................................

49,253

(e) If Kinyae Electronics made instalments of fixed principal payments on a semi-annual basis, the fixed principal payment would be: $700,000 ÷ the total number of payments 20 = $35,000. (f) 2014 June 30 Interest Expense ............................ 24,500 Mortgage Note Payable ................ 35,000 Cash ..................................... Dec. 31 Interest Expense* .......................... 23,275 Mortgage Note Payable ................ 35,000 Cash ..................................... * ($700,000 – $35,000) × 3.5% = $23,275

59,500

58,275

Taking It Further: The advantage in making fixed principal payments is that over the term of the loan, the total amount of interest paid is reduced. The disadvantage of the fixed principal payment is that the amount of the payment at the beginning of the term of the loan is larger than with the blended payments, reducing available cash when the business likely needs it most. A benefit of blended payments is that the amount of the payment is constant which helps with cash budgeting.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 15-9A (a)

In order for Manitoba Enterprises, a public company, to record a lease as a finance lease, one of the following criteria needs to be met. (1) there will be a transfer of ownership, (2) there is a bargain purchase option, (3) the lease term is for the major part of the economic life, (4) the present value of the lease payments amounts to substantially all of the fair value of the leased property, or (5) the asset is a specialized asset. Criteria 1, 2 and 5 are not present on any of the three leases. Criteria 3 and 4 are present in the case of the vehicle lease and so it should be treated as a finance lease. Both the manufacturing and office equipment leases should be reported as operating leases, because none of the criteria are met to require treatment as a finance lease. It should be noted that only one condition need be met to require capitalization.

(b) Equipment Rental Expense .......................... 14,000 Cash .....................................................

14,000

Equipment Rental Expense ............................ 3,900 Cash .....................................................

3,900

The vehicle lease is a finance lease. The entry to record the finance lease on January 1, 2014 is as follows: Leased Asset—Vehicles............................... 74,800 Lease Liability ..................................... Solutions Manual .

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PROBLEM 15-9A (Continued) Lease Liability ............................................... 14,981 Cash ....................................................................... 14,981 (c)

Since the manufacturing and office equipment leases do not qualify as finance leases, nothing would appear on Manitoba’s balance sheet regarding either one. The annual rental fees would be charged to expense when they are paid each year and reported on the income statement as: Equipment Rental Expense $17,900 ($14,000 + $3,900). The vehicle lease is a finance lease. Therefore, the vehicles would be recorded as assets on Manitoba’s balance sheet, along with other assets in property, plant, and equipment. The amount recorded would be the present value of the lease rental payments of $74,800, reduced by any accumulated depreciation recorded in 2014. The amount of the depreciation would be reported on the income statement. A corresponding liability for leased assets would also be recorded in the amount $74,800. This amount would be reduced by December 31, 2014 by the principal portion of the annual lease payment. Interest expense included in the annual lease payment would also appear on the income statement.

Taking It Further: The adjusting journal entry on December 31, 2014 for the accrual of interest on the lease liability would be as follows: Interest Expense on Finance Leases ............ 4,786 Interest Payable................................... (($74,800 – $14,981) × 8% = $4,786)

4,786

Since the rental cost of the manufacturing and office equipment have been paid and expensed during the year, no accruals need be recorded for the two remaining leases.

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PROBLEM 15-64A (a)

($ in millions) Debt to total assets = Total debt ÷ Total assets 2011 2010

$11,421 ÷ $17,428 = 65.5% $11,238 ÷ $16,841 = 66.7%

Interest coverage = EBIT ÷ Interest expense 2011 2010

($769 + $327 + $288) ÷ $327 = 4.2 times ($675 + $353 + $319) ÷ $353 = 3.8 times

(b) Although Loblaw has a significant amount of debt, the company is generating sufficient profit to continue to operate without any concerns as to solvency. The debt to total asset ratio improved in 2011 and the times interest earned ratio improved dramatically, mainly due to improved profitability. Loblaw’s solvency improved. Taking It Further: The use of the operating leases improves the company’s solvency ratios. Since operating leases are accounted for as rent expense, Loblaw Companies Limited can avoid reporting the lease obligations on its balance sheet. In terms of assessing solvency, the use of operating leases causes the debt to total assets ratio to be lower because of the off-balance sheet financing (keeping liabilities off the balance sheet). As well, because the company has less debt, its interest expense is lower than it would be if the leases were considered to be finance leases. This causes its interest coverage ratio to be higher than it would have been if the leases had been accounted for as finance leases. However, it would still appear that Loblaw does not have concerns about solvency.

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PROBLEM 15-11A (a) SYKES LTD. Balance Sheet (Partial) October 31, 2014 Liabilities and shareholders’ equity Current liabilities Accounts payable ............................................... Interest payable .................................................. Income taxes payable......................................... Unearned revenue .............................................. Current portion of lease liability ........................ Current portion of note payable ........................ Total current liabilities ............................................

$57,000 15,000 5,900 10,000 26,430 9,675 1 124,005

Non-current liabilities Bonds payable, due 2020 ................................... Note payable, net of current portion ................. Lease liability, net of current portion ................ Total non-current liabilities .................................... Total liabilities .........................................................

500,000 220,536 2 13,813 3 734,349 858,354

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

350,000 835,7934 1,185,793 $2,044,147

$20,800 – $11,125 = $9,675 $230,211 – $9,675 = $220,536 3 $40,243 – $26,430 = $13,813 4 $824,793 + $36,000 – $25,000 = $835,793 2

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PROBLEM 15-11A (Continued) (b) Debt to total assets = Total debt ÷ Total assets Total debt = $57,000 + $500,000 + $15,000 + $5,900 + $230,211 + $40,243 + $10,000 = $858,354. $858,354 ÷ $2,044,147 = 42% Interest coverage = EBIT ÷ Interest expense ($36,000 + $53,330 + $11,800) ÷ $53,330 = 1.9 times (c)

Sykes’s debt to total assets shows reasonable solvency, but Sykes’s interest coverage is alarmingly low. The number of times interest can be paid is likely low due to low profitability.

Taking It Further: It would be useful to know the amount and details of Sykes’s assets. If the majority of the assets owned are non-current, one could conclude that although the debt to total assets ratio appears strong, Sykes’s ability to pay debt when due may be poor. It would be useful to determine any off balance sheet financing obtained through operating leases. As well, details of the income statement would be useful in determining the cause of the low interest coverage ratio. Finally, comparative financial information would be useful to assess any trends in Sykes’s liquidity position and ability to pay interest.

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PROBLEM 1567B (a) The contractual rate of interest on the bonds is 3% [($18,000 × 2) ÷ $1,200,000]. (b) Jan. 1 Interest Payable .................................18,000 Cash ...........................................

18,000

(c) Jan. 1 Bonds Payable ................................. 400,000 Gain on Bond Redemption ........ 8,000 Cash ($400,000 × 98%) ............... 392,000 (d) July 1 Interest Expense ................................ 12,000 Cash ............................................ [($1,200,000 – $400,000) × 3% × 6/12]

12,000

(e) Dec. 31 Interest Expense ................................ 12,000 Interest Payable.......................... [($1,200,000 – $400,000) × 3% × 6/12]

12,000

(f)

Jan. 1 Bonds Payable .............................. 800,000 Cash ....................................... ($1,200,000 – $400,000)

800,000

Taking It Further: The bonds were initially issued at par. The market rate of interest at the time of the redemption was greater than the rate the bonds were issued at because the bonds were trading at a discount ($400,000 × 98%) when they were redeemed.

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PROBLEM 15-2B (a)

2013 Oct. 1 Cash ($800,000 × 98%) ................ 784,000 Bonds Payable .....................

(b) 2014 Sep. 30 Interest Expense....................... Bonds Payable ..................... Interest Payable ($800,000 × 5%) ....................

784,000

41,257 1,257 40,000

(c) PFQ Corp. Balance Sheet (Partial) September 30, 2014 Current liabilities Interest payable .......................................

$40,000

Non-current debt Bond payable........................................... *($784,000 + $1,257) = $785,257 (d) 2014 Oct. 1 Interest Payable ........................ Cash ...................................... (e)

2014 Oct. 1 Bonds Payable.......................... Gain on Bond Redemption ($785,257 – $776,000)........... Cash ($800,000 × 97%).........

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*785,257

40,000 40,000

785,257 9,257 776,000

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PROBLEM 15-2B (Continued) Taking It Further: The market rate of interest on Oct 1, 2013 was 5.26%. Using a financial calculator: PV $ 784,000 I ? Yields 5.2623% N 10 PMT $(40,000) FV $(800,000) Type 0

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PROBLEM 15-3B (a)

2013

July 1 Cash .............................................. 3,449,423 Bonds Payable ..................... 3,449,423

Dec. 31 Interest Expense ($3,449,423 × 5% × 6/12) .................... 86,236 Bonds Payable ...................................... 9,764 Interest Payable ($3,200,000 × 6% × 6/12) ............... 96,000

2014 Jan 1 Interest Payable .................................. 96,000 Cash ............................................... 96,000

Jul.

1 Interest Expense [($3,449,423 – $9,764) × 5% × 6/12] ... 85,991 Bonds Payable .................................... 10,009 Cash ............................................... 96,000

(b) 1.

Interest expense for 2013 is $86,236.

Interest expense for bonds issued at a discount is greater than interest expense for bonds issued at a premium. When bonds are issued at a premium, as they are in this problem, the interest expense is less than the interest payment by the amount of the amortization. When bonds are issued at a discount, the interest expense is more than the interest payment by the amount of the amortization.

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PROBLEM 15-3B (Continued) (b) (Continued) 3.

The total cost of borrowing will payments less the premium. Total interest payments ($3,200,000 × 3% × 20) Premium ($3,449,423 – $3,200,000) Total cost of borrowing

be the total interest

$1,920,000 249,423 $1,670,577

Interest expense for bonds issued at a discount is greater than interest expense for bonds issued at a premium, whether calculated annually (as explained in part (b) (2)), or in total. When bonds are issued at a premium, as they are in this problem, the interest expense is less than the interest payment by the amount of the premium as shown above in part (b) (3). When bonds are issued at a discount, the interest expense is more than the interest payment by the amount of the discount.

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PROBLEM 15-3B (Continued) 5.

$3,200,000 × 0.50257 = $3,200,000 × 3% × 14.2124 = (3.5%, 20 periods)

$1,608,224 1,364,390 $2,972,614

Using a financial calculator: PV $ ? Yields $2,972,602 I 3.5% N 20 PMT $ (96,000) FV $ (3,200,000) Type 0 The total cost of borrowing will be the total interest payments plus the discount. Total interest payments = $3,200,000 × 3% × 20 = Discount ($3,200,000 – $2,972,614) Total cost of borrowing

$1,920,000 227,386 $2,147,386

Taking It Further: Had the market rate of interest gone to 5.5% in December 2013, there would be no change in how the debt was accounted for on the records of Waubonsee Ltd. The company would likely be happy that it managed to sell the bond before the market interest rate went up.

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PROBLEM 15-4B (a) The bonds were issued at a premium. Note that the amortized cost is decreasing and will continue to decrease until the maturity date in ten years time at which time the carrying amount will equal the face value of the bond of $2,500,000. (b) [1] [2] [3] [4] [5] (c)

$2,695,981 + $8,412 = $2,704,393. $62,500 – $8,412 = $54,088 or $2,704,393 × 2% (market rate (e) below = $54,088) $62,500 $62,500 – $53,573 = $8,927 $2,678,649 – $8,927 = $2,669,722

The face value of the bond is $2,500,000.

(d) Contractual interest rate = 5% $62,500 ÷ $2,500,000 = 2.5% semi-annually, × 2 = 5% annually (e)

(f)

Market interest rate = 4% [2] $54,088 ÷ $2,704,393 = 2% semi-annually, × 2 = 4% annually 2013 Jan 1 Cash............................................ 2,704,393 Bonds Payable ...................... 2,704,393

2014 (g) July 1 Interest Expense ........................ Bonds Payable ........................... Cash ....................................... 2014 (h) Dec. 31 Interest Expense ........................ Bonds Payable ........................... Interest Payable..................... Solutions Manual .

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PROBLEM 15-4B (Continued) (i) PONASIS CORPORATION Balance Sheet (Partial) December 31, 2014 Current liabilities Interest payable .......................................................

$62,500

Non-current liabilities Bonds payable, due 2023 ...........................................$2,669,722

(j) (k)

(l)

2015 Jan. 1 Interest Payable ......................... Cash .......................................

62,500 62,500

Since the contractual interest rate of 5% is equal to the market rate of interest of 5% at the date of the redemption, the amount paid to redeem the bonds is the face value of $2,500,000.

2015 Jan. 1

Bonds Payable .............................2,669,722 Gain on Bond Redemption ($2,699,722 – $2,500,000) ........ 169,722 Cash ......................................... 2,500,000

Taking It Further: The legal documents, which state the contractual interest rate, are often prepared well in advance of the actual bond issue and the market rate of interest fluctuates on a daily basis. It is nearly impossible to predict, months in advance, what the market interest rate will be on the date of issue. In this case the market rate of interest decreased after the contractual rate was set. Solutions Manual .

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PROBLEM 15-5B (a) ($5,000,000 × 0.78120) + ($5,000,000 × 2% × 8.75206) = $4,781,206 (2.5%, 10 periods) Using a financial calculator: PV $ ? Yields $4,781,198 I 2.5% N 10 PMT $ (100,000) FV $ (5,000,000) Type 0 (b) VISION INC. Bond Discount Amortization Table Effective Interest Method—Semi-annual Interest Payments 4% Bonds Issued at market rate of 5%

Date

Jan. 1, 2013 July 1, 2013 Jan. 1, 2014 July 1, 2014 Jan. 1, 2015

Solutions Manual .

(A) (B) (C) Interest Interest Discount Payment Expense $5,000,000 × (D) × 5% × Amortization (B) – (A) 4% × 6/12 6/12 $100,000 100,000 100,000 100,000

$119,530 120,018 120,519 121,032

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$19,530 20,018 20,519 21,032

(D) Bond Amortized Cost (D) + (C) $4,781,206 4,800,736 4,820,754 4,841,273 4,862,305

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PROBLEM 15-5B (Continued) 2013 (c) Jan. 1 Cash............................................ 4,781,206 Bonds Payable ................... 4,781,206 July 1 Interest Expense .................... Bonds Payable .................. Cash ....................................

119,530

Dec. 31 Interest Expense .................... Bonds Payable .................. Interest Payable..................

120,018

19,530 100,000

20,018 100,000

(d) VISION INC. Balance Sheet (Partial) December 31, 2013 Current liabilities Interest Payable ................................... Non-current liabilities Bonds payable, due 2018 ....................

2014 (e) Jan. 1 Interest Payable ............................ 100,000 Cash ......................................

$100,000 4,820,754

100,000

2015 (f) Jan. 1 Bonds Payable ........................... 4,862,305 Loss on Bond Redemption ($4,900,000 – $4,862,305) .... 37,695 Cash ($5,000,000 × 98%) ...... 4,900,000 2018 (g) Jan. 1 Bonds Payable ........................... 5,000,000 Cash ...................................... 5,000,000

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PROBLEM 15-5B (Continued)

(h) The total amount of interest payment: Contract rate (4% × $5,000,000 × 5 years)

$1,000,000

Total interest expense: Interest paid ............................................ Add: discount ($5,000,000 – $4,781,206) Total interest expense ............................

$1,000,000 218,794 $1,218,794

Taking It Further: Because the bonds were issued at a discount, the reduction in the proceeds from the issuance of the bond served to effectively increase the amount of interest expense incurred by Vision Inc. over the term of the bond. The total amount of the interest payments is fixed to the contractual rate. On the other hand, the total interest expense is only the same as the contractual amount of interest paid if the bonds are issued at par.

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PROBLEM 15-6B (a)

2014 May

1 Cash ........................................... 120,000 Note Payable .......................

120,000

(b) (A) Cash Payment

Period May 1, 2014 Oct. 31, 2014 $22,520 Apr. 30, 2015 22,520 Oct. 31, 2015 22,520 Apr. 30, 2016 22,520 Oct. 31, 2016 22,520 Apr. 30, 2017 22,520 Total $135,120 *rounded

(c)

2014 Oct. 31

2015 Apr. 30

(d)

(B) (C) (D) Interest Principal Expense Reduction Balance (D) × 7% × 6/12 (A) – (B) (D) – (C) $120,000 $4,200 $18,320 101,680 3,559 18,961 82,719 2,895 19,625 63,094 2,208 20,312 42,782 1,497 21,023 21,759 761* 21,759 0 $15,120 $120,000

Note Payable............................ Interest Expense ..................... Cash.....................................

18,320 4,200

Note Payable............................ Interest Expense ..................... Cash.....................................

18,961 3,559

22,520

Current liabilities Current portion of instalment note payable.............. $39,937 ($19,625 + $20,312 = $39,937) Non-current liabilities Instalment note payable, net of current portion... 42,782

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PROBLEM 15-6B (Continued) (e) Principal portion = $120,000 ÷ (3 × 2) = $20,000 each payment period. Oct. 31:

$20,000 + [$120,000 × 7% × 6/12] = $24,200

Apr. 30: $20,000 + [($120,000 – $20,000) × 7% × 6/12] = $23,500 Taking It Further: Where the note is repaid in fixed principal payments, the reduction of the principal is the same ($20,000) each period. With the fixed payment of principal each payment, a larger amount of principal is paid in the earlier portion of the loan, and so the principal balance reduces more quickly. Where the note is repaid in blended principal plus interest payments, the reduction of the principal balance increases each period and the principal component in the final blended payment will be larger than the fixed principal payment.

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PROBLEM 15-7B (a) 2013 Sep. 30 Equipment .................................... 800,000 Cash ...................................... Mortgage Note Payable .......

(A) Quarterly Interest Period Sep. 30, 2013 Dec. 31, 2013 Mar. 31, 2014

Cash Payment

(B) Interest Expense (D) × 4% × 3/12

$66,637 66,637

$7,500 6,909

(C)

2014 Mar. 31 Interest Expense....................... Mortgage Note Payable ............ Cash ......................................

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(D)

Reduction Principal of Principal Balance (A) – (B) (D) – (C) $750,000 $59,137 690,863 59,728 631,135

(b) Dec. 31 Interest Expense....................... Mortgage Note Payable ............ Cash ......................................

Solutions Manual .

50,000 750,000

7,500 59,137 66,637 6,909 59,728 66,637

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PROBLEM 15-7B (Continued) (c) (A)

(B)

Monthly Interest Period

Cash Payment (B) + (C)

Dec. 31 Mar. 31

$70,000 69,375

(C) (D) Interest Principal Expense (D) × 4% × Reduction Balance 3/12 of Principal (D) – (C) $750,000 $7,500 $62,500 687,500 6,875 62,500 625,000

7,500 62,500

2014 Mar. 31 Interest Expense....................... Mortgage Note Payable ............ Cash ......................................

6,875 62,500

70,000

69,375

Taking It Further: Total payments ($66,637 × 4 × 3) Less: Principal repayment Total interest expense of note

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PROBLEM 15-8B (a) (A) Semi-annual Interest Period Dec. 31, 2013 June 30, 2014 Dec. 31, 2014 June 30, 2015 Dec. 31, 2015 (b)

Cash Payment (B) + (C) $39,375 38,531 37,688 36,844

(B) (C) (D) Interest Expense Principal (D) × 7.5% Reduction Balance × 6/12 of Principal (D) – (C) $450,000 $16,875 $22,500 427,500 16,031 22,500 405,000 15,188 22,500 382,500 14,344 22,500 360,000

2013 Dec. 31 Cash ............................................. 450,000 Mortgage Note Payable ..........

450,000

(c) ELITE ELECTRONICS Balance Sheet (Partial) December 31, 2013 Current liabilities Current portion of mortgage note payable ................ $ 45,000 Non-current liabilities Mortgage notes payable, 7.5% ...................................... *405,000 * $450,000 – $45,000 = $405,000 or see Dec. 31, 2014 balance (d) 2014 June 30 Interest Expense.......................... 16,875 Mortgage Note Payable ............... 22,500 Cash .........................................

39,375

Dec. 31 Interest Expense.......................... 16,031 Mortgage Note Payable ............... 22,500 Cash .........................................

38,531

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PROBLEM 15-8B (Continued) Taking It Further: If the semi-annual payments were blended, (calculated to be $32,382.94) the amount of the payment for the first two instalments would be smaller than the amounts using the fixed principal payment in (a) above. The trend reverses to the end of the term of the note and so the last instalment payment is greater with the blended payments.

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PROBLEM 15-9B (a)

In order for Klippert Inc., a public company, to record a lease as a finance lease, one of the following criteria needs to be met: (1) there will be a transfer of ownership, (2) there is a bargain purchase option, (3) the lease term is for the major part of the economic life, (4) the present value of the lease payments amounts to substantially all of the fair value of the leased property, or (5) the asset is a specialized asset. Criteria 1, 2 and 5 are not present on any of the three leases. Criteria 3 and 4 are present in the case of the manufacturing equipment lease and so it should be treated as a finance lease. Both the equipment and vehicle leases should be reported as operating leases, because none of the criteria are met to require treatment as a finance lease. It should be noted that only one condition need be met to require capitalization.

(b) Equipment Rental Expense........................ Cash .....................................................

4,800

Equipment Rental Expense........................ Cash .....................................................

7,000

4,800

7,000

The manufacturing equipment lease is a finance lease. The entry to record the finance lease on January 1, 2014 is as follows: Solutions Manual .

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PROBLEM 15-9B (Continued) Leased Asset—Manufacturing Equipment Lease Liability .....................................

45,000

Lease Liability............................................. Cash .....................................................

8,823

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PROBLEM 15-9B (Continued) (c)

Since the equipment and vehicle leases do not qualify as finance leases, nothing would appear on Klippert Inc. balance sheet for either one. The annual rental fees would be charged to expense when they are paid each year and reported on the income statement as: Equipment Rental Expense $11,800 ($7,000 + $4,800). The manufacturing equipment lease is a finance lease. Therefore, the manufacturing equipment would be recorded as an asset on Klippert’s balance sheet, along with other assets, in property, plant and equipment. The amount recorded would be the present value of the lease rental payments of $45,000, reduced by any accumulated depreciation recorded in 2014. The amount of the depreciation would be reported on the income statement. A corresponding liability for leased assets of $45,000 would be recorded on January 1, 2014. This amount would be reduced by the first lease payment which was made on January 1, 2014. Interest expense accrued for 2014 would also appear on the income statement.

Taking It Further: The adjusting journal entry on December 31, 2014 for the accrual of interest on the lease liability would be as follows: Interest Expense on Finance Leases ............ 2,532 Interest Payable................................... (($45,000 – $8,823) × 7% = $2,532)

2,532

Since the rental cost of the equipment and vehicles have been paid and expensed during the year, no accruals need be recorded for the two remaining leases.

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PROBLEM 15-10B a)

($ in thousands) Debt to total assets = Total debt ÷ Total assets 2011 2010

$2,010,346 ÷ $2,940,459 = 68.4% $1,848,138 ÷ $2,834,910 = 65.2%

Interest coverage = EBIT ÷ Interest expense 2011 2010

($87,331 + $70,747 + $24,469) ÷ $70,747 = 2.6 times ($35,613 + $64,874 + $19,077) ÷ $64,874 = 1.8 times

(b) In 2011, Maple Leaf Foods’ solvency has deteriorated. The company’s debt to total assets ratio has climbed from 65.2% in 2010 to 68.4% in 2011. On the other hand, the times interest earned ratio improved dramatically, mainly due to improved profitability in 2011. Taking It Further: The use of the operating leases improves the company’s solvency ratios. Since operating leases are accounted for as rent expense, Maple Leaf Foods can avoid reporting the lease obligations on its balance sheet. In terms of assessing solvency, the use of operating leases causes the debt to total assets ratio to be lower because of the off-balance sheet financing (keeping liabilities off the balance sheet). As well, because the company has less debt, its interest expense is lower than it would be if the leases were considered to be finance leases. This causes its interest coverage ratio to be higher than it would have been had the leases been accounted for as finance leases. The company’s liquidity problem in 2011, as revealed by the ratios, could be even worse. Solutions Manual .

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PROBLEM 15-11B (a) CAREY CORPORATION Balance Sheet (Partial) December 31, 2014 Liabilities and shareholders’ equity Current liabilities Accounts payable ............................................... Interest payable .................................................. Income taxes payable......................................... Unearned revenue .............................................. Current portion of lease liability ........................ Current portion of note payable ........................ Total current liabilities ............................................

$76,000 30,000 37,176 25,000 22,800 16,920 1 207,896

Non-current liabilities Bonds payable, due 2019 ................................... Note payable, net of current portion ................. Lease liability, net of current portion ................ Total non-current liabilities .................................... Total liabilities .........................................................

1,000,000 141,746 2 77,069 3 1,218,815 1,426,711

425,000 742,3204 1,167,320 $2,594,031

$24,400 – $7,480 = $16,920 $158,666 – $16,920 = $141,746 3 $99,869 – $22,800 = $77,069 4 $608,820 + $173,500 – $40,000 = $742,320 2

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PROBLEM 15-11B (Continued) (b) Debt to total assets = Total debt ÷ Total assets Total debt = $76,000 + $1,000,000 + $30,000 + $37,176 + $158,666 + $99,869 + $25,000 = $1,426,711 $1,426,711 ÷ $2,594,031 = 55% Interest coverage = EBIT ÷ Interest expense ($173,500 + $49,568 + $74,353) ÷ $49,568 = 6 times (c)

Sykes’s debt to total assets and interest coverage show excellent solvency.

Taking It Further: Long-term creditors and investors are more interested in solvency ratios, which measure a company’s ability to repay its non-current liabilities and survive over a long period of time. They are particularly interested in a company’s ability to pay interest when it is due and to repay its debt at maturity.

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CONTINUING COOKIE CHRONICLE (a)

Alternative 1

Interest Period

Sept. 1, 2014 Mar. 1, 2015 Sept. 1, 2015 Mar. 1, 2016 Sept. 1, 2016 Mar. 1, 2016 Sept. 1, 2016 Totals

(A)

(B)

(C)

Cash Payment

Interest Expense

(B) + (C)

(D) × 4% × 6/12

Reduction of Principal

$3,920 3,850 3,780 3,710 3,640 3,570 $22,470

$420 350 280 210 140 70 $1,470

$3,500 3,500 3,500 3,500 3,500 3,500 $21,000

(D) Principal Balance (D) – (C) $21,000 17,500 14,000 10,500 7,000 3,500 0

Alternative 2

Interest Period

Sept. 1, 2014 Mar. 1, 2015 Sept. 1, 2015 Mar. 1, 2016 Sept. 1, 2016 Mar. 1, 2017 Sept. 1, 2017 Totals *$1 Solutions Manual .

(A) Cash Payment

(B) Interest Expense

(D) Principal Balance

(D) × 4% × 6/12

(A) – (B)

(D) – (C) $21,000 17,671 14,275 10,812 7,279 3,676 0

$3,749 $420 3,749 353 3,749 286 3,749 216 3,749 146 3,749 73* $22,494 $1,494 rounding 15-90

$3,329 3,396 3,463 3,533 3,603 3,676 $21,000

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CONTINUING COOKIE CHRONICLE (Continued) (b) Sept. 1 Equipment ................................. Cash ...................................... Note Payable ........................ (c)

25,000 4,000 21,000

Alternative 1 2015 Mar. 1 Note Payable ............................. Interest Expense....................... Cash ...................................... Sept. 1 Note Payable ............................. Interest Expense....................... Cash ......................................

3,500 420 3,940 3,500 350 3,850

Alternative 2 2015 Mar. 1 Note Payable ............................. Interest Expense....................... Cash ...................................... Sept. 1 Note Payable ............................. Interest Expense....................... Cash ......................................

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CONTINUING COOKIE CHRONICLE (Continued) (d) 1

Current Portion Non-current Portion 1

(e)

Alternative 1 $7,000 10,500 $17,500

Alternative 2 $6,859 10,812 $17,671

$3,500 + $3,500 = $7,000 $3,396 + $3,463 = $6,859

Alternative 1 2015 July 31 Interest Expense....................... Interest Payable ................... ($17,500 × 4% × 5/12) = $292 Alternative 2 July 31 Interest Expense....................... Interest Payable ................... ($17,671 × 4% × 5/12) = $295

292 292

295 295

(f) The alternatives are almost identical when it comes to cost. In Alternative 1 the total cash paid is $22,470 and in Alternative 2 total cash paid is $22,494, a difference of only $24. There is a difference when it comes to the cash flow, however. Alternative 1 requires higher payments at the beginning, and lower ones at the end of the loan. Alternative 2 requires a steady payment and may be easier for budgeting purposes given the fixed payment.

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BYP 15-1 FINANCIAL REPORTING PROBLEM * dollar amounts are in thousands (a)

Reitmans’ total debt

Jan. 28, 2012 $8,573

Jan. 29, 2011 $10,047

Total debt decrease by $1,474 or 14.7 %. (b) Yes, Reitmans reported a current portion of non-current debt in the current liability section of its balance sheet. At January 28, 2012, Reitmans had $1,474 of its non-current debt as currently due. (c)

Reitman’s non-current debt consists of a mortgage payable secured by the company’s distribution centre.

(d) The interest rate paid on the mortgage payable is 6.4% and the mortgage will be fully paid by November 2017. (e)

By January 31, 2013, the current liability portion of the mortgage payable will be $1,570.

(f)

In Note 18 to the financial statements, it is disclosed that Reitmans has significant leases for retail stores, offices, automobiles and equipment that are being treated as operating leases for accounting purposes. The use of operating leases is a form of off-balance sheet financing.

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BYP 15-1 (Continued) (g)

2011 Debt to total assets = Total debt ÷ Total assets Debt to total assets

($91,309 + $55,248) $633,861

23.1%

Interest coverage = EBIT ÷ Interest expense =

($88,985 + $845 + $38,817) $845

= 152.2

times

Reitmans’ solvency worsened in 2012. Debt to total assets was virtually unchanged. However, the profit available for the payment of interest decreased in 2012 while interest expense increased. This is apparent from the decrease in the interest coverage ratio from 152.2 times in 2011 to 45 times in 2012. However, the interest coverage ratio remains extremely high.

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BYP 15-2 INTERPRETING FINANCIAL STATEMENTS (a) In spite of the fact that the financial statements of Gap Inc. and Le Château are prepared using different currencies and are rounded, in the case of the GAP Inc. in millions, and Le Château in thousands, the comparisons using ratios will remain unaffected by these differences. This is one of the main advantages of the use of ratios to make comparisons in the performance and condition of different companies. When dollars are divided by dollars, the result is not dollars – it is just a number. (b) Gap Inc.

($ in millions) U.S. Debt to total assets Times interest earned

$4,667 $7,422

= 62.9%

($833 + $74 +$536) $74

Le Château

($ in thousands) Debt to total assets Times interest earned

Solutions Manual .

= 19.5 times

$90,689 $233,794 = 38.8% (($2,386) + $1,974 + ($596)) = – 0.51 times $1,974

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BYP 15-2 (Continued) (c)

Gap Inc. relied more heavily on debt financing; 62.9% of every dollar of assets was financed with debt versus only 38.8% by Le Château. In spite of having a higher debt to total asset ratio, Gap Inc. has a positive times interest earned ratio compared to Le Château that experienced a large loss for the year and had a negative times interest earned ratio.

(d) Operating leases give the appearance that a company’s solvency is better than it really is. Even though they are not shown on the balance sheet or used in the standard ratio calculations, they are a commitment the company must meet. (e)

The $10 million loan obtained by Le Château during the last month of the fiscal year had the effect of increasing the assets (cash) and the total liabilities by the same amount. The cash was likely used to pay off current liabilities immediately. Although the net result was to obtain long term financing, which improved liquidity, the debt to total asset position of Le Château remained unchanged. Due to the timing of the loan, by the end of the 2012 fiscal year, Le Château would not have incurred significant interest costs, and so the times interest earned ratio would not have been significantly affected by the loan’s interest costs.

(f)

Although the banks’ prime lending rate was 3% at the end of 2012, this rate is seldom used by bank in their loans to businesses. The banks generally lend money to their customers at the prime rate of interest in very rare cases where the loans have very short repayment terms and are very low risk secured loans. Due to the extremely poor profit performance of Le Château, it is likely that the interest rate obtained from the company owned by of the directors as least as low as the rate the banks would have charged Le Château.

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BYP 15-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

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BYP 15-4 COMMUNICATION ACTIVITY To: Friend From: Accounting student Re: Liabilities Liabilities represent obligations of the business that have to be settled in the future, based on events that have happened in the past. While many liabilities have to be settled in cash, not all the obligations of a business require that a cheque be written. For example, a company may have a liability referred to as “Unearned Revenue.” Unearned revenue is recognized when the business is paid cash by a customer before any services are provided. In this situation, the company has an obligation (liability) to provide goods or services to the customer rather than cash. Occasionally, a company may have other obligations that are not reported as liabilities on the balance sheet. For example, if the amount that has to be paid is undeterminable or the likelihood of having to pay the obligation is not known, the potential obligation is disclosed in the notes to the financial statements. These types of liabilities are referred to as contingencies. Examples of contingencies include unsettled lawsuits and guarantees. Operating leases represent a second type of liability that often goes unreported on the balance sheet. Commitments to make payments under the terms of an operating lease are only recognized in the financial statements when payments are actually made. However, companies are required to disclose their commitments under such leases in the notes to the financial statements. Accounting standards state that the disclosures related to operating lease commitments include the amount of payments required for the next five years. Solutions Manual .

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BYP 15-4 (Continued) As you can see, in order to get a clear picture of the obligations of a company, it is necessary to look not only on the balance sheet but to also carefully examine the notes to the financial statements.

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BYP 15-5 ETHICS CASE (a)

The stakeholders in the Lehman Brothers case are: Senior Management (e.g., CEO) Board of Directors Shareholders Existing creditors (debt holders) Employees, suppliers, and customers General stock market investors

(b) Paying debt off reduces cash and reduces liabilities. A debt to total assets ratio will be improved by this transaction. (c)

Paying debt off and then immediately borrowing again, immediately after the financial statements are published has the sole purpose of manipulating the financial position of the company as of the balance sheet date. Paying the debt off immediately before issuing financial statements gave investors an incorrect representation of the true liquidity and solvency position of Lehman Brothers. In turn, the investors may have made inappropriate investment decisions. The manipulated balance sheet does not faithfully represent the economic events of Lehman Brothers. Management should be ethically obligated to ensure that the company’s financial statements accurately reflect the true financial position of the company so that investors (shareholders) can make informed decisions.

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BYP 15-6 “ALL ABOUT YOU” ACTIVITY

(a)

A fixed interest rate is set for the term of the loan. For example, a loan with a fixed interest rate of 5% means that annual interest of 5% will be paid for the duration of the loan period. A floating interest rate changes over the duration of the loan period, with a base (such as the prime interest rate). For example, a loan with a floating interest rate of prime + 2.5% will increase and decrease along with the prime rate. For example, if the prime rate is 3%, the floating interest rate on your loan will be 5.5% (3% + 2.5%). If the prime rate is 4.5%, the floating interest rate on your loan will be 7% (4.5% + 2.5%). Fixed rates usually carry higher rates of interest to cover for the risk of changing interest rates. If it is expected that interest rates will rise during the payment period, a fixed rate will likely be less costly.

(b)

Answers will vary depending of the date retrieved. Prime rate is not set by the calculator but by the rate declared by the five largest Canadian financial institutions. The fixed rate of interest is calculated by adding 5% to the prime rate. For example, if the prime rate is 3%, fixed rate on the Loan Repayment Calculator will be 8% (3% + 5% = 8%).

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BYP 15-6 (Continued) (c)

Answers will vary by student, depending on the interest rate assumed. The following answers assume a prime interest rate of 3%: 1. 2.

(d)

Answers will vary by student, depending on the interest rate assumed. The following answers assume a prime interest rate of 3%: 3. 4.

(e)

Monthly payment = $261.07 Interest payable = $8,961.69 (rounded) (114 × $261.07 – $20,800 including grace period interest)

Monthly payment = $391.60 Interest payable = $13,442.54 (rounded) (114 × $391.60 – $31,200 including grace period interest)

Answers will vary by student depending on the interest rate assumed. The following answers assume a prime interest rate of 3%: 1. 2.

Monthly payment = $303.51 Interest payable = $21,611.54

(f) Take home pay per month Rent Car loan Expenses Available

$2,800 $750 300 1,100

2,150 $ 650

Based on the above calculation, loan repayments on either the $20,000 or $30,000 amounts could be made comfortably.

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CHAPTER 16 Investments ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Problems Exercises Exercises Set A

1. Identify reasons to invest, and classify investments.

1, 3

1, 2

2. Account for debt investments that are reported at amortized cost.

2, 4, 5, 6, 7

3, 4, 5

3, 4, 6

1, 2, 3, 6

3. Account for trading investments.

4, 5, 6, 7, 8

6, 7, 8, 9, 10

5, 7, 8, 9, 10

1, 3, 4, 5, 6

4. Account for strategic investments.

8, 9, 10, 11, 12, 13, 14

11, 12, 13

11, 12

6, 7, 8

5. Indicate how investments are reported in the financial statements.

15, 16, 17

14, 15, 16

12, 13, 14

1, 2, 3, 4, 5, 6, 7, 9, 10

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Problems Set B

Chapter 16

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number 1A

Description Record debt investments; show statement presentation.

Difficulty Level Moderate

Time Allotted (min.) 30-40

Record debt investments at amortized cost; show statement presentation.

Moderate

20-25

Record debt investment at amortized cost and fair value, prepare bond amortization schedule, and record liability; show statement presentation.

Moderate

50-60

Record equity and debt trading investments; show statement presentation.

Moderate

30-40

Record equity trading investments; show statement presentation.

Moderate

35-45

Identify impact of investments on financial statements.

Simple

20-25

Record strategic equity investment, using fair value and equity methods. Show statement presentation.

Moderate

25-35

Analyze strategic investment and compare fair value, equity method, and cost method.

Complex

35-45

Prepare income statement and statement of comprehensive income.

Simple

20-30

10A

Prepare statement of comprehensive income and balance sheet.

Moderate

40-50

Record debt investments; show statement presentation.

Moderate

30-40

Record debt investments; show statement presentation.

Moderate

20-25

Record debt investment at amortized cost and fair value, prepare bond amortization schedule, and record liability; show statement presentation.

Moderate

40-50

Record debt and equity trading investments; show statement presentation.

Moderate

30-40

Record equity trading investments; show statement presentation.

Moderate

35-45

Identify impact of investments on financial statements.

Simple

20-25

Record strategic equity investment, using fair value and equity methods. Show statement presentation.

Moderate

25-35

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Accounting Principles, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 8B

Description Analyze strategic investment and compare fair value, equity method, and cost method.

Difficulty Level Complex

Time Allotted (min.) 35-45

Prepare income statement and statement of comprehensive income.

Simple

20-30

10B

Prepare statement of comprehensive income and balance sheet.

Moderate

40-50

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Accounting Principles, Sixth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom's Taxonomy, Study Objectives and End-ofChapter Material Study Objective Knowledge Comprehension Application 1. Identify reasons to BE16-1 Q16-1 invest, and classify Q16-3 investments. BE16-2 E16-1 E16-2 2. Account for debt Q16-2 BE16-3 P16-2A investments that BE16-4 P16-3A are reported at Q16-4 BE16-5 P16-6A amortized cost. P16-1B Q16-5 E16-3 Q16-6 E16-4 P16-2B P16-3B E16-6 Q16-7 P16-1A P16-6B 3. Account for trading Q16-8 Q16-4 BE16-6 P16-1A investments. Q16-5 BE16-7 P16-3A Q16-6 BE16-8 P16-4A Q16-7 BE16-9 P16-5A BE16-10 P16-6A E16-5 P16-1B E16-7 P16-3B P16-4B E16-8 P16-5B E16-9 E16-10 P16-6B

Analysis Synthesis Evaluation

4. Account for strategic investments.

Q16-8 Q16-9 Q16-10 Q16-13

Q16-11 Q16-12 Q16-14

BE16-11 P16-6A BE16-12 P16-7A BE16-13 P16-6B E16-11 P16-7B E16-12

P16-8A P16-8B

5. Indicate how investments are reported in the financial statements.

Q16-15 Q16-16

Q16-17

BE16-14 P16-7A BE16-15 P16-9A BE16-16 P16-10A E16-12 P16-1B E16-13 P16-2B E16-14 P16-3B P16-1A P16-4B P16-2A P16-5B P16-3A P16-6B P16-4A P16-7B P16-5A P16-9B P16-6A P16-10B BYP 16-4 BYP 16-2 BYP 16-6 BYP 16-3 Continuing Cookie BYP 16-5 Chronicle

Broadening Your Perspective

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ANSWERS TO QUESTIONS 1.

A corporation would purchase debt or equity securities of another corporation to provide a source of income (dividends and interest) from investing excess cash held by the business in the short term. The corporation might hope to sell the securities at a higher price than they originally paid for them and thereby generate some gains on the sale. Lastly, companies might buy common shares of another company as a strategic investment which will bring business advantages to the corporation.

Non-strategic investments are made to earn investment income. Strategic investments are made to influence or control the operations of another company in some way.

Bell Canada and Rogers Communications purchased 79.53% of MLSE as a strategic, long-term investment. This acquisition helped the investors solidify their control over the broadcast of sporting events to generate advertising revenue.

Reporting investments held to earn interest at amortized cost provides the users of financial statements more relevant information than if they were reported at fair value since these investments are held to earn interest income over long periods of time. It is not management’s intention to resell these investments at a gain and so the debt investments are best reported at amortized cost. In the case of trading investments, the debt or equity securities are purchased and held for resale in the short term. Reporting these investments at fair value is more relevant to the financial statement users as their fair value is closer to their intended realizable value.

The method of accounting for bonds depends on management’s intention when purchasing the bonds. If the bonds are purchased for holding for a short term and for trading, they are reported at fair value. On the other hand, if the bonds are purchased to earn interest revenue, they are reported at amortized cost.

For a public company, bonds purchased for trading are reported at fair value. Bonds held to earn interest revenue are reported at amortized cost.

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QUESTIONS (Continued) 7.

Because the bonds were purchased and are held to earn interest income, the amortization of the discount increases the interest revenue beyond the amount of the interest collected. The amortization of the discount will affect the interest revenue recognized in each accounting period and in total over the term of the bond. If the bonds had instead been purchased for trading, the discount would not be amortized and therefore there would be no impact on interest revenue beyond the amount of the interest collected. This is because the bonds are held for such as short period of time any misstatement of revenue from not amortizing the discount is not considered significant.

Gains and losses on fair value adjustments can be reported as other comprehensive income if the investments are strategic investments purchased by a public company following IFRS.

Private companies following ASPE should use the cost method to report strategic investments when there is no quoted market price for investments if (1) there is not significant influence, or (2) the company chooses to use the cost method for significant influence investments.

10.

(a) Whenever the investor's influence on the operating and financial affairs of its associate (the investee) is not significant, the fair value method should be used. The major factor in determining significant influence is the percentage of ownership interest held by the investor in the associate. The general guideline for use of the fair value method is less than 20% ownership interest. Companies are required to use judgement, however, rather than to blindly follow the 20% guideline. For example, 25% ownership in a company that is 75% controlled by another company would not necessarily indicate significant influence. (b) If the investor does exert significant influence, which is generally the case with 20% or more ownership, the investment should be accounted for using the equity method.

11. The equity method is used when an investor has significant influence over the affairs of an associate, its investee. This occurs when an investment is purchased for strategic purposes and not for passive (to generate a return) purposes. Trading and long-term equity securities without significant influence are passive investments available to be sold in the future. Since the purpose is to generate a return on the investment, using the fair value model provides the best method of measuring the profit or loss from the investment.

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QUESTIONS (Continued) 12.

(a) Under the fair value method, the company’s initial investment is recorded at cost. The investment account is not directly affected by the income of the company in which the investment is made. The investing company records any dividends received as investment revenue, leaving the carrying value of the investment intact. The carrying value of the investment is revalued to fair value at the balance sheet dates. (b) Under the cost model, the company’s initial investment is recorded at cost. That value does not change with the change in fair value, nor from the performance of the investee, nor from payment of dividends as is the case in the equity method. (c) Under the equity method, the investment is also recorded at cost on the day the investment is made. However, the investment account is increased or decreased by the investor’s share of the associate’s profit or loss for the period. The investing company would reduce the carrying value of its investment by any dividends received from the investee, since the value of the latter’s net assets decreases as it pays dividends. The investment account is not revalued to fair value at the balance sheets dates.

13. An investee is referred to as an associate in the case where significant influence is present over the associate by the investor. In order for the investee to be a subsidiary, the investor must control the investee by owning at least 50% plus one share of voting stock. 14. Opal Limited is the parent and Fashion Runway Inc. is the subsidiary. In order for a parent relationship to exist, investor must control the investee by owning at least 50% plus one share of voting stock. When control exists over an investee, the financial statements of the two entities must be consolidated. 15. Trading investments are reported as current assets because management purchased the investments for the purpose of selling them in the near future at a gain. On the other hand, when debt investments are purchased to earn interest, management’s intention is to hold on to the investments and not sell the investments quickly at a gain. Depending on the maturity date of the debt investments, the classification can be current or non-current.

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 16. (a)

Trading investments are classified as a current assets and reported at fair value.

(b)

Short-term debt investments purchased to earn interest are classified as current assets and reported at amortized cost.

(c)

Debt investments purchased to earn interest, with maturities longer than 12 months, are classified as long-term investments and reported at amortized cost.

(d)

Strategic investments reported at fair value are classified as long-term investments.

(e)

Strategic investments accounted for using the equity method are classified as long-term investments.

17. Gains and losses on fair value adjustments of long-term strategic equity investments can be reported as other comprehensive income in the statement of comprehensive income if the investor is a public company following IFRS. If the strategic equity investment is going to be held and not sold, then it may be inappropriate to affect a company’s profit with the gains and losses on fair value adjustments caused by market fluctuations.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16-1 (a) (b) (c) (d)

4. Debt investments reported at amortized cost 1. Strategic investments 3. Trading investments 2. Non-strategic investments

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-2

1. 2.

(a) Reason 120-day treasury bill Nonstrategic Common shares Nonpurchased by a strategic bank for resale in the near future at a gain 15% of the common Strategic shares of a public company purchased to hold with the intent of acquiring control of the company 5-year bonds Nonpurchased by a strategic company reporting under ASPE, to hold and earn interest 10-year bonds Nonpurchased by a strategic public company to sell in the near future at a gain 5-year bonds Nonpurchased by a strategic public company, to hold and earn interest

(b) (c) Classification Valuation Current asset Amortized cost Current asset Fair value

Non-current asset

Fair value*

Non-current asset

Amortized cost

Current asset

Fair value

Current Asset

Amortized cost

* It is assumed that 15% ownership does not constitute significant influence.

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BRIEF EXERCISE 16-3 (a) Dec. 2 Short-Term Investments—Treasury Bill ................................................ 148,900 Cash............................................. (b) Dec. 31 Short-Term Investments—Treasury Bill ............................................ 275 Interest Revenue ......................... (c) Apr. 1 Short-Term Investments—Treasury Bill ............................................ 825 Interest Revenue ......................... Cash ..................................................... 150,000 Short-Term Investments—Treasury Bill ............................................

148,900

275

825

150,000

BRIEF EXERCISE 16-4 (a) Jan. 1 Long-Term Investment—Pullen Bonds 600,000 Cash.................................................. 600,000 (b) July 1 Cash ($600,000 × 4% × 6/12) .................... 12,000 Interest Revenue .............................. 12,000 (c) Dec. 31 Interest Receivable .................................. 12,000 Interest Revenue .............................. 12,000 Since the bonds are held to earn interest income, there is no fair value adjustment at December 31.

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BRIEF EXERCISE 16-5 (a) June 30 Long-Term Investments—Hydrocor Bonds ........................................... 297,000 Cash ($300,000 × .99)..................... 297,000 (b) Dec. 31 Cash ($300,000 × 4% × 6/12) .............. 6,000 Long-Term Investments—Hydrocor Bonds ......................................... 273 Interest Revenue ............................

6,273

Since the bonds are being held to earned interest income, there is no fair value adjustment on December 31.

BRIEF EXERCISE 16-6 (a) June 30 Trading Investment—Hydrocor Bonds ........................................... 297,000 Cash ($300,000 × .99)..................... 297,000 (b) Dec. 31 Cash ($300,000 × 4% × 6/12) .............. Interest Revenue ............................

6,000

(c) Dec. 31 Loss on Fair Value Adjustment of Trading Investments...................... Trading Investments—Hydrocor Bonds (($300,000 × .98) – $297,000)

3,000

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6,000

3,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-7 Assuming the bonds are purchased to earn interest, BE16-5: Jan. 1 Cash ($300,000 × .98) ........................................... 294,000 Loss on Sale of Bonds....................... 3,273 Long-Term Investments—Hydrocor Bonds ($297,000 + $273)........... 297,273 Assuming the bonds are purchased to trade, BE16-6: Jan. 1 Cash ($300,000 × .98) ........................................... 294,000 Trading Investments—Hydrocor Bonds ($297,000 – $3,000) ........ 294,000

BRIEF EXERCISE 16-8 Aug.

1 Trading Investments—Datawave Common Shares........................ 114,000 Cash................................................ 114,000

Oct. 15 Cash (3,000 × $2.75) ........................... Dividend Revenue.......................... Dec.

8,250

1 Cash .................................................... 120,000 Trading Investments—Datawave Common Shares ...................... Gain on Sale of Trading Investments

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8,250

114,000 6,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-9 Nov. 30 Loss on Fair Value Adjustment of Trading investments ($46,000 – $44,000) ....... 2,000 Trading Investments— Deal Inc. Common Shares .......................... 2,000

Dec. 31 Trading Investments— Deal Inc. Common Shares............................... 3,000 Gain on Fair Value Adjustment of Trading Investments ($47,000 – $44,000) .. 3,000

BRIEF EXERCISE 16-10 Jan. 15 Cash............................................................... 49,000 Gain on Sale of Trading Investments ..... 2,000 Trading Investments— 47,000 Deal Inc. Common Shares .......................

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BRIEF EXERCISE 16-11 (a) Jan. 1 Long-Term Investments— Hook Common Shares ........................ 250,000 Cash.................................................

250,000

Dec. 31 Cash (20% × $15,000) ............................... 3,000 Dividend Revenue ..............................

3,000

Dec. 31 Long-Term Investments— Hook Common Shares ........................... 20,000 Other Comprehensive Income—Gain On Fair Value Adjustment .................

20,000

(b) Jan. 1 Investment in Associate— Hook ..................................................... 250,000 Cash.................................................

250,000

Dec. 31 Investment in Associate— Hook ....................................................... 44,000 Revenue from Investment in Associate (20% × $220,000)............

44,000

Dec. 31 Cash (20% × $15,000) .............................. 3,000 Investment in Associate— Hook.................................................

3,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-12 (a) Fair Value Balance Sheet: Long-term investment in Dong Ltd. common shares Investment in Associate, Dong Ltd. Income Statement: Dividend revenue Revenue from investment in associate Other Comprehensive Income: Gain on fair value adjustment

(b) Equity Method

$315,000 $346,000 * $4,000

0 $50,000

$15,000

* Long-term investment in Dong Ltd. Common shares Less dividend (20% × $20,000) Add: associate income (20% × $250,000) Carrying value of investment

$300,000 (4,000) 50,000 $346,000

BRIEF EXERCISE 16-13 Jan. 1

Investment in Associate— Tomecek ............................................... 175,000 Cash.................................................

175,000

Dec. 31 Cash ($12,000 × 25%) .............................. 3,000 Dividend Revenue ...........................

3,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-14 ATWATER CORPORATION Statement of Comprehensive Income Year Ended April 30, 2014

Profit............................................................................ Other comprehensive income Gain on fair value adjustment on strategic investments, net of income tax ............................ Comprehensive income .............................................

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$650,000

46,000 $696,000

Chapter 16

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-15 Financial Statement

Classification

Trading investments

Balance Sheet

Current assets

Dividend revenue

Income Statement

Other revenue

Investment in associate

Balance Sheet

Long-term investments

Long-term investment—bonds

Balance Sheet

Long-term investments

Gain on sale of trading investments

Income Statement

Other revenue

Gain on fair value adjustment for trading investments

Income Statement

Other revenue

Loss on fair value adjustment for strategic investment

Statement of Comprehensive Income

Other comprehensive losses

Interest revenue on bonds purchased for trading

Income Statement

Other revenue

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 16-16 SABRE CORPORATION Balance Sheet (Partial) November 30, 2014 Assets Current assets Treasury bills—at amortized cost ........................... Trading investments—at fair value .........................

$25,125 74,000 99,125

Long-term investments Equity investment—fair value ................................. 105,000 Bond investment—amortized cost ......................... 150,000 Investment in associate ............................................... 250,000 505,000

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SOLUTIONS TO EXERCISES EXERCISE 16-1 1.

Strategic investment  Management’s intention is to influence the operations of Lewis Telecommunications. Non-Strategic investment  The purpose is to generate investment income. Since the investment is in bonds, influence on the operations of Li Internet Ltd. cannot be exercised. 95% of the common Strategic investment shares of Barlow  The percentage of ownership Internet Services Inc. gives Awisse Telecommunications control over the operations of Barlow. 120-day treasury bill Non-Strategic investment  The investment does not consist of common shares and the intention is to generate interest income. 10% of the common Non-Strategic investment  The investment was made with shares of Talk to Us the intention to generate gains Ltd. from trading the investment. 15% of the common shares of Lewis Telecommunications Inc. 100% of 15-year bonds of Li Internet Ltd.

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EXERCISE 16-2

10-year BCE bonds

(a) Nonstrategic

10-year GE bonds

Nonstrategic

Noncurrent

1-year Government of Canada bonds 180-day treasury bill

Nonstrategic

Current Amortized cost

No change

Nonstrategic

Current Amortized cost

No change

Bank of Montreal preferred shares Tim Hortons common shares Pizzutto Holdings common shares Kesha Inc., common shares – 22% interest *

Nonstrategic

Current Fair value

No change

Nonstrategic Strategic

Current Fair value

No change No change

6. 7.

Strategic

(b) Noncurrent

Noncurrent

N/A

Noncurrent

Equity method

(d) No change Amortized cost

Can also choose fair value or cost

Assume exercise significant influence and have quoted market price (if no quoted market price, must use cost method under ASPE).

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-3 (a) Jan.

May

Aug.

2 Short-Term Investments—T-Bills ........ 39,760 Cash..................................................

39,760

1 Cash ...................................................... 40,000 Short-Term Investments—T-Bills ... Interest Revenue ..............................

39,760 240

1 Short-Term Investments— Money Market Fund .............................. 65,000 Cash..................................................

65,000

31 Short-Term Investments— Money Market Fund.............................. Interest Revenue ..............................

163

Sept. 30 Short-Term Investments— Money Market Fund.............................. Interest Revenue ..............................

163

Oct.

163

1 Short-Term Investments—T-Bills ........ 29,821 Cash.................................................. 15 Cash ...................................................... 65,408 Interest Revenue .............................. Short-Term Investments—Money Market Fund ($65,000 + $163 + $163)

29,821

82 65,326

(b) Oct. 31 Interest Receivable ($29,821 × 2.4% × 1/12)......................... Interest Revenue ..............................

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60 60

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-4 (a) (1) Imperial (investor) July 1 Long-Term Investments—Acme Bonds ...................................................... 461,000 Cash................................................ 461,000 (2) Acme (investee) July 1 Cash ........................................................ 461,000 Bonds Payable ............................... 461,000 (b) (1) Imperial (investor) Dec. 31 Interest Receivable ($500,000 × 4% × 6/12)........................ Long-Term Investments—Acme Bonds .................................................. Interest Revenue ........................... ($461,000 × 5% × 6/12) (2) Acme (investee) Dec. 31 Interest Expense................................. Bonds Payable ............................... Interest Payable ............................. (c) (1) Imperial (investor) Jan. 1 Cash .................................................... Interest Receivable ........................ (2) Acme (investee) Jan. 1 Interest Payable.................................. Cash................................................

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10,000 1,525 11,525

11,525 1,525 10,000

10,000 10,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-4 (Continued) (d) The accounting for the bond investment by Imperial Inc. mirrors the accounting for the bond liability by Acme Corp. because Imperial purchased the bond directly from Acme. This means that the discount is the same for both the investee and the investor. The accounting would not be a mirror image if Imperial had purchased the bond investment from a third party because there would likely be a difference between the issue price by the investee and the purchase price of the investor.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-5 (a) 2014: July 1 Trading Investments—Acme Bonds . Cash................................................ (b) Dec. 31 Interest Receivable............................. Interest Revenue ............................ ($500,000 × 4% × 6/12) Dec. 31 Trading Investments—Acme Bonds . Gain on Fair Value Adjustment of Trading Investments...................... ([$500,000 × 0.96] – $461,000)

461,000 461,000

10,000 10,000

19,000 19,000

(c) The investment will be shown in the current asset section. (d) 2015: Jan. 1 Cash .................................................... Interest Receivable ........................ (e) July

10,000 10,000

1 Cash ($500,000 × 0.97) ........................... 485,000 Gain on Sale of Trading Investments 5,000 Trading Investments—Acme Bonds 480,000

(f) The sale of the Acme bonds would have occurred though the bond market to another investor and that is why there would be no entries on the Imperial accounting records, as the bonds remain outstanding.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-6 (a)

The carrying value at April 1, 2013 of $418,444 is higher than the face or maturity value of $400,000, which indicates that the bond was sold at a premium.

(b) $400,000, as given in the description of the bonds. (c)

The bond amortized cost will be $400,000 at the maturity date.

(d) Contractual interest rate = 4% $8,000 ÷ $400,000 = 2% semi-annually × 2 = 4% annually Market interest rate = 3% $6,277 ÷ $418,444 = 1.5% semi-annually × 2 = 3% annually (e)

2013 Apr. 1

2013 Oct. 1

Long-Term Investments—Bight Bonds ........................................... 418,444 Cash .........................................

418,444

Cash ................................................. 8,000 Long-Term Investments—Bight Bonds....................................... Interest Revenue .....................

1,723 6,277

2014 Mar. 31 Interest Receivable .......................... 8,000 Long-Term Investments—Bight Bonds....................................... Interest Revenue ..................... 2014 Apr. 1 Cash ................................................. 8,000 Interest Receivable .................

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16-26

1,749 6,251

8,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-6 (Continued) (f)

Total interest received = $80,000 $400,000 × 4% × 5 years = $80,000 or $8,000 × 10 semi-annual periods = $80,000 Total interest revenue = $61,556 $80,000 (interest payment) – $18,444 (premium) = $61,556

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-7 (a) Jan. 1 Trading Investments—Harris Bonds 121,200 Cash ($120,000 × 1.01) .......................

121,200

July 1 Cash ($120,000 × 6% × 6/12) .................... 3,600 Interest Revenue ................................

3,600

1 Cash ........................................................ 64,000 Gain on Sale of Trading Investments ($64,000 – $60,600)............................. Trading Investments— Harris Bonds ($121,200 × 1/2) ..........

60,600

Dec.31 Interest Receivable ................................... 1,800 Interest Revenue ($60,000 × 6% × 6/12) .........................

1,800

Dec.31 Loss on Fair Value Adjustment of Trading Investments............................... Trading Investments—Harris Bonds ($60,600 – $60,000).............................

3,400

600 600

(b) If the bonds had been purchased to earn interest, the accounting for the investment of the bonds would be at amortized cost. The interest revenue entry on July 1 and the accrued interest receivable entry on December 31 would both include amortization of the premium paid for the bonds.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-8 2014 Sept. 28 Trading Investments—Cygman Shares (3,500 × $40) ........................................ 140,000 Cash................................................. 140,000 Oct.

1 Trading Investments—Rauk Bonds ... 300,000 Cash................................................. 300,000

Nov. 12 Cash (1,900 × $42) ............................... 79,800 Trading Investments—Cygman Shares ($140,000 ÷ 3,500 × 1,900) .................... 76,000 Gain on Sale of Trading Investments……… 3,800 Dec.

1 Cash [(3,500 – 1,900) × $1.50] ............. Dividend Revenue...........................

2,400 2,400

31 Trading Investments—Rauk Bonds (($300,000 × 1.01) – $300,000). 3,000 Loss on Fair Value Adjustment of Trading Investments ........................... 200 Trading Investments—Cygman Shares [(3,500 – 1,900) × ($40 – $38)]………

3,200

31 Interest Receivable.............................. Interest Revenue ($300,000 × 4% × 3/12) ....................

3,000

2015 Mar. 31 Cash (1,600 × $40) ................................... 64,000 Gain on Sale of Trading Investments Trading Investments—Cygman Shares (1,600 × $38) .................................... Apr.

1 Cash ($300,000 × 4% × 6/12) .....................6,000 Interest Receivable ............................ Interest Revenue ................................

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16-29

3,200 60,800

3,000 3,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-8 (Continued)

Oct.

1 Cash ($300,000 × 4% × 6/12) .................. 6,000 Interest Revenue ................................

6,000

Dec. 31 Interest Receivable................................. 3,000 Interest Revenue ($300,000 × 4% × 3/12) .......................

3,000

31 Loss on Fair Value Adjustment of Trading Investments ........................... Trading Investments—Rauk Bonds [$300,000 × (1.01 – 1.00)]

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16-30

3,000 3,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-9 (a) Dec. 31 Loss on Fair Value Adjustment of Trading Investments .................................................. 5,000 Trading Investments—Co. B Preferred Shares .......................................... 1,500 Trading Investments—Co. A Common Shares ....................................... 2,500 Trading Investments—Co. C Bonds ........ 4,000 (b) YANIK, INC. Balance Sheet (Partial) December 31, 2014

Current assets Trading investments, at fair value ......................... $49,000

YANIK, INC. Income Statement (Partial) Year Ended December 31, 2014

Other expenses Loss on fair value adjustment of trading investments ............................................................... $5,000 (c) 2015 Mar. 20 Cash ....................................................... Loss on Sale of Trading Investments .. Trading Investments—Co. B Preferred Shares ............................

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13,500 500 14,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-10 (a)

The cash amount received on the sale of the investment is the carrying value of the investment sold of $4,000 less the loss on sale of the trading investment of $3,000 which is equal to $1,000.

(b) 2014 Dec.31 Cash ......................................................... Loss on Sale of Trading Investments .... Trading Investments ........................... Dec. 31 Trading Investments ........................... Gain on Fair Value Adjustment of Trading Investments.......................

1,000 3,000 4,000 2,500 2,500

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Trading Investments ........................... Cash.................................................

16-32

4,000

5,500 5,500

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-11 1. Jan.

2 Investment in Associate—Diner ............ 216,000 Cash (30,000 × 40% × $18) .............. 216,000

June 15 Cash ($30,000 × 40%) ............................... 12,000 Investment in Associate—Diner ..... 12,000 Dec. 31 Investment in Associate—Diner ............ 152,000 Revenue from Investment in........... Associate ($380,000 × 40%) ............ 152,000 2. Mar. 18 Long-Term Investments— Image Fashion Common Shares ........... 480,000 Cash (400,000 × 10% × $12) ............. 480,000 June 30 Cash ($44,000 × 10%) ............................ Dividend Revenue.............................

4,400 4,400

Dec. 31 Other Comprehensive Income— Loss on Fair Value Adjustment ............. 40,000 Long-Term Investments— Image Fashion Common Shares .... 40,000 (400,000 × 10% × [$12 – $11])

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-12 (a) Jan.

1 Investment in Associate— Walla Walla .......................................... 480,000 Cash .............................................. 480,000

Dec. 31 Cash ($35,000 × 25%) .......................... Investment in Associate— Walla Walla....................................

8,750 8,750

Dec. 31 Investment in Associate— Walla Walla .......................................... 70,000 Revenue from Investment in Associate 70,000 ($280,000 × 25%) ........................... (b)

Balance Sheet Long-Term Investment in Associate ($480,000 – $8,750 + $70,000) ...............

$541,250

Income Statement Other revenue Revenue from investment in associate

$70,000

1 Long-Term Investments— Walla Walla Common Shares ............. 480,000 Cash .............................................. 480,000

Dec. 31 Cash ($35,000 × 25%) .......................... Dividend Revenue ........................

8,750 8,750

Dec. 31 Long-Term Investments—Walla Walla Common shares .................................. $145,000 Gain on Fair Value Adjustment... 145,000 (50,000 shares × $12.50/share) – $480,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-12 (Continued) (c)

(d) Jan.

(Continued) Balance Sheet Long-term investments—fair value ($480,000 + $145,000) ............................

$625,000

Income Statement Other revenue Dividend revenue................................... Gain on fair value adjustment ................

$8,750 145,000

1 Long-Term Investments— Walla Walla Common Shares ............. 480,000 Cash .............................................. 480,000

Dec. 31 Cash ($35,000 × 25%) .......................... Dividend Revenue ........................

8,750 8,750

Balance Sheet Long-term investments—cost ..............

$480,000

Income Statement Other revenue Dividend revenue...................................

$8,750

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-13 NEW BAY INC. Balance Sheet December 31, 2014

Assets Current assets Cash........................................................................... $ 22,000 Trading investments, at fair value ........................... 48,500 Accounts receivable ...................................... $60,000 Less: Allowance for doubtful accounts ..... 10,000 50,000 Interest receivable .................................................... 1,500 Total current assets ............................................. 122,000 Long-term investments Equity investments—fair value ................................ 25,000 Note receivable, 5%, due April 21, 2018 .................. 60,000 Bond investment—amortized cost .......................... 180,000 Investment in associates ......................................... 55,000 Total investments................................................. 320,000 Property, plant, and equipment Equipment ................................................... $66,000 Less: Accumulated depreciation ............... 40,000 26,000 Total assets .............................................................. $468,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-13 (Continued) NEW BAY INC. Balance Sheet (Continued) December 31, 2014

Liabilities and Shareholders' Equity Current liabilities Accounts payable ..................................................... Interest payable ........................................................ Total current liabilities......................................... Long-term liabilities Bond payable, 8%, due 2016 .................................... Total liabilities ...................................................... Shareholders' equity Common shares, no par value, unlimited shares authorized, 10,000 shares issued ...................................................................... Retained earnings..................................................... Accumulated other comprehensive income ........... Total shareholders' equity................................... Total liabilities and shareholders' equity ...........

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$ 35,000 18,000 53,000 268,000 321,000

100,000 45,000 2,000 147,000 $468,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 16-14 (a)

Oakridge uses IFRS. Under ASPE, the comprehensive income account would not exist.

Other

(b) OAKRIDGE LTD. Statement of Comprehensive Income Year Ended December 31, 2014

Profit from operations ....................................................... $125,000 Other revenue Interest revenue ............................................... $5,000 Gain on sale—trading investments ................ 1,500 6,500 131,500 Other expenses Interest expense .............................................. 8,000 Loss on fair value adjustment— trading investments ..................................... 7,500 15,500 Profit before income tax ..................................................... 116,000 Income tax ($116,000 × 30%) ........................................... 34,800 Profit....................................................................................... 81,200 Other comprehensive income: Gain on fair value adjustment (net of $900 income tax)*.. 2,100 Comprehensive income ...................................................... $83,300 * [$3,000 – ($3,000 × 30%)]

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SOLUTIONS TO PROBLEMS PROBLEM 16-1A 2014: (a) Jan. 1 Long-Term Investments— Pearl Bonds .................................... 627,660 Cash ......................................... (b) Jul. 1 Cash ($600,000 × 4% × 6/12) ............ 12,000 Long-Term Investments— Pearl Bonds ............................. Interest Revenue ..................... ($627,660 × 3% × 6/12) (c) Dec. 31 Interest Receivable ...................... 12,000 Long-Term Investments— Pearl Bonds ............................. Interest Revenue ..................... [($627,660 – $2,585) × 3% × 6/12] (d) MORRISON INC. Partial Balance Sheet December 31, 2014

Long-term investments Bonds investment—amortized cost ........................ ($627,660 – $2,585 – $2,624) (e) 2015: Jan. 1 Cash ...................................................... 12,000 Interest Receivable..................

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627,660

2,585 9,415

2,624 9,376

$622,451

12,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-1A (Continued) 2019: (f) Jan. 1 Cash ................................................ 600,000 Long-Term Investments— Pearl Bonds .............................

600,000

(g) Trading – entries that would be different: 2014: 1 Cash .................................................. Interest Revenue .....................

12,000

Dec. 31 Interest Receivable........................... Interest Revenue .....................

12,000

Jul.

12,000

Dec. 31 Loss on Fair Value Adjustment of Trading Investments .................... 7,660 Trading Investments—Pearl Bonds ($627,660 – $620,000)

12,000

7,660

Taking It Further: The market rate of interest was 3.108% per year. The interest calculated below of 1.554% × 2 for the semi-annual interest payments. Using a financial calculator: PV $ (620,000) I/Y ? Yields 1.554% N 8 PMT $12,000 FV $600,000 Type 0

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-2A (a) Jan. 1 Short-Term Investments— Treasury Bill........................................... 98,039 Cash...................................................

98,039

June 30 Cash ....................................................... 100,000 Interest Revenue ............................... Short-Term Investments—Treasury Bill

1,961 98,039

July 5 Short-Term Investments— Money-Market Fund.................................. 25,000 Cash...................................................

25,000

Oct.

1 Cash .......................................................... 25,185 Short-Term Investments— Money-Market Fund .......................... Interest Revenue ...............................

25,000 185

1 Short-Term Investments— Term Deposit ............................................ 75,000 Cash...................................................

75,000

Dec. 31 Interest Receivable ($75,000 × 3% × 3/12) Interest Revenue .................................

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563 563

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-2A (Continued) (b) LIU CORPORATION Partial Balance Sheet December 31, 2014

Current assets Interest receivable ..................................................... $ 563 Short-term investment—term deposit .......................... 75,000

LIU CORPORATION Income Statement Year Ended December 31, 2014

Other revenue Interest revenue ($1,961 + $185 + $563) ........................... $2,709

Taking It Further: Interest earned ($100,000 – $98,039) Principal Annual rate ($1,961 ÷ $98,039) × 12/6

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$1,961 98,039 4.0%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3A (a) Finance Company paid $959,400 for the Power bonds purchased $4,797,000 ÷ 5 = $959,400 or ($5,000,000 ÷ $4,797,000 = 0.9594), and ($1,000,000 × 0.9594) = $959,400 (b) 2014 – Finance Company Jan. 1 Long-Term Investments— Power Bonds ............................. Cash.......................................

959,400 959,400

(c) Bond Discount Amortization Table Effective Interest Method—Semi-annual Interest Payments 7% Bonds Issued at market rate of 8%

Date

Jan. 1, 2014 July 1, 2014 Jan. 1, 2015 July 1, 2015 Jan. 1, 2016

(A) (B) (C) Interest Interest Received Revenue Discount $1,000,000 × (D) × 8% × Amortization 7% × 6/12 6/12 (B) – (A) $35,000 35,000 35,000 35,000

$38,376 38,511 38,651 38,798

(d) 2014 – Finance Company July 1 Cash ........................................... Long-Term Investments— Power Bonds ............................. Interest Revenue ................... Dec. 31 Interest Receivable.................... Long-Term Investments— Power Bonds .................................... Interest Revenue ...................

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$3,376 3,511 3,651 3,798

(D) Bond Amortized Cost (D) + (C) $959,400 962,776 966,287 969,938 973,736

35,000 3,376 38,376 35,000 3,511 38,511

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3A (Continued) (d) (Continued) 2015 – Finance Company Jan. 1 Cash ........................................... Interest Receivable ...............

35,000 35,000

(e) FINANCE COMPANY Balance Sheet (Partial) December 31, 2014

Long-term Investments Long-term investment in bonds, at amortized cost

$966,287

FINANCE COMPANY Income Statement Year Ended December 31, 2014

Other revenues Interest revenue ($38,376 + $38,511) .......................

$76,887

(f) 2014 – Power Ltd. Jan. 1 Cash ............................................... 4,797,000 Bonds Payable ......................

4,797,000

(g) 2014 – Power Ltd. Jul. 1 Interest Expense ($38,376 × 5) . Bonds Payable ($3,376 × 5) .. Cash ($5,000,000 × 7% × 6/12) ....... Dec. 31 Interest Expense ($38,511 × 5) . Bonds Payable ($3,511 × 5) .. Interest Payable ($5,000,000 × 7% × 6/12) .......

Solutions Manual .

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191,880 16,880 175,000 192,555 17,555 175,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3A (Continued) (g) (Continued) 2015 – Power Ltd. Jan. 1 Interest Payable ......................... Cash.......................................

175,000 175,000

(h) POWER LTD. Balance Sheet (Partial) December 31, 2014 Current liabilities Interest payable .......................................................

$175,000

Non-current liabilities Bonds payable, 8%, due 2019 ................................... $4,831,435* *($966,287 × 5) POWER LTD. Income Statement Year Ended December 31, 2014

Other expenses Interest expense [($38,376 + $38,511) × 5] ..............

$384,435

(i) 2014 – Finance Company Jan. 1 Trading Investments— Power Bonds ............................. Cash.......................................

959,400

July 31 Cash ($1,000,000 × 7% × 6/12) .. Interest Revenue ................... Dec. 31 Interest Receivable ($1,000,000 × 7% × 6/12) ............ Interest Revenue ...................

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959,400

35,000 35,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3A (Continued) (i) (Continued) 2014 – Finance Company Dec. 31 Trading Investments— Power Bonds ........................................ 20,600 Gain on Fair Value Adjustment on Trading Investments ................... ($1,000,000 × .98) – $959,400 = $20,600

20,600

(j) FINANCE COMPANY Balance Sheet (Partial) December 31, 2014

Current assets Trading investments, at fair value .........................

$980,000

FINANCE COMPANY Income Statement Year Ended December 31, 2014

Other revenues Interest revenue ........................................................ $70,000 Gain on fair value adjustment of trading investments 20,600

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3A (Continued) Taking It Further: (1) To hold and earn interest: 2015: Jan. 1 Cash ($1,000,000 × .995) ........................ 995,000 Gain on Sale of Bonds....................... 28,713 Long-Term Investments— Power Bonds ...................................... 966,287 (2) For purposes of trading: 2015: Jan. 1 Cash ($1,000,000 × .995) ........................ 995,000 Gain on Sale of Trading Investments 15,000 Trading Investments— Power Bonds ...................................... 980,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-4A (a) Feb. 1 Trading Investments— IBF Common Shares ............................. 25,300 Cash...................................................

25,300

Mar. 1 Trading Investments— Raimundo Common Shares.................. 48,000 Cash...................................................

48,000

Apr. 1 Trading Investments— CRT Bonds ............................................. 210,000 Cash................................................... 210,000 July 1 Cash (575 × $1) ...................................... Dividend Revenue .............................

575 575

Aug. 1 Cash (250 × $48) .................................... 12,000 Gain on Sale of Trading Investments Trading Investments— IBF Common Shares [($25,300  575) × 250] ...................... Oct.

1 Cash ($200,000 × 3% × 6/12) ................. Interest Revenue ...............................

1,000

11,000

3,000 3,000

1 Cash ........................................................ 215,000 Gain on Sale of Trading Investments 5,000 Trading Investments— CRT Bonds ........................................ 210,000

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PROBLEM 16-4A (Continued) Dec. 31 Trading Investments—IBF Common Shares ($16,250 – $14,300) ... 1,950 Loss on Fair Value Adjustment of Trading Investments ($62,300 – $58,250) ...............4,050 Trading Investments—Raimundo Common Shares ($48,000 – $42,000) Common Shares IBF Raimundo

Cost $14,300* 48,000 $62,300 * $25,300 – $11,000 (b)

Fair Value $16,250 42,000 $58,250

6,000

(325 × $50) (1,500 × $28)

RAKAI CORPORATION Balance Sheet (Partial) December 31, 2014

Current assets Trading investments, at fair value ......................... $58,250

RAKAI CORPORATION Income Statement (Partial) Year Ended December 31, 2014

Other revenue Interest revenue .................................. Dividend revenue ................................ Gain on sale of trading investments . Other expenses Loss on sale of trading investments .

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$3,000 575 6,000

$9,575

4,050

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PROBLEM 16-4A (Continued) Taking It Further: If the company will need the cash in the near future, it is usually not recommended to invest in equity securities. Equity securities tend to fluctuate suddenly and dramatically, when compared to fixed income investments. The principal amount invested may not be recovered. Money-market instruments are recommended because they are low-risk and highly liquid.

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PROBLEM 16-5A (a) FINANCIAL HOLDINGS Balance Sheet (Partial) December 31, 2013

Current assets Trading investments, at fair value ................................. $38,000 (b) FINANCIAL HOLDINGS Income Statement (Partial) Year ended December 31, 2013

Other expenses Loss on fair value adjustment of trading investments....................... (c)

$1,000

2014

Jan. 15 Trading Investments— Hazmi Common Shares......................... 22,500 Cash (1,500 × $15) ............................

22,500

Mar. 20 Cash ......................................................... 3,000 Dividend Revenue (2,000 × $1.50)....

3,000

June 15 Cash (750 × $15.75) ............................... 11,813 Gain on Sale of Trading Investments Trading Investments— Sabo Common Shares...................... ($13,500 ÷ 1,000 × 750)

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1,688 10,125

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PROBLEM 16-5A (Continued) (c) (Continued) Aug. 5 Cash ....................................................... Dividend Revenue (250 × $2.50).......

625 625

Oct. 15 No entry is necessary for the stock split. The number of shares held is now doubled to 3,000 (1,500 × 2), at a carrying amount of $4.50 per share ($13,500 ÷ 3,000). Dec. 31 Trading Investments—Sabo Common Shares ($4,000 – $3,375) ....... 625 Trading Investments—PYK Preferred Shares ($27,500 – $24,400)..... 3,000 Gain on Fair Value Adjustment on Trading Investments ($52,500 – $50,375) Trading Investments—Hasmi Commons Shares ($22,500 – $21,000) ($35,000 – $32,340 = $2,660) Number of Market Price Shares $16.00 250 13.75 2,000 7.00 3,000

Sabo PYK Hasmi Total * $13,500 – $10,125 = $3,375

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Carrying Amount $ 3,375* 24,500 22,500 $50,375

2,125 1,500

Fair Value $4,000 27,500 21,000 $52,500

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-5A (Continued) Taking It Further: Sabo common shares purchased in 2013 and sold on June 15, 2014 yielded a net overall profit of $563. The original cost of 750 of the 1,000 common shares issued in 2013 was $11,250 ($15,000 ÷ 1,500 × 750) and the proceeds from the sale of 750 the common shares in 2014 was $11,813. This profit was recognized in two fiscal years. In the year ended December 31, 2013, a loss on the fair value adjustment of the shares was recorded in the amount of $1,500 ($15,000 – $13,500). This amount was for all 1,000 shares held at that date. The corresponding amount of the fair value adjustment for the 750 shares subsequently sold was $1,125 ($1,500 ÷ 1,000 × 750). In the fiscal year ending December 31, 2014, there was a gain on the sale of the shares of $1,688 recorded . Together these two amounts make up the total net profit of $563 ($1,688 gain on sale less $1,125 loss from the fair value adjustment).

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PROBLEM 16-6A

Balance Sheet

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

Assets NE (+/–) NE (+/–) + NE (+/–) NE (+/–) NE (+/–) + + NE + NE – NE

Liabilities NE NE NE NE NE NE NE NE NE NE NE NE NE

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Income Statement

Shareholders’ Equity NE NE + NE NE NE + + NE + NE NE

16-54 .

Revenues Expenses NE NE NE NE + NE NE NE NE NE NE NE + NE + NE NE NE + NE NE NE NE NE NE NE

Profit NE NE + NE NE NE + + NE + NE NE NE

Statement of Comprehensive Income Other Comprehensive Income NE NE NE NE NE NE NE NE NE NE NE – NE

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-6A (Continued) Taking It Further: If Olsztyn Inc. is a private company reporting using ASPE, there is no Other Comprehensive Income. For this difference, transaction #12 would be affected. Olsztyn’s investment in Havenot’s common shares would be reported at fair value on its balance sheet and the loss on the fair value adjustment would be reported on the income statement if a quoted market price is available or at cost if none is available. Olsztyn Inc. would also have a choice in the way in which it accounts for investment with significant influence in LaHave Ltd. It could account for the investment using the equity method as given for under IFRS but could also account for the investment at fair value if the shares quoted market price is readily available or at cost if the shares quoted market price is not readily available.

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PROBLEM 16-7A

(a) Situation 1: Fair Value 100,000 ÷ 1,000,000 = 10% Situation 2: Equity Method 300,000 ÷ 1,000,000 = 30% Situation 3: Equity Method* 1,000,000 ÷ 1,000,000 = 100% * Consolidated financial statements are also prepared for reporting purposes. (b) Situation 1 Jan. 10 Long-Term Investments— Sub Common Shares .................... Cash (100,000 × $10)................. Dec. 31 Cash (100,000 × $0.35) .................. Dividend Revenue ..................... Dec. 31 Long-Term Investments— Sub Common Shares .................... Other Comprehensive Income— Gain on Fair Value Adjustment (100,000 × [$12 – $10]) Situation 2 Jan. 10 Investment in Associate—Sub ..... Cash (300,000 × $10).................

1,000,000 1,000,000 35,000 35,000

200,000 200,000

3,000,000 3,000,000

Dec. 31 Cash (300,000 × $0.35) .................. Investment in Associate—Sub

105,000

31 Investment in Associate—Sub ..... Revenue from Investment in Associate ($260,000 × 30%)......

78,000

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105,000

78,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-7A (Continued) (c) Under situation 2, if Par were reporting under ASPE, it would have the choice to report the investment in Sub at (1) fair value because Sub’s shares are traded on an active market and, therefore, a quoted market price can be obtained for the shares or (2) at cost if there is no quoted market price. Jan. 10 Investment in Associate—Sub ..... Cash (300,000 × $10).................

3,000,000

Dec. 31 Cash (300,000 × $0.35) .................. Dividend Revenue .....................

105,000

3,000,000

105,000

(d) (1) Fair Value Balance Sheet Long-term investments—Sub* Investment in associate—Sub** Investment in associate—Sub*** Comprehensive Income Statement Income Statement Revenue from investment in Sub Dividend revenue Other Comprehensive Income Other Comprehensive Income— Gain on Fair Value Adjustment****

(2) Cost Method

(3) Equity Method

$3,600,000 $3,000,000 $2,973,000

78,000 105,000

105,000

600,000

* 300,000 shares × $12 = $3,600,000 ** 300,000 shares × $10 = $3,000,000 *** $3,000,000 – $105,000 + $78,000 = $2,973,000 **** (300,000 × [$12 – $10])

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PROBLEM 16-7A (Continued) Taking It Further: ASPE is set of standards developed for use primarily by private companies. Private companies are more likely to invest in other private companies and the shares of such companies do not trade actively on public stock exchanges. It is therefore more common for private companies to have difficulty reporting investments at fair value because such values are not readily obtained. So, if fair value cannot be determined, ASPE allows the use of the cost method. Under ASPE, companies can choose to use the cost model rather than the equity method to account for investments subject to significant influence if the fair value of the shares is not known. Private companies often have few users and the information provided by the equity method may not relevant. When choosing between the equity method and the fair value method, the private business reporting under ASPE might choose to report using the fair value method, (but not to other comprehensive income) because of the particular needs of the financial statement users, and possibly also for consistency in comparison with other long-term investments.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-8A (a)

Kang purchased 30,000 shares [($1,320,000 – $120,000) ÷ $40].

(b)

Kang owns 25% (30,000 ÷ 120,000) of Sandhu shares.

(c)

The cash dividend per share was $3.00 ($90,000 ÷ 30,000 shares).

(d)

The fair value per share was $44 ($1,320,000 ÷ 30,000).

(e)

Because Kang can exercise significant influence over the Sandhu Ltd., the equity method will be used to account for the long-term investment. Accordingly, the investment account will be increased for the acquisition of shares and for Kang‘s share of Sandhu’s profits for the year that it held the investment in Sandhu. The investment account will be decreased when Sandhu pays dividends. Accordingly the investment account contains the following: Investment in Sandhu Ltd. (30,000 shares × $40) Less: cash dividends received Plus: 25% of Sandhu Ltd.’s earnings for the year that the investment was owned (derived) Balance of investment, December 31, 2012

$1,200,000 (90,000) 1,110,000 290,000 $1,400,000

If $290,000 is 25% of Sandhu’s income for the year, then the Sandhu Ltd. must have earned $1,160,000 throughout the year ($290,000 ÷ 25%).

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PROBLEM 16-8A (Continued) (f)

Under the equity method, Kang would report its share of Sandhu Ltd.’s profits as follows: KANG INC. Income Statement (Partial) Year Ended December 31, 2014 Other revenues Revenue from investment in associate.......

(g)

$290,000

Under the cost model, Kang would report only the dividends received as revenues as follows: KANG INC. Income Statement (Partial) Year Ended December 31, 2014 Other revenues Dividend revenue..........................................

$90,000

Taking It Further: The potential advantages of having significant influence over another company include for example: a) The investor’s ability to secure a relationship with the associate as an essential source of supply for a key raw material in a manufacturing process. b) The investor’s ability to secure a relationship with the associate as a key customer. c) The investor and associate could exchange key management personnel for their mutual benefit. d) The investor could provide its associate with key technological information which will help the associate become more profitable and the investment more lucrative for the investor.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-9A (a) SILVER LINING CORPORATION Income Statement Year ended December 31, 2015 (in millions) Silver sales Cost of sales Gross profit Operating expenses Profit from operations Other revenue Dividend revenue Interest revenue

$3,350 2,214 1,136 639 497 $6 38

Other expenses Loss from investment in associate Loss on fair value adjustments—trading investments Interest expense Income before income tax Income tax expense Profit

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44 541

$6 27 7

40 501 60 $ 441

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-9A (Continued) (a) (Continued) SILVER LINING CORPORATION Statement of Comprehensive Income Year ended December 31, 2015 (in millions)

Profit Other comprehensive income Gains on fair value adjustment—strategic investment (net of tax of $5) Comprehensive income

(b)

Accumulated other comprehensive income ($49 + $12)

$441

12 $453

$61 million

Taking It Further: Standard-setters are concerned about the manipulation of profit through reclassifications. The classification of investments is based on management’s intention at the time the investment is purchased.

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PROBLEM 16-10A STINSON CORPORATION Statement of Comprehensive Income Year Ended April 30, 2015

Service revenue ................................................................. $550,000 Operating expenses Salary expense .............................................. $235,000 Rent expense ............................................. 79,000 Depreciation expense................................ 27,500 341,500 Profit from operations ......................................................... 208,500 Other revenues Dividend revenue ........................................... $ 11,000 Gain on sale of trading investments ........ 3,000 Gain on fair value adjustment of trading investments ................................ 1,500 Interest revenue ......................................... 3,360 18,860 227,360 Other expenses Loss on fair value adjustment of trading investments ................................ $ 1,500 Interest expense ........................................ 7,500 9,000 Profit before tax................................................................... 218,360 Income tax expense ........................................................... 82,860 Profit..................................................................................... 135,500 Other comprehensive income Loss on fair value adjustment, net of $3,600 tax ....... 12,000 Comprehensive income .................................................... $123,500

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PROBLEM 16-10A (Continued) STINSON CORPORATION Balance Sheet April 30, 2015

Assets Current assets Cash............................................................................. $ 100,480 Trading investments, at fair value ............................ 76,000* Accounts receivable ................................................... 48,000 Interest receivable ......................................................... 1,680 Total current assets ................................................... 226,160 Non-current assets Long-term investments Long-term investment— Verma common shares, at fair value ........ $220,000 Investment in associate ................................ 170,000 Long-term investment—bonds, due 2017 at amortized cost ........................................ 24,000 Total investments ....................................................... 414,000 Property, plant and equipment Equipment .................................................... $275,000 Less: Accumulated depreciation ................ 72,000 203,000 Total assets ................................................................... $843,160 * ($15,000 + $61,000 = $76,000)

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-10A (Continued) STINSON CORPORATION Balance Sheet (Continued) April 30, 2015

Liabilities and Shareholders' Equity Current liabilities Accounts payable ...................................................... $ 65,000 Income tax payable ..................................................... 25,000 Total current liabilities.......................................... 90,000 Long-term liabilities Bonds payable ............................................................. 150,000 Total liabilities ......................................................... 240,000 Shareholders' equity Share capital Common shares, no par value, unlimited authorized, 200,000 shares issued ..................................................... Retained earnings* ................................................... Accumulated other comprehensive income** Total shareholders' equity.................................... Total liabilities and shareholders' equity ............

300,000 297,160 6,000 603,160 $843,160

* $161,660 + $135,500 Profit = $297,160 ** $18,000 – $12,000 = $6,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-10A (Continued) Taking It Further: If Stinson Corporation were a private company and reported under ASPE, it would present an income statement only. Assuming there is a quoted market price for the Verma common shares, the loss on fair value adjustment would be reported in Other Expenses and profit would be reduced by $12,000. The balance sheet would not include Accumulated Other Comprehensive Income in Shareholders’ Equity. If there is not a quoted market price for the Verma shares, then the investment would be reported at cost and not fair value.

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PROBLEM 16-1B 2014: (a) July 1 Long-Term Investments— Schuett Bonds................................ 275,400 Cash ($300,000 × .918) ............ (b) Dec. 31 Interest Receivable ($300,000 × 3% × 6/12) ................. Long-Term Investments— Schuett Bonds.............................. Interest Revenue ..................... ($275,400 × 4% × 6/12)

275,400

4,500 1,008 5,508

Current assets Interest receivable .................................................... Long-term investments Bonds investment—amortized cost ........................ ($275,400 + $1,008) 2015: (d) Jan. 1

Cash.............................................. Interest Receivable..................

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$276,408

4,500

(e) July 31 Cash.............................................. 4,500 Long-Term Investments— 1,028 Schuett Bonds.............................. Interest Revenue ..................... [($275,400 + $1,008) × 4% × 6/12]

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$4,500

4,500

5,528

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-1B (Continued) 2024: (f) July 1 Cash.............................................. 300,000 Long-Term Investments— Schuett Bonds .........................

300,000

(g) Trading – entries that would be different: 2014: Dec. 31 Interest Receivable........................... Interest Revenue ..................... Dec. 31 Long-Term Investments— Schuett Bonds .................................. Gain on Fair Value Adjustment— of Trading Investments................ [($300,000 × .96) – $275,400]

4,500 4,500

12,600 12,600

Taking It Further: The market rate of interest was 3.4986 % per year. The interest calculated below of 1.7493% × 2 for the semiannual interest payments. Using a financial calculator: PV $ (288,000) I/Y ? Yields 1.7493% N 19 PMT $4,500 FV $300,000 Type 0

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PROBLEM 16-2B (a) Feb. 1 Short-Term Investments— Term Deposit ....................................... 50,000 Cash.................................................

50,000

Aug. 1 Cash ..................................................... 51,250 Short-Term Investments— Term Deposit................................... Interest Revenue .............................

50,000 1,250

Aug. 1 Short-Term Investments— Money Market Fund ............................. 55,000 Cash.................................................

55,000

Dec. 1 Cash ..................................................... 55,735 Short-Term Investments— Money Market Fund ........................ Interest Revenue .............................

55,000 735

1 Short-Term Investments— Treasury Bill......................................... 99,260 Cash.................................................

99,260

31 Short-Term Investments— Treasury Bill ($99,508 – $99,260)........ Interest Revenue .............................

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PROBLEM 16-2B (Continued) (b) LANNAN CORP. Partial Balance Sheet December 31, 2014

Current assets Short-term investment—treasury bill ......................... $99,508

LANNAN CORPORATION Income Statement Year Ended December 31, 2014

Other revenue Interest revenue ($1,250 + $735 + $248) ........................... $2,233

Taking it Further: Interest earned (February 1 to August 1)—6 months Principal Annual Rate ($1,250 ÷ $50,000) × 2..............

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$1,250 50,000 5.0%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-3B (a) Treasury Ltd. paid $2,080,000 for the Surge bonds purchased ($2,000,000 × 1.04) (b) 2014 – Treasury Ltd. Jan. 1 Long-Term Investments— Surge Bonds .................................. 2,080,000 Cash....................................... 2,080,000 (c) Bond Premium Amortization Table Effective Interest Method—Semi-annual Interest Payments 5% Bonds Issued at market rate of 4.5%

Date

Jan. 1, 2014 July 1, 2014 Jan. 1, 2015 July 1, 2015 Jan. 1, 2016

(A) (B) (C) Interest Interest Received Revenue Premium $2,000,000 × (D) × 4.5% Amortization 5% × 6/12 × 6/12 (B) – (A) $50,000 50,000 50,000 50,000

$46,800 46,728 46,654 46,579

(d) 2014 – Treasury Ltd. July 1 Cash ........................................... Long-Term Investments— Surge Bonds ......................... Interest Revenue ................... Dec. 31 Interest Receivable.................... Long-Term Investments— Surge Bonds ......................... Interest Revenue ...................

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$3,200 3,272 3,346 3,421

(D) Bond Amortized Cost (D) + (C) $2,080,000 2,076,800 2,073,528 2,070,182 2,066,761

50,000 3,200 46,800 50,000 3,272 46,728

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PROBLEM 16-3B (Continued) (d) (Continued) 2015 – Treasury Ltd. Jan. 1 Cash ........................................... Interest Receivable ...............

50,000 50,000

TREASURY LTD. Balance Sheet (Partial) December 31, 2014

Long-term Investments Long-term investment in bonds, at amortized cost $2,073,528 TREASURY LTD. Income Statement Year Ended December 31, 2014

Other revenues Interest revenue ($46,800 + $46,728) .......................

$93,528

(e) 2014 – Surge Ltd. Jan. 1 Cash ($6,000,000 × 1.04) ............... 6,240,000 Bonds Payable ......................

6,240,000

(f) 2014 – Surge Ltd. Jul. 1 Interest Expense ($46,800 × 3) . Bonds Payable ($3,200 × 3)....... Cash ($6,000,000 × 5% × 6/12) ....... Dec. 31 Interest Expense ($46,728 × 3) . Bonds Payable ($3,272 × 3)....... Interest Payable ($6,000,000 × 5% × 6/12) .......

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140,400 9,600 150,000 140,184 9,816 150,000

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PROBLEM 16-3B (Continued) (f) (Continued) 2015 – Surge Ltd. Jan. 1 Interest Payable ......................... Cash.......................................

150,000 150,000

(g) SERGE LTD. Balance Sheet (Partial) December 31, 2014 Current liabilities Interest payable ............................................................ $150,000 Non-current liabilities Bonds payable, 5%, due 2024 .................................... $6,220,584* *($2,073,528 × 3) SERGE LTD. Income Statement Year Ended December 31, 2014

Other expenses Interest expense [($46,800 + $46,728) × 3] ..............

$280,584

(h) 2014 – Treasury Ltd. Jan. 1 Trading Investments— Serge Bonds .............................. Cash.......................................

2,080,000

July 31 Cash ($2,000,000 × 5% × 6/12) .. Interest Revenue ................... Dec. 31 Interest Receivable ($2,000,000 × 5% × 6/12) ............ Interest Revenue ...................

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2,080,000

50,000 50,000

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PROBLEM 16-3B (Continued) (h) (Continued) 2014 – Treasury Ltd. Dec. 31 Loss on Fair Value Adjustment on Trading Investments ............................ 20,000 Trading Investments— Serge Bonds................................. $2,080,000 – ($2,000,000 × 1.03) = 20,000

20,000

(i) TREASURY LTD. Balance Sheet (Partial) December 31, 2014

Current assets Trading investments, at fair value ............................ $2,060,000 TREASURY LTD. Income Statement Year Ended December 31, 2014

Other revenues Interest revenue ........................................................

$100,000

Other expenses Loss on fair value adjustment of trading investments $20,000

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PROBLEM 16-3B (Continued) Taking It Further: The market rate of interest increased. When Serge purchased the bonds, the market rate of interest was 4.5% and lower than the stated rate of 5%. Serge paid 104 for the bonds. This made the bonds more attractive and this explains why Treasury was willing to pay a premium for a higher contractual rate of interest. At Dec. 31, 2014 the bonds were trading at 103. The effective interest rate increased since January 1, 2014. If Treasury purchased the bonds to earn interest, and intends to hold them to maturity, they should not care if the market rate of interest increases or decreases. Should an emergency arise which requires Treasury to sell the bonds before maturity, in spite of their original intention, they would want the current market interest rate to be lower so that their Serge bonds will be more attractive on resale and command a higher price on the date they are sold.

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PROBLEM 16-4B (a) Feb. 1 Trading Investments—Lemelin Common Shares ............................... Cash..............................................

63,600

Mar. 1 Trading Investments— RSD Common Shares ...................... Cash..............................................

7,500

Apr. 1 Trading Investments— MRT Bonds ($100,000 × .98) ............ Cash..............................................

98,000

63,600

7,500

98,000

July 1 Cash (2,400 × $2) .............................. Dividend Revenue ........................

4,800

Aug. 1 Cash (1,600 × $25) ............................ Loss on Sale of Trading Investments Trading Investments— Lemelin Common Shares [($63,600 ÷ 2,400) × 1,600] ..........

40,000 2,400

1 Cash ($100,000 × 4% × 6/12) ............ Interest Revenue ..........................

2,000

2 Cash .................................................. Gain on Sale of Trading Investments .................... Trading Investments— MRT Bonds ...................................

100,000

Oct.

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4,800

42,400 2,000

2,000 98,000

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PROBLEM 16-4B (Continued) (a) (Continued) Dec. 31 Trading Investments— Lemelin Common Shares ................ Trading Investments— RSD Common Shares ...................... Gain on Fair Value Adjustment of Trading Investments ....................

Number of Cost Shares Lemelin 2,400 – 1,600 = 800 $21,200* RSD 600 7,500 Total $28,700 * $63,600 – $42,400 (b)

1,200 900 2,100

Fair Value $22,400 8,400 $30,800

(800 × $28) (600 × $14)

MEAD INVESTMENT CORPORATION Balance Sheet (Partial) December 31, 2014

Current assets Trading investments, at fair value ................................. $30,800 MEAD INVESTMENT CORPORATION Income Statement (Partial) Year ended December 31, 2014

Other revenues Dividend revenue................................... Interest revenue ..................................... Gain on fair value adjustment of trading investments....................... Gain on sale of trading investments .... Other expenses Loss on sale of trading investment ...... Solutions Manual .

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$4,800 2,000 2,100 2,000 $10,900 $

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PROBLEM 16-4B (Continued) Taking It Further: When Mead invested in the MRT bonds, it was anticipating a decline in the market interest rate which would in turn increase the resale value of the bonds.

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PROBLEM 16-5B (a) COMMERCIAL INC. Balance Sheet (Partial) December 31, 2013

Current assets Trading investments, at fair value ................................. $55,000 (b) COMMERCIAL INC. Income Statement (Partial) Year ended December 31, 2013

Other revenues Gain on fair value adjustment of trading investments....................... (c)

$5,000

2014

Feb. 10 Trading Investments— Almina Common Shares ....................... 30,000 Cash (2,500 × $12)............................. Apr. 15 Cash (1,250 × $27) ................................. 33,750 Gain on Sale of Trading Investments Trading Investments— Fahim Common Shares .................... ($39,000 ÷ 1,500 × 1,250) June 15 Trading Investments— Fahim Common Shares......................... 27,500 Cash (1,000 × $27.50)........................

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30,000

1,250 32,500

27,500

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PROBLEM 16-5B (Continued) (c) (Continued) Aug. 5 Cash ......................................................... 5,000 Dividend Revenue (2,000 × $2.50)....

5,000

Oct. 15 No entry is necessary for the stock dividend. The number of shares held is now 2,750 (2,500 × 1.1), at a cost of $10.91 per share ($30,000 ÷ 2,750). Dec. 31 Trading Investments—Fahim Common Shares ($37,500 – $34,000) ..... 3,500 Trading Investments—Almina Common Shares ($34,375 – $30,000) ..... 4,375 Gain on Fair Value Adjustment on Trading Investments ($83,875 – $80,000) Trading Investments—PLJ Commons Shares ($16,000 – $12,000) ($35,000 – $32,340 = $2,660) Number of Market Price Shares $30.00 250 + 1,000 6.00 2,000 12.50 2,750

Fahim PLJ Almina Total * $39,000 – $32,500 + $27,500 = $34,000

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Carrying Amount $34,000* 16,000 30,000 $80,000

3,875 4,000

Fair Value $37,500 12,000 34,375 $83,875

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PROBLEM 16-5B (Continued) Taking It Further: Fahim common shares purchased in 2013 and sold on April 15, 2014 yielded a profit of $3,750. The cost of the 1,250 common shares was $30,000 ($36,000 ÷ 1,500 × 1,250) and the proceeds from the sale of the common shares were $33,750. This profit was recognized in two fiscal years. In the year ended December 31, 2013, a gain on the fair value adjustment of the shares was recorded in the amount of $3,000 ($39,000 – $36,000). This amount was for all 1,500 shares held at that date. The corresponding amount of the fair value adjustment for the 1,250 shares subsequently sold was $2,500 ($3,000 ÷ 1,500 × 1,250). In the fiscal year ending December 31, 2014, there was a gain on the sale of the shares of $1,250. Together these two amounts make up the total profit of $3,750.

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PROBLEM 16-6B

Balance Sheet

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

Assets NE (+/–) NE NE (+/–) + NE (+/–) – (+/–) NE (+/–) + NE (+/–) NE (+/–) + NE – – + + NE

Liabilities NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE

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Income Statement

Shareholders’ Equity NE NE NE + NE – NE + NE NE + NE – – + + NE

16-82 .

Revenues Expenses NE NE NE NE NE NE + NE NE NE NE + NE NE + NE NE NE NE NE + NE NE NE NE – NE – + NE NE NE NE NE

Profit NE NE NE + NE – NE + NE NE + NE – – + NE NE

Statement of Comprehensive Income Other Comprehensive Income NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE + NE

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Accounting Principles, Sixth Canadian Edition

PROBLEM 16-6B (Continued) Taking It Further: If Abioye Inc. is a private company reporting using ASPE, there is no Other Comprehensive Income. For this difference, transaction #16 would be affected. Abioye’s investment in Sarolta’s common shares would be reported at fair value on its balance sheet and the gain on the fair value adjustment would be reported on the income statement if a quoted market price is available or at cost if none is available. Abioye Inc. would also have a choice in the way in which it accounts for investment with significant influence in Xing Ltd. It could account for the investment using the equity method as given for under IFRS but could also account for the investment at fair value if the shares quoted market price is readily available or at cost if the shares quoted market price is not readily available.

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PROBLEM 16-7B (a) Situation 1: Fair Value 30,000 ÷ 300,000 = 10% Situation 2: Equity Method 90,000 ÷ 300,000 = 30% Situation 3: Equity Method* 300,000 ÷ 300,000 = 100% * Consolidated financial statements are also prepared for reporting purposes. (b) Situation 1 2014 Oct. 1 Long-Term Investments— Hat Common Shares ........................ 1,200,000 Cash (30,000 × $40)..................... 1,200,000 2015 Sept. 30 Cash ................................................. 12,000 Dividend Revenue (30,000 × $0.40) 12,000 Sept.30 Long-Term Investments— Hat Common Shares ....................... Other Comprehensive Income— Gain on Fair Value Adjustment .. [30,000 × ($43 – $40)]

90,000 90,000

Situation 2 2014 Oct. 1 Investment in Associate—Hat ......... 3,600,000 Cash (90,000 × $40)...................... 3,600,000 2015 36,000 Sept. 1 Cash (90,000 × $0.40) ....................... Investment in Associate—Hat ..... 36,000 Sept.30 Investment in Associate—Hat ......... Revenue from Investment in Associate ($675,000 × 30%).........

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202,500 202,500

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PROBLEM 16-7B (Continued) (c) Under situation 2, if Pankaj were reporting under ASPE, it would have the choice to report the investment in Sub at (1) fair value because Hat’s shares are traded on an active market and so a quoted market price can be obtained for the shares or (2) at cost if there is no quoted market price. 2014 Oct. 1 Investment in Associate—Hat ......... 3,600,000 Cash (90,000 × $40)................... 3,600,000 2015 Sept. 1 Cash (90,000 × $0.40) .................... 36,000 Dividend Revenue ..................... 36,000 (d) (1) Fair Value Balance Sheet Long-term investments—Sub* Investment in associate—Sub** Investment in associate—Sub*** Comprehensive Income Statement Income Statement Revenue from investment in Sub Dividend revenue Other Comprehensive Income Other Comprehensive Income— Gain on Fair Value Adjustment****

(2) Cost Method

(3) Equity Method

$3,870,000 $3,600,000 $3,766,500

202,500 36,000

36,000

270,000

* 90,000 shares × $43 = $3,870,000 ** 90,000 shares × $40 = $3,600,000 *** $3,600,000 – $36,000 + $202,500 = $2,766,500 **** (90,000 × [$43 – $40])

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PROBLEM 16-7B (Continued) Taking It Further: Fair value, Sept. 30, 2016: 30,000 × $45 = Cost: 30,000 × $40 Cumulative other comprehensive income Less income taxes (30% × $150,000) Accumulated other comprehensive income, Sept. 30, 2016

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$1,350,000 1,200,000 150,000 45,000 $105,000

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PROBLEM 16-8B (a)

Hadley’s accountant used the equity method to account for the investment which resulted in Hadley recognizing 20% of Letourneau’s income as revenue ($200,000 ÷ $1,000,000). Therefore, Hadley Inc. must own 20% of the common shares of Letourneau Corp.

(b)

Hadley would have received 20% of any dividends declared by Letourneau, or $40,000 ($200,000 × 20%).

(c)

Hadley purchased 80,000 common shares of Letourneau Corp. This amount could be calculated as follows: Balance in long-term investment account, Dec. 31 $960,000 Less: Hadley’s share of Letourneau’s earnings (200,000) 1 Add: Hadley’s share of Letourneau’s dividends 40,000 Investment account (at cost) $800,000* *Since the cost of the investment was $800,000 and the issue price of Letourneau’s shares was $10 per share, it follows that 80,000 shares were purchased. 1 Part (b) above

(d)

If significant influence does not exist Hadley should use the fair value method to account for the investment in Letourneau Corp. Under the fair value method, Hadley would report the investment in Letourneau Corp. as follows: HADLEY INC. Balance sheet (Partial) December 31, 2014 Investments Long-term investments.............................

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$970,000

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PROBLEM 16-8B (Continued) (d) (Continued) HADLEY INC. Income Statement (Partial) Year Ended December 31, 2014 Other revenue Dividend revenue ...................................... Unrealized gain on long-term investments ($970,000 – $800,000) (e)

$ 40,000 170,000

Under the cost model, Hadley would report the investment at cost of $800,000 on the balance sheet and only the dividends received of $40,000 as other revenue on the income statement.

Taking It Further: Among the questions that should be considered in determining an investor’s influence are whether:  The investor has representation on the investee’s board of directors  The investor participates in the investee’s policy-making process  There are material transactions between the investor and the investee  The common shares held by other shareholders are concentrated among a few investors or dispersed among many A company owning 19% of the common shares of another company could have significant influence over that associate. This situation could occur when the common shares held by other shareholders are widely dispersed.

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PROBLEM 16-9B (a) INVESTMENTS R US COMPANY Income Statement Year ended December 31, 2015 (in millions) Revenues Operating expenses Profit from operations Other revenue Gain on disposal of land Interest revenue Revenue from investment in associate Dividend revenue Gain on fair value adjustment— trading investments Other expenses Interest expense Loss on sale of trading investments Other expenses Profit before income tax Income tax expense Profit

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$7,240 4,616 2,624 $ 26 6 4 3 2

$ 299 194 21

41 2,665

514 2,151 781 $1,370

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PROBLEM 16-9B (Continued) (a) (Continued) INVESTMENTS R US COMPANY Statement of Comprehensive Income Year ended December 31, 2015 (in millions)

Profit Other comprehensive income: Loss on fair value adjustment—strategic equity investment, net of tax Comprehensive income

(b)

Accumulated other comprehensive loss: ($150 + $68)

$1,370

68 $1,302

$218 million

Taking It Further: Fair value adjustments of trading investments are included in profit because the investments are short-term in nature. Including the gain or loss in profit helps users predict future profitability. Valuing these investments at fair value on the balance sheet also provides more relevant information for statement users. For long-term equity investments, since the investment is going to be held and not sold, it may be inappropriate to affect a company’s profit with the gains and losses on fair value adjustments caused by market fluctuations. The fair value adjustment may therefore be kept out of profit, but instead reflected in other comprehensive income on the statement of comprehensive income.

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PROBLEM 16-10B VLADIMIR CORPORATION Statement of Comprehensive Income Year Ended December 31, 2014 Service revenues.............................................................. $651,000 Operating expenses Salary expense ............................................. $335,000 Rent expense ............................................. 45,000 Depreciation expense................................ 28,000 408,000 Profit from operations...................................................... 243,000 Other revenues Revenue from investment in associate ........ $ 31,000 Dividend revenue....................................... 9,000 Gain on sale of trading investments ........ 2,500 Gain on fair value adjustment of trading investments .............................. 2,600 Interest revenue ......................................... 3,300 48,400 291,400 Other expenses Interest expense ............................................ $ 12,500 Loss on fair value adjustment on trading securities ................................................. 1,500 14,000 Profit before tax................................................................. 277,400 Income tax expense .......................................................... 79,290 Profit................................................................................... 198,110 Other comprehensive income Gain on fair value adjustment, net of $3,600 tax ....... 12,000 Comprehensive income .................................................... $210,110

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PROBLEM 16-10B (Continued) VLADIMIR CORPORATION Balance Sheet December 31, 2014

Assets Current assets Cash............................................................................... $150,000 Trading investments at fair value .................................. 119,500* Accounts receivable ...................................... $68,000 Less: Allowance for doubtful accounts .... 4,000 64,000 Total current assets ............................................. 333,500 Non-current assets Long-term investments Notes receivable, due 2017 ........................... $75,000 Long-term investment in bonds, due 2016, at amortized cost ........................................... 36,000 Long-term equity investment, at fair value 185,000 Investment in associate .............................. 215,000 Total investments................................................. 511,000 Property, plant, and equipment Equipment ............................................... $288,000 Less: Accumulated depreciation ........... 92,000 196,000 Total assets ........................................................... $1,040,500 * ($37,000 + $82,500 = $119,500)

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PROBLEM 16-10B (Continued) VLADIMIR CORPORATION Balance Sheet (Continued) December 31, 2014

Liabilities and Shareholders' Equity Current liabilities Accounts payable ..................................................... $ 85,000 Interest payable ........................................................ 5,000 Income tax payable .................................................... 16,000 Total current liabilities......................................... 106,000 Long-term liabilities Bonds payable ........................................................... 250,000 Total liabilities ...................................................... 356,000 Shareholders' equity Common shares, no par value, unlimited shares authorized, 200,000 shares........................ 250,000 Retained earnings * .................................................. 394,500 Accumulated other comprehensive income** ....... 40,000 Total shareholders' equity................................... 684,500 Total liabilities and shareholders' equity ........... $1,040,500 * Total liabilities and shareholders’ equity (equal Total assets) $1,040,500 Less: Total Liabilities 356,000 Total shareholders’ equity 684,500 Less: Accumulated other comprehensive income** 40,000 Less: Common shares 250,000 Retained earnings $394,500 ** Beginning Balance of Accumulated other Comprehensive income Add: Other comprehensive income for the year Ending Balance

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$28,000 12,000 $40,000

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PROBLEM 16-10B (Continued)

Taking It Further: The Long-term investment in common shares would be shown at its fair value if there is a quoted fair value from an active market; otherwise it would be shown at its cost or carrying value. The fair value adjustment (assuming quoted market price) would be reported in other revenues on the income statement,. If Vladimir Corporation were a private company and reported under ASPE, it would present an income statement only. The balance sheet would not include Accumulated Other Comprehensive Income in Shareholders’ equity.

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CONTINUING COOKIE CHRONICLE (a)

1. The amount of influence you would have in La Madeleine Ltd. would determine how you would account for the investment. Given that you would own 20% of the common shares of La Madeleine Ltd., it would be assumed (unless there was evidence to the contrary) that you could exert significant influence over the day-to-day operations of the business. This is especially so given the small number of shareholders. Significant influence over an associate may also result from representation on the board of directors, participation in policy-making processes, material intercompany transactions. Assuming significant influence exists, the investment would be accounted for using the equity method of accounting. However, in this case, the Thornton sisters will still exercise majority control and may not be willing to let an investor participate in the decision making process. In particular, since each sister owns 40%, this means that any decision proposed can be overturned by the sisters. This makes significant influence unlikely. In this case, the investment would be accounted for using the cost method. This method would be used rather than fair value, since there is no active market in the shares given that there are only three shareholders.

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CONTINUING COOKIE CHRONICLE (Continued) 2. One of the major advantages of going ahead with this investment would be the strategic advantage of the horizontal and vertical integration that would occur. Not only would you eliminate a competitor but you both could learn the business of making fancy French cookies while taking advantage of the expertise the Thornton sisters have developed with respect to the operation of the bakery. 3. There would be disadvantages associated with this investment as well. For example, there may be a significant time investment required by you three, especially since both of the Thornton sisters are very busy and would like the investor to take over some of the responsibilities of running the business. As well, the Thornton sisters will still together exercise majority control and may not be willing to let an investor participate in the decision making process. Finally, if the investment did not work out it may be difficult to find another investor to purchase the shares held by Cookie & Coffee Creations. (b) Since the equity method is applied when an investor can exercise significant influence, details of the relationship between Cookie & Coffee Creations and La Madeleine Ltd. are required to support or refute significant influence. For example, who are the current members of the board of directors and how many positions would be vacated from the sale of the shares? How many positions on the board of directors would be occupied by the new shareholder? How will decisions regarding company policy be made, what will Janet, Brian and Natalie’s responsibilities be in the running of La Madeleine Ltd.? Because of the voting control exercised by the two sisters, Janet, Brian and Natalie should have a contract setting out their responsibilities and amount of influence they would be able to exercise. Solutions Manual .

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CONTINUING COOKIE CHRONICLE (Continued) (c)

Because the investment in La Madeleine Ltd. is a strategic investment, it would be classified as a long-term investment in the non-current assets section of Cookie & Coffee Creations’ balance sheet. If the investment were accounted for using the cost method, it would be recorded at its original cost. Its value would be adjusted at year-end to its fair value, if the shares had a market value; however this is unlikely since there are only three shareholders. If the investment were accounted for using the equity method, it would be accounted for at its original cost plus a proportionate share of the La Madeleine’s income, less a proportionate share of any dividends paid by La Madeleine Ltd.

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CUMULATIVE COVERAGE: CHAPTERS 13 TO 16 (a) Jan.

7 Cash ..................................................... 25,000 Preferred Shares ............................ 25,000

Mar. 16 Trading Investments— Osborne Common Shares .................. 19,200 Cash (800 × $24) ............................. 19,200 July

1 Long-Term Investments— Solar Inc. Bonds ................................. 108,200 Cash ($100,000 × 108.2) ................. 108,200

Aug.

2 Cash (800 × $25) ................................. 20,000 Trading Investments— 19,200 Osborne Common Shares ............. Gain on Sale of Trading Investments 800 5 Short-Term Investments— Money Market Fund ............................ 20,000 Cash ................................................ 20,000

Sep. 25 Preferred Shares ($25,000 ÷ 1,000 × 500) ....................... 12,500 Common Shares.............................

12,500

Oct. 24 Cash ..................................................... 20,200 Short-Term Investments— Money Market Fund........................ 20,000 Interest Revenue ............................ 200 Nov. 30 Cash ..................................................... 50,000 Note Payable................................... 50,000

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CUMULATIVE COVERAGE (Continued) (a) (Continued) Dec.

1 Cash Dividends (500 × $2).................. 1,000 Dividends Payable..........................

1,000

Dec. 31 Interest Expense ($50,000 × 6% × 1/12) .......................... 250 Note Payable ($1,521 – $250) ............ 1,271 Cash ................................................

1,521

31 Investment in Associate—RES ($20,000 × 40%) ................................ 8,000 Revenue from Investment in Associate—RES ..........................

8,000

31 Cash.................................................. Investment in Associate—RES ($1,200 × 40%)..................................

480

31 Interest Receivable ($100,000 × 5% × 6/12) ......................... 2,500 Long-Term Investments— Solar Inc. Bonds ($2,500 – $2,164) . Interest Revenue ($108,200 × 4% × 6/12)..................... 31 Interest Expense ($126,025 × 7%) ....... 8,822 Bonds Payable ($8,822 – $7,800).... Interest Payable ($130,000 × 6%)................................

480

336 2,164

1,022 7,800

31 Other Comprehensive Income— Loss on Fair Value Adjustment* ......... 2,000 Long-Term Investments—BCB Shares 2,000 * $28,000 (fair value) – $30,000 (carrying amount) = $2,000

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CUMULATIVE COVERAGE (Continued) (b) PLANKTON CORPORATION Trial Balance December 31, 2015

Debit

Credit

Cash ($48,000 + $25,000 – $19,200 – $108,200 + $20,000 – $20,000 + $20,200 + $50,000 – $1,521 + $480) ........................................... $ 14,759 Accounts receivable ........................................ 51,000 Allowance for doubtful accounts .................... $ 2,500 Interest receivable............................................ 2,500 Merchandise inventory ................................... 22,700 Investment in associate—RES ($85,000 + $8,000 – $480) ............................ 92,520 Long-term investment – Solar bonds ($108,200 – $336) ......................................... 107,864 Long-term investment—BCB common shares ($30,000 – $2,000) ............ 28,000 Land .................................................................. 90,000 Building............................................................. 200,000 Accumulated depreciation—building ............. 40,000 Equipment......................................................... 40,000 Accumulated depreciation—equipment ......... 15,000 Accounts payable............................................. 18,775 Dividends payable ............................................ 1,000 Income tax payable .......................................... 4,500 Interest payable ................................................ 7,800 Note payable ($50,000 – $1,271) ...................... 48,729 Bonds payable (6%, due 2019) ($126,025 + $1,022) ...................................... 127,047 $2-noncumulative preferred shares, convertible no par value, 500 issued 12,500 ($25,000 – $12,500)........................................ Common shares, no par value, 102,500 issued ($100,000 + $12,500)...................................... 112,500 Solutions Manual .

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CUMULATIVE COVERAGE (Continued) (b) (Continued) PLANKTON CORPORATION Trial Balance (Continued) December 31, 2015

Debit

Credit 110,775

Retained earnings ........................................ Cash dividends............................................. 1,000 Accumulated other comprehensive income 5,000 Sales.............................................................. 750,000 Cost of goods sold....................................... 370,000 Operating expenses ..................................... 180,000 Interest revenue ($375 + $200 + $2,164) ..... 2,739 Interest expense ($6,250 + $250 + $8,822) .. 15,322 Revenue from investment in associate—RES ....................................... 8,000 Income tax expense ..................................... 50,000 Gain on sale of trading investments........... 800 Other Comprehensive Income: Loss on fair value adjustment ............................... 2,000 Totals $1,267,665 $1,267,665

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CUMULATIVE COVERAGE (Continued) (c)

Revenues Sales....................................................... Interest revenue .................................... Revenue from investment in associate—RES. .............................. Gain on sale of trading investments .... Expenses Cost of goods sold ................................ Operating expenses .............................. Interest expense .................................... Income before income tax ...................

$750,000 2,739 8,000 800 $761,539

$370,000 180,000 15,322

Dec. 31 Income Tax Expense [($196,217 × 27%) – $50,000].......... 2,979 Income Tax Payable...................

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565,322 196,217

2,979

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CUMULATIVE COVERAGE (Continued) (c)

(Continued) PLANKTON CORPORATION Trial Balance December 31, 2015

Debit

Credit

Cash ($48,000 + $25,000 – $19,200 – $108,200 + $20,000 – $20,000 + $20,200 + $50,000 – $1,521 + $480) ........................................... $ 14,759 Accounts receivable ........................................ 51,000 Allowance for doubtful accounts .................... $ 2,500 Interest receivable............................................ 2,500 Merchandise inventory ................................... 22,700 Investment in associate—RES ($85,000 + $8,000 – $480) ............................ 92,520 Long-term investment—Solar bonds 107,864 ($108,200 – $336) ......................................... Long-term investment—BCB common shares ($30,000 – $2,000) ............ 28,000 Land .................................................................. 90,000 Building............................................................. 200,000 Accumulated depreciation—building ............ 40,000 Equipment......................................................... 40,000 Accumulated depreciation—equipment ......... 15,000 Accounts payable............................................. 18,775 Dividends payable ............................................ 1,000 Income tax payable ($4,500 + $2,979) ............. 7,479 Interest payable ................................................ 7,800 Note payable ($50,000 – $1,271) ...................... 48,729 Bonds payable (6%, due 2019) ($126,025 + $ 1,022) ..................................... 127,047 $2-noncumulative preferred shares, convertible no par value, 500 issued 12,500 ($25,000 – $12,500)........................................ Common shares, no par value, 102,500 issued 112,500 ($100,000 + $12,500)...................................... Solutions Manual .

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CUMULATIVE COVERAGE (Continued) (c) (Continued) PLANKTON CORPORATION Trial Balance (Continued) December 31, 2015 Debit

Credit 110,775

Retained earnings ........................................ Cash dividends............................................. 1,000 Accumulated other comprehensive income 5,000 Sales.............................................................. 750,000 Cost of goods sold....................................... 370,000 Operating expenses ..................................... 180,000 Interest revenue ($375 + $200 + $2,164) ..... 2,739 Interest expense ($6,250 + $250 + $8,822) .. 15,322 Revenue from investment in associate—RES ....................................... 8,000 Income tax expense ($50,000 + $2,904) ...... 52,979 Gain on sale of trading investments........... 800 Other Comprehensive Income: Loss on fair value adjustment ............................... 2,000 Totals $1,270,644 $1,270,644

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CUMULATIVE COVERAGE (Continued) (d) PLANKTON CORPORATION Income Statement Year Ended December 31, 2015 Sales................................................................................ $750,000 Cost of goods sold......................................................... 370,000 Gross profit .................................................................... 380,000 Operating expenses ....................................................... 180,000 Profit from operations.................................................... 200,000 Other revenues Interest revenue ................................................ $2,739 Revenue from long-term equity investment . 8,000 Gain on sale of trading investments ............... 800 11,539 211,539 Other expenses Interest expense ........................................................ 15,322 Profit before income tax ................................................ 196,217 Income tax expense ....................................................... 52,979 Profit................................................................................ $143,238

PLANKTON CORPORATION Statement of Comprehensive Income Year Ended December 31, 2015 Profit............................................................................ Other comprehensive income Loss on fair value adjustment ................................ Comprehensive income .............................................

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$143,238 2,000 $141,238

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Statement of Changes in Shareholders’ Equity Year Ended December 31, 2015

Share capital, preferred shares Balance, January 1, ................................................ Issued for cash, 1,000 shares ........................... Converted 500 shares ........................................ Balance, December 31, 500 shares issued ........... Share capital, common shares Balance, January 1, 100,000 shares issued .......... Converted preferred shares, 2,500 shares ....... Balance, December 31, 102,500 shares issued .... Retained earnings Balance, January 1, ................................................ Profit ................................................................... Cash dividends................................................... Balance, December 31............................................ Accumulated other comprehensive income Balance, January 1 ................................................. Other comprehensive income (loss) ................ Balance, December 31............................................ Total shareholders' equity..........................................

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0 25,000 (12,500) 12,500

$100,000 12,500 112,500 $110,775 143,238 (1,000) 253,013 $ 5,000 (2,000) 3,000 $381,013

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Balance Sheet December 31, 2015

Assets Current assets Cash................................................................................ $ 14,759 Accounts receivable .........................................$51,000 Less: Allowance for doubtful accounts ........ 2,500 48,500 Interest receivable ........................................................ 2,500 Merchandise inventory .................................................. 22,700 Total current assets ..................................................... 88,459 Non-current Long-term investments Long-term investment, at fair value.................$28,000 Long-term investment in bonds at amortized cost ..........................................107,864 Investment in associate RES ...........................92,520 Total investments ....................................................... 228,384 Property, plant and equipment Land ..................................................................$ 90,000 Building ........................................... $200,000 Less: Accumulated depreciation ... 40,000 160,000 Equipment ........................................ $ 40,000 Less: Accumulated depreciation .. 15,000 25,000 Total property, plant and equipment......................... 275,000 Total assets .............................................................. $591,843

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Balance Sheet (Continued) December 31, 2015

Liabilities and Shareholders' Equity Current liabilities Accounts payable .......................................................... $ 18,775 Dividends payable ...................................................... 1,000 Income tax payable..................................................... 7,479 Interest payable .......................................................... 7,800 Current portion of note payable..................................... 15,757 Total current liabilities........................................... 50,811 Long-term liabilities Notes payable, 6%, due 2018 ........................ $ 32,972* Bonds payable, 6%, due 2019 ........................ 127,047 Total long-term liabilities ......................................... 160,019 Total liabilities .......................................................... 210,830 Shareholders' equity Share capital $2-noncumulative preferred shares, convertible, no par value, 500 shares issued .................................. $ 12,500 Common shares, no par value, unlimited number of shares authorized, 102,500 shares issued ........................... 112,500 125,000 Total share capital ............................................. Retained earnings ...................................................... 253,013 Accumulated other comprehensive income ............. 3,000 Total shareholders' equity ................................ 381,013 Total liabilities and shareholders' equity......... $591,843 *($48,729 – $15,757 = $32,972) Solutions Manual .

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CUMULATIVE COVERAGE (Continued) (e) If Plankton had purchased the Solar Inc. bonds to trade, the bond investment would have been accounted for at fair value instead of amortized cost. The bonds would have been classified as current assets on the balance sheet. In this case the bonds which had a carrying amount of $107,864 based on amortized cost, would have been reported at the fair value of $106,000 ($100,000 × 106%). The reduction in the carrying amount would have a modest reduction of profit in the amount of $1,864 ($107,864 – $106,000). This difference of $1,864 reconciles with the interest revenue recognized at amortized cost of $2,164 and the interest received of $2,500 ($336) and the amount of the change in the market price of the bonds from the date of acquisition to the year end date. ($108,200 – $106,000 = $2,200) (f)

If Plankton Corporation were a private company and reported under ASPE, it would present an income statement only. The amount for profit would remain the same. The balance sheet would not include Accumulated Other Comprehensive Income in Shareholders’ equity. The Long-term investment in common shares in RBC would be shown at its fair value if there is a quoted fair value from an active market; otherwise it would be shown at its carrying value.

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BYP 16-1 FINANCIAL REPORTING PROBLEM

The fair value gains reported on the comprehensive income statement of Reitmans (Canada) Limited for the year ended January 28, 2012 in the amount of $530,000 relate to other investments (called available-for-sale financial assets) and not to trading investments (called marketable securities) on the balance sheet. Fair value adjustments on trading investments must go through profit. Companies may choose to record fair value adjustments on non-trading investments in other comprehensive income.

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BYP 16-2 INTREPRETING FINANCIAL STATEMENTS (a) Royal Bank likely chooses to invest a higher percentage of its trading investments in debt instruments instead of equity instruments to reduce the risk of losses due to market fluctuations since the bank may need access to the money on short notice to issue new loans to clients. Debt investments are low risk and typically low income yielding investments, while equity investments are higher risk and potentially higher income yielding investments. Royal Bank favours the lower risk investments. (b) Since both debt and equity trading investments are actively traded on the stock and bond markets, they will be valued on Royal Bank’s balance sheet at fair value. (c) Royal Bank has a higher percentage of its trading investments in government instruments as opposed to other debt instruments to reduce risk. Government debt investments are low risk and typically low income yielding investments, while non-government corporate debt investments are higher risk and potentially higher income yielding investments. Royal Bank favours the lower risk investments. (d) The Royal Bank chooses to report long-term strategic equity investment gains and losses from the fair value adjustments in other comprehensive income to remove the market fluctuations from profit. The realized gains and losses from market fluctuations will be reflected in profit when the investments are sold. This has the advantage of reducing the volatility of profit. The disadvantage is that the profit figure does not reflect all gains and losses from market fluctuations. Only gains and losses from trading and non-strategic investments are included.

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BYP 16-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

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BYP 16-4 COMMUNICATION ACTIVITY

Memo to: President of Lunn Financial Enterprises From: Accountant Subject: Reporting of debt investments at amortized cost and at fair value. Debt investments are reported at both amortized cost and at fair value depending on the intentions of management in acquiring the investment. For example, debt investments that are acquired for the purposes of earning interest are reported at amortized cost. This treatment is required because the primary purpose of the investment is to hold the investment and earn interest, and not to trade and realize gains on market fluctuations. Using amortized cost provides a more relevant balance sheet valuation and a more accurate representation of the profit generated from the investment. It also allows users to assess cash flows from the receipt of interest. Debt investments may also be acquired for speculative purposes and sold to generate gains. For these investments, fair value results in a more relevant value for balance sheet presentation purposes. In this case, the earning of interest revenue is incidental. The fair value measure of the investment allows users to better predict cash flows and assess the company’s liquidity and solvency. The method applied to debt investments is based on the purpose of the investment and management’s intention at the time the investment is purchased. Each method shows financial results on the income statement based on the intention of the investment – debt investments acquired to receive interest will report mostly interest revenue whereas debt investments acquired for trading will mostly generate gains and losses from fair value adjustments and selling.

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BYP 16-5 ETHICS CASE

(a) By classifying the securities that have increased in fair value as trading investments, the company would show any gains on the fair value adjustment of these securities on its income statement. It is also true that any losses on the company’s strategic investments would not affect the company’s income statement until these investments are sold. By classifying the debt securities that have decreased in market value as investments held to earn interest, the company would avoid showing any losses on the fair value of these debt investments on its income statement. It is also true that any gains on the company’s strategic securities would not affect the company’s income statement. (b) What Lemke proposes is unethical since it is knowingly not in accordance with IFRS. It is the company’s intention with respect to its investment securities and not their potential effects on earnings that should determine how they are classified. (c) The affected stakeholders are other members of the company’s officers and directors, the independent auditors, the shareholders, and prospective investors. (d) The qualitative characteristic of faithful representation is not met if the investments are classified based on performance. The classification is meant to reflect the purpose of each investment for both balance sheet and income statement presentation. Classification based on performance also violates neutrality because it factors in a bias to attain a predetermined result.

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BYP 16-5 (Continued)

(e) Under IFRS: - Trading investments (debt and equity) are classified as current assets and reported at fair value with the realized and unrealized gains and loss reporting in profit. - Short-term debt investments purchased to earn interest are classified as current assets and reported at amortized cost. - Debt investments purchased to earn interest, with maturities longer than 12 months, are classified as longterm investments and reported at amortized cost. - Strategic investments reported at fair value are classified as long-term investments. - Investments in associates accounted for using the equity method are classified as long-term investments.

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BYP 16-6 “ALL ABOUT YOU” ACTIVITY

(a) An RRSP is primarily intended for retirement savings. RRSP’s provide an incentive to Canadians to invest because of a tax deduction for RRSP contributions. Contributions to a TFSA are not tax-deductible. An investment in an RRSP is usually considered strategic in that it is part of an individual’s long-term strategy for retirement planning. A TFSA investment may be either strategic or non-strategic. It can be used as part of a longterm strategic plan for income growth or for short-term purposes. (b) The type of investment income that can be generated from equity securities include: dividend and gains from the sale of the investments. Bonds can generate interest income as well as from the sale of the bonds. While the equity securities offer more variety in the types of companies in which to invest, they bring with them higher risk due to market fluctuations but also potentially higher returns. (c) Assuming monthly contributions of $200 per month for 20 years at a return of 6%, using an income range of $10,000 to $39,999, the TFSA account would yield a balance of $92,870 vs. $85,894 for a taxable account, an increase of $6,976. (d) Assuming monthly contributions of $200 per month for 20 years at a return of 6%, but using an income range of $40,000 to $79,999, the TFSA account would yield a balance of $92,870 vs. $80,024 for a taxable account, an increase of $12,846.

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BYP 16-6 (Continued)

(e) Assumptions used by the TFSA calculator: 1. Monthly investment contributions are made at the beginning of each month. 2. Provincial tax rates are equal to half of the federal income tax rate. 3. The investment portfolio is diversified with a return consisting of 40% interest, 30% dividends and 30% capital gains.

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CHAPTER 17 The Cash Flow Statement ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems Problems Set A Set B

1. Describe the purpose 1, 2, 3, 4, and content of the 5, 6, 7 cash flow statement.

1, 2

2. Prepare a cash flow statement using either: the indirect method or the direct method.

8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21

3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18

3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13,

2A, 3A, 2B, 3B, 4A, 5A, 4B, 5B, 6A, 7A, 6B, 7B, 8A, 9A, 8B, 9B, 10A, 11A, 10B, 11B, 12A 12B

3. Analyze the cash flow statement.

22, 23, 24,

14, 15

13A

Study Objectives

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17-1

13B

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Classify transactions by activity. Indicate impact on cash and profit.

Simple

25-35

Prepare operating activities section–indirect and direct methods.

Moderate

30-40

Prepare operating activities section–indirect and direct methods.

Moderate

25-35

Calculate cash flows for investing activities and financing activities.

Complex

50-60

Prepare cash flow statement–indirect method.

Moderate

20-25

Prepare cash flow statement–direct method.

Moderate

20-25

Prepare cash flow statement–indirect method.

Moderate

30-40

Prepare cash flow statement–direct method.

Moderate

30-40

Prepare cash flow statement–indirect method.

Moderate

30-40

10A

Prepare cash flow statement–direct method.

Moderate

30-40

11A

Prepare cash flow statement–indirect method.

Moderate

30-40

12A

Prepare cash flow statement–direct method.

Moderate

30-40

13A

Calculate free cash flow and evaluate cash.

Simple

10-15

Classify transactions by activity. Indicate impact on cash and profit.

Simple

25-35

Prepare operating activities section–indirect and direct methods.

Moderate

30-40

Prepare operating activities section–indirect and direct methods.

Moderate

25-35

Calculate cash flows for investing activities and financing activities.

Complex

50-60

Prepare cash flow statement–indirect method.

Moderate

20-25

Prepare cash flow statement–direct method.

Moderate

20-25

Prepare cash flow statement–indirect method.

Moderate

30-40

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare cash flow statement–indirect method.

Moderate

30-40

10B

Prepare cash flow statement–direct method.

Moderate

30-40

11B

Prepare cash flow statement–indirect method.

Moderate

30-40

12B

Prepare cash flow statement–direct method.

Moderate

30-40

13B

Calculate free cash flow and evaluate cash.

Simple

10-15

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objective 1. Describe the purpose and content of the cash flow statement. 2. Prepare a cash flow statement using either: the indirect method or the direct method.

Knowledge Q17-2 Q17-5 Q17-7

Comprehension Q17-1 Q17-3 Q17-4 Q17-6 BE17-2 Q17-8 Q17-9 Q17-10 Q17-11 Q17-12 Q17-13 Q17-14 Q17-15 Q17-17 Q17-18 Q17-19 Q17-20 Q17-21

Analyze the cash flow statement.

Q17-16 BE17-3 BE17-4 BE17-5 BE17-6 BE17-7

E17-10 E17-11 E17-12 P17-2A P17-3A P17-4A

BE17-8 BE17-9 BE17-10 BE17-11 BE17-12 BE17-13 BE17-14 BE17-15 BE17-16 BE17-17 BE17-18 E17-2 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9

P17-5A P17-6A P17-7A P17-8A P17-9A P17-10A P17-11A P17-12A P17-2B P17-3B P17-4B P17-5B P17-6B P17-7B P17-8B P17-9B P17-10B P17-11B P17-12B

Q17-22 Q17-23 Q17-24

Broadening Your Perspective

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Application BE17-1 E17-1 P17-1A P17-1B

Continuing Cookie Chronicle

17-4

Analysis

Synthesis

BE17-19 E17-13 E17-14 P17-13A P17-13B BYP17-1 BYP17-2 BYP17-3 BYP17-4

Evaluation

BYP17-5 BYP17-6

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ANSWERS TO QUESTIONS 1.

A cash flow statement is a statement that shows sources and uses of cash classified along the three main lines of business activities: operating, investing and financing. The cash flow statement is useful because it helps investors, creditors and others assess the following aspects of the firm’s financial position:    

the company’s ability to generate future cash flows the ability of the company to pay dividends and meet obligations the reasons for the difference between profit and cash provided (used) by operating activities the cash investing and financing transactions during a period.

For the cash flow statement preparation, cash is generally defined as cash on hand (coins, paper currency, cheques) and money on deposit at a bank less any bank overdrafts.

Cash equivalents are short-term, highly-liquid investments that are both: (1) readily convertible to known amounts of cash and (2) so near their maturity that their market value is relatively insensitive to changes in interest rates. Generally, only investments with original maturities of three months or less qualify under this definition. Cash equivalents, being equivalent to cash, are treated as cash; i.e., included in the cash account balance and the increase or decrease in the cash balance. As such, they should be included with cash when preparing the cash flow statement.

The three activities are: Operating activities include the cash effects of transactions that create revenues and expenses, and enter into the determination of profit. An example would be a sale of goods for cash. Investing activities include: (a) acquiring and disposing of investments and productive long-lived assets and (b) lending money and collecting loans. An example is buying land (not for resale) for cash. Financing activities include: (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders and providing them with a return on their investment. An example is the payment of the principal on a mortgage payable.

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QUESTIONS (Continued) 5.

In general terms, current assets and current liabilities relate to accruals contained in the operating activities and are used to adjust income statement elements (revenues and expenses) and convert them to cash collections and cash payments. Non-current assets generally involve investing activities and are used to extract information about sources and uses of cash in investing activities. Long-term liabilities and equity items involve financing activities and are used to extract information about sources and uses of financing activities. An exception to these general guidelines is a short term note payable that does not relate to purchases. Although this note payable is classified as a current liability, it is a result of the business borrowing and later repaying a note payable. Consequently cash transactions relating to this note payable would be classified as financing activities.

Mandeep’s request to reclassify interest paid from the operating activities to the financing activities of the cash flow statement appears to demonstrate an intention to engineer the financial reports. Most likely, the reclassification will improve the cash generated by operating activities and minimize the impact of a poor performance. This motive is evidenced by the president’s suggestion that the classification as operating activity could be resumed next year. The reclassification of interest paid as a financing activity is allowed under IFRS as an alternative to using the operating activity normal classification. The classification adopted and followed in prior fiscal years should be followed in the current year for reasons of consistency and comparability. If the reclassification between cash flow categories is adopted and applied retroactively to all prior years reported on the comparative cash flow statement, then consistency will be re-established. Any retroactive change in the classification will warrant a note disclosure to the financial statements to that effect.

Since the transaction involving the acquisition of the equipment and the issuance of the shares are with the same entity, they do not represent independent transactions of borrowing and then investing the cash in equipment. Geoff, the chief financial officer is incorrect. The exchange of equipment for common shares at their fair market value will nonetheless be disclosed in the financial statement notes.

The cash flow statement is prepared from a comparative balance sheet, an income statement and selected transaction information. It presents information that is not readily available in the other financial statements since the balance sheet and income statement are prepared on an accrual basis.

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QUESTIONS (Continued) 9.

Revenues and expenses, and consequently profit are recognized based on the accrual method of accounting and not on the cash basis of accounting. Consequently, profit and loss reported on the income statement will be consistent with cash increase and decreases. A number of factors could have caused a decrease in cash despite the company earning profit. These include (1) low cash-based revenues relative to high cash-based expenses; (2) purchase of property, plant, and equipment; (3) purchase of investments; and (4) repayment of debt or reacquisition of share capital. An increase in cash could have occurred despite a loss. Factors that could lead to this include (1) high cash-based revenues relative to low cash-based expenses; (2) sales of property, plant, and equipment; (3) sales of investments; and (4) issuing of debt or share capital.

10.

When revenues and expenses are recorded using accrual basis accounting, it is necessary to adjust profit for the changes in the related noncash current assets and current liabilities to determine the amount of cash provided from operations. These adjustments are necessary when using the indirect method of showing cash provided (used) by operating activities. Increases in current assets occur when cash has been spent acquiring assets not yet used in operations, or not yet converted to cash from operations. Consequently, the amount of the increase of these asset balances must be deducted from profit to arrive at cash provided (used) by operations. Similarly, when noncash current liabilities increase, it is generally because expenses have been incurred for which payments have not yet been made. Since no cash has yet been spent, the increases in these liability accounts balances are added to profit to arrive at cash provided (used) by operations.

11.

Vijaya is incorrect. While it is true that depreciation is an expense that does not involve cash flow, it is an expense that has been deducted from revenues to arrive at the profit. When using the indirect method, we add back the depreciation expense to profit effectively cancelling this expense to arrive at the amount of cash provided (used) by operations.

12.

Gains and losses do not normally arise from operating activities. Under the indirect method, losses are added back to profit, and gains are deducted from profit, to reconcile profit to net cash provided by operating activities. Since losses are deductions in calculating profit, and are already included in the profit figure; adding them back to profit effectively cancels them. Conversely, gains have already increased profit, so deducting them cancels their effect on profit.

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QUESTIONS (Continued) 13.

When bonds are issued at a premium, the amount of cash paid for interest is less than the total amount of the interest expense that will be incurred over the term of the bond, by the amount of the premium. When the premium is amortized, that portion of interest expense recorded does not involve cash. Consequently an adjustment must be made to the amount of profit to convert interest expense (lower than cash interest paid) to the amount of interest paid. An addition to profit is made in this case, for amortizing a premium. The opposite is true for discounts, using the same logic. A deduction to profit is needed to convert the interest expense (higher than amount of cash interest paid) to arrive at the amount of cash used to pay interest.

14.

Sales on the income statement include cash and credit sales made in the current period only. Cash collected from customers on the statement of cash flows can come from sales in the current or previous periods, and not all current period sales are collected in the current period.

15.

Depreciation expense is not listed in the direct method operating activities section because it is not a cash flow item—it does not affect cash. Recall the journal entry to record depreciation: debit Depreciation Expense and credit Accumulated Depreciation. No cash is involved in this entry.

16.

No, Terry is incorrect. Since at the date of the investment, the bonds were purchased at a discount, the amount of the interest revenue will not equal the amount of cash interest received over the term of the bond, by the amount of discount. The total amount of interest earned will be higher than the amount of cash interest received by the amount of the discount at the date of purchase. The amount of the amortization of the bond discount will be deducted from the profit to arrive at the cash provided (used) by operations.

17.

The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that it does not reconcile the cash flows from operating activities with profit. The advantage of the indirect method is its reconciliation of profit to net cash provided by operating activities. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation. Both methods are acceptable. Standard setters prefer the direct method. Most companies favour the indirect method because: (1) it is easier to prepare, (2) it provides a reconciliation between profit and net cash flow from operating activities, (3) it also discloses less competitive information about the company and (4) it is the format most familiar to users of financial statements.

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QUESTIONS (Continued) 18.

The change in method of reporting will have no effect on the cash provided (used) by operating activities. Although the approaches are different, both the direct and indirect methods will produce the same net cash provided by operating activities.

19.

The cash received from the sale of equipment is reported as an inflow in the investing activities section. Neither the gain nor the loss itself provided or used cash from operating activities. Because a gain does not provide cash from operating activities, it must be deducted from profit in the operating activities section of a cash flow statement prepared using the indirect method. The noncash gain, which was included in profit, must be deducted from profit on the cash flow statement to convert profit to net cash provided by operating activities. When the statement is prepared using the direct method, any gain is simply excluded from the operating activities section. Because a loss does not use cash from operating activities, it must be added to profit in the operating activities section of a cash flow statement prepared using the indirect method. The noncash loss, which was deducted from profit in the income statement, must be added to profit on the cash flow statement to convert profit to net cash provided by operating activities. When the statement is prepared using the direct method, any loss is simply excluded from the operating activities section.

20.

Unless a cash dividend is paid, the simple declaration of a dividend which causes it to be reported as a reduction of retained earnings in the statement of changes in shareholder’s equity will not result in any reduction in cash reported as an outflow in the cash flow statement.

21.

When short-term notes receivable relate to trade (i.e., sale of merchandise or settlement of accounts receivable) transactions, they should be reported in the operating activities section of the cash flow statement along with the revenue accounts to which they relate. When short-term notes receivable relate to lending, they should be reported in the investing activities section of the cash flow statement.

22.

A financially healthy, growing company will generally be generating positive flows from operating activities. Growth is evidenced by negative flows in investing activities as the company purchases property, plant, and equipment and replaces older assets to assist its growth. The financing activities section will usually show negative flows as the company repays debt and pays dividends to owners or occasionally positive flows if the company is issuing debt to finance growth.

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QUESTIONS (Continued) 23.

Companies in the early stages of development typically have negative flows from operating activities and investing activities, and positive flows from financing activities. The companies are issuing debt and/or equity and using the funds to acquire property, plant, and equipment. In the early stages of development, the company is not operating at its optimal level and generally experiences a loss or a small profit.

24.

If the net capital expenditures exceed the cash provided by operating activities, the free cash flow will be negative.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17-1 (a) (b) (c) (d) (e) (f) (g) (h) (i)

− + − − NE + + NE NE

BRIEF EXERCISE 17-2 (a) (b)

(i)

(F) Financing activity (I) Investing activity (Note: The sale of land is an investing activity. If using the indirect method the loss is added back under operating activities to cancel its impact on profit.) (F) Financing activity (O) Operating activity (NC) Significant noncash activity (F) Financing activity (O) Operating activity None. Depreciation expense is reported in the operating activities section using the indirect method only to cancel it from profit. It is neither a source nor a use of cash in any way. None. The payment of cash dividends results in a financing activity. The declaration is not a use of cash.

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BRIEF EXERCISE 17-3 (a) (b) (c) (d) (e) (f) (g) (h) (i)

+ + − − + + − + +

BRIEF EXERCISE 17-4 DIAMOND INC. Cash Flow Statement (Partial) Year Ended November 30, 2014

Operating activities Profit ............................................................................... $ 850,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $175,000 Loss on the sale of equipment ................... 25,000 Decrease in accounts receivable .......... 80,000 Increase in prepaid expenses.................... (35,000) Decrease in accounts payable .............. (170,000) .. 75,000 Net cash provided by operating activities .............. $925,000

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BRIEF EXERCISE 17-5 MIRZAEI LTD. Cash Flow Statement (Partial)—Indirect Method Year Ended March 31, 2014 Operating activities Profit .................................................................. $330,000 Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ................................ $50,000 Gain on sale of equipment .......................... (45,200) Increase in trading investments............. (5,000) Increase in accounts receivable ................. (20,000) Decrease in inventory ............................. 7,000 Decrease in prepaid expenses ............... 2,000 Decrease in accounts payable ............... (5,000) Increase in income tax payable .............. 6,000 (10,200) Net cash provided by operating activities.......... $319,800

BRIEF EXERCISE 17-6 Sales revenue ............................................. $640,000 Add: Decrease in accounts receivable ..... 13,650 Cash receipts from customers.................. $653,650

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BRIEF EXERCISE 17-7 (a) Increase in inventory ................................. Add: Cost of goods sold ............................ Cost of goods purchased ..........................

$ 5,600 89,500 $95,100

(b) Cost of goods sold..................................... Add: Increase in inventory......................... Less: Increase in accounts payable ......... Cash payments to suppliers......................

$89,500 5,600 (7,200) $87,900

BRIEF EXERCISE 17-8 Operating expenses ......................................... $100,000 Plus: Increase in prepaid expenses................ 10,900 Less: Increase in accrued expenses payable (6,400) Cash payments for operating expenses ......... $104,500

BRIEF EXERCISE 17-9 Salaries expense .............................................. $188,000 Add : Decrease in salaries payable................. 1,500 Cash payments to employees ......................... $189,500

BRIEF EXERCISE 17-10 (a) The bonds were sold at a premium since the carrying amount is decreasing. (b) Interest expense........................................ Amortization of bond premium ................ Cash payments for interest ......................

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17-14

$25,000 5,000 $30,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-11 Loss from fair value adjustment of trading investments $ 5,500 Increase in trading investments...................... 15,000 Cash payment for purchase of trading investments $20,500 Trading Investments Beg. Bal. 2013 30,000 FV adj. Purchases 20,500 End. Bal. 2014 45,000

5,500

BRIEF EXERCISE 17-12 Income tax expense ............................................. $90,000 Less increase in income tax payable .................. (9,000) Cash payments for income tax............................ $81,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-13 ANGUS MEAT CORPORATION Cash Flow Statement (Partial) Year Ended December 31, 2014

Operating activities Cash receipts from customers1 ................................. $350,000 Cash payments: To suppliers2 ....................................... $(164,000) For operating expenses3 ................... (71,000) 4 For income taxes .............................. (45,000) (280,000) Net cash provided by operating activities ............. $ 70,000 1.

Sales revenue ............................................ $375,000 Less: Increase in accounts receivable .... (25,000) Cash receipts from customers ................. $350,000

Cost of goods sold .................................... $150,000 Add: Increase in inventory ...................... 7,000 Add: Decrease in accounts payable ....... 7,000 Cash payments to suppliers ..................... $164,000

Operating expenses .................................. Less: Decrease in prepaid expenses....... Cash payments for operating expenses ..

$75,000 (4,000) $71,000

Income tax expense .................................. Less: Increase in income tax payable...... Cash payments for income tax.................

$50,000 (5,000) $45,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-14 (a) Indirect method: Operating activities: Loss on sale of equipment

$ 1,500

Investing activities: Sale of equipment

17,000*

The operating activities section would also show depreciation expense of $12,000 and the investing activities section would show purchase of equipment of $(41,600). * Cash ............................................ 17,000 Loss on Sale of Equipment .......... 1,500 Accumulated Depreciation .......... 5,500 Equipment ................................................ 24,000 (b) Under the direct method, the operating activities section would not show the loss. The investing activities section would be the same as the indirect method.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-15 Investing activities: Proceeds from sale of land ...................................$120,000 1 Equipment purchase .............................................. (147,000) 2 Proceeds from equipment sale................................ 23,000 3 Net cash used by investing activities..................... $ (4,000) 1.

Decrease in land ($180,000 − $95,000)........... $ 85,000 Plus gain .......................................................... 35,000 Cash proceeds from sale of land ................... $120,000

Balance in equipment account, Dec. 31, 2014 $237,000 Less: balance in account before equipment purchase: Balance, Jan. 1, 2014 ............... $148,000 Less cost of equipment sold.. (58,000) 90,000 Cost of equipment purchased ........................ $147,000

Carrying amount of equipment sold ............... Plus gain ........................................................... Cash proceeds from sale of equipment ........

$18,000 5,000 $23,000

BRIEF EXERCISE 17-16 Dividends paid $46,000 Proof: Retained earnings December 31, 2014 .............. Profit..................................................................... Retained earnings, December 31, 2013 ............. Dividends declared during 2014 ........................ Increase in dividends payable............................ Cash payment for dividends...............................

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$ (261,000) 197,000 114,000 50,000 (4,000) $ 46,000

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-17 Financing activities Sale of common shares 1 ............................ $ 10,000 Repayment of mortgage payable ................... (25,000) Payment of cash dividends 2..........................(60,000) Net cash used by financing activities ....................... (75,000) 1.

$10,000 = $55,000 − $45,000

Payment of cash dividends: Retained earnings, beginning of year ........................ $85,000 Add: Profit.................................................................. 145,000 230,000 Less: Cash dividends declared (calculated) ............ (65,000) Retained earnings, end of year ................................ $165,000 Dividends payable, beginning of year ..................... $15,000 Add: Cash dividends declared ................................. 65,000 80,000 Less: Cash dividends paid (calculated)................... (60,000) Dividends payable, end of year ................................ $20,000

Note X: During the year, the company acquired a building with a cost of $500,000 by paying $200,000 cash and incurring a mortgage payable of $300,000. The increase in bonds payable of $5,000 comes from the bond discount amortization of $5,000.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-18 BAKER CORPORATION Cash Flow Statement—Direct Method Year Ended April 30, 2014

Operating activities Net cash provided by operating activities ............

$ 49,000

Investing activities Proceeds from sale of equipment .......... $ 6,000 Purchase of land (Note X) ........................ (25,000) Net cash used by investing activities ...............

(19,000)

Financing activities Proceeds from issue of note payable ...... $20,000 Payment to reacquire common shares .. (19,000) Payment of dividends ............................... (25,000) Net cash used by financing activities...............

(24,000)

Net increase in cash ................................................... Cash, May 1 ................................................................. Cash, April 30 ..............................................................

6,000 8,500 $ 14,500

Note X: Land was purchased by paying $25,000 issuing a mortgage note payable for $75,000.

cash and

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 17-19 (a) Free cash flow = Cash provided (used) by operating activities − Cash used (provided) by investing activities Company A Company B = $(10,000) − $70,000 = $50,000 − $(30,000) = $(80,000) = $80,000 (b) Company A is more likely to be in the early stages of its development. It has negative cash flow from operating and investing activities and positive cash flow from financing. This indicates the company issued debt and/or equity and used some of the money to buy assets and fund its operations.

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 17-1 Transaction 1. Sold inventory for $1,000 cash. 2. Purchased machine for $30,000. Made a $5,000 down payment and issued long-term note for the remainder. 3. Issued common shares for $50,000. 4. Collected $16,000 of accounts receivable. 5. Paid a $25,000 cash dividend. 6. Sold a long-term equity investment with a carrying value of $15,000 for $10,000 cash. 7. Redeemed bonds having an amortized cost of $200,000 for $175,000. 8. Paid $18,000 on accounts payable. 9. Purchased inventory for $28,000 on account. 10. Purchased a long-term investment in bonds for $100,000. 11. Sold equipment with a carrying amount of $16,000 for $13,000. 12. Paid $12,000 interest expense on long-term notes payable.

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(a) Classification O

(b) Cash Inflow or Outflow +$1,000

−$5,000

NC F

NE +$50,000

+$16,000

F I

−$25,000 +$10,000

−$175,000

O NC

−$18,000 NE

−$100,000

+$13,000

−$12,000

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EXERCISE 1723 PESCI LTD. Cash Flow Statement (Partial) Year Ended November 30, 2014

Operating activities Profit ............................................................................... $ 78,000 Adjustments to reconcile profit to net cash provided (used) by operating activities: Depreciation expense ............................... $50,000 Gain on sale of equipment......................... (10,000) Decrease in accounts receivable ............... 36,000 Increase in inventory ................................. (19,000) Increase in prepaid expenses ..................... (2,000) Decrease in accounts payable .................. (12,000) Decrease in income taxes payable .......... (4,000) 39,000 Net cash provided by operating activities .................. $117,000

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EXERCISE 1724 PESCI LTD. Cash Flow Statement (Partial) Year Ended November 30, 2014

Operating activities Cash receipts from customers1 ................................. $984,000 Cash payments: To suppliers2 ....................................... $(521,000) For operating expenses3 ................. (312,000) 4 For income taxes ............................ (34,000) (867,000) Net cash provided by operating activities .............. $117,000 1.

Sales revenue ............................................ $948,000 Add: Decrease in accounts receivable .... 36,000 Cash receipts from customers ................. $984,000

Cost of goods sold .................................... $490,000 Add: Increase in inventory ...................... 19,000 Add: Decrease in accounts payable ....... 12,000 Cash payments to suppliers ..................... $521,000

Operating expenses .................................. $310,000 Add: Increase in prepaid expenses ......... 2,000 Cash payments for operating expenses .. $312,000

Income tax expense .................................. Add: Decrease in income tax payable...... Cash payments for income tax.................

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$30,000 4,000 $34,000

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EXERCISE 17-4 CHARRON INC. Cash Flow Statement (Partial) Year Ended October 31, 2014

Operating activities Profit ................................................................................ $87,000 Adjustments to reconcile profit to net cash provided (used) by operating activities: Depreciation expense ............................... $23,000 Loss on sale of equipment ......................... 10,000 Increase in trading investments* .............. (12,000) Increase in accounts receivable ............... (11,000) Decrease in inventory ................................. 13,500 Increase in prepaid expenses ..................... (1,700) Increase in accounts payable ....................... 7,000 Decrease in accrued expenses payable .. (3,000) Decrease in income taxes payable .......... (5,000) 20,800 Net cash provided by operating activities .................. $107,800 * Includes gain on fair value adjustment of trading investments of $2,000.

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EXERCISE 17-5 (a) Sales revenue........................................... Less: Increase in accounts receivable .. Cash receipts from customers................

$275,000 (14,100) $260,900

(b) Cost of goods sold................................... Less: Decrease in inventory................... Add: Decrease in accounts payable ..... Cash payments to suppliers....................

$110,000 (3,300) 1,700 $108,400

(c) Operating expenses ................................. Less: Depreciation expense ................... Add: Increase in prepaid expenses ........ Increase in accrued expenses payable........................................ Cash payments for operating expenses..

$70,000 (20,000) 2,500

(d) Interest expense....................................... Less: Increase in bonds payable from amortization of discount ............ Cash payments for interest expense ......

$18,000

(e) Gain on fair value adjustment ................. Less: increase in trading investments ... Cash payments for trading investments

$(6,000) 9,000 $ 3,000

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2,000 $54,500

(2,000) $16,000

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EXERCISE 17-6 McTAVISH LTD. Cash Flow Statement (partial)—Direct Method Year Ended September 31, 2014

Operating activities Cash receipts Cash receipts from customers 1.............................. $262,000 Cash payments For operating expenses 2...................... $(114,600) For interest 3 ......................................... (3,500) 4 For income taxes ............................... (28,700) (146,800) Net cash provided by operating activities ......... $115,200 1. Cash receipts from customers Service revenue .................................................. Less: Increase in accounts receivable.............

2. Cash payments for operating expenses Operating expenses ........................................... Add: Increase in prepaid expenses ................... Less: Increase in accrued expenses payable...

3. Cash payments for interest Interest expense ................................................. Less: Increase in interest payable.....................

4. Cash payments for income taxes Income tax expense............................................ Less: Increase in Income taxes payable ...........

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$285,000 (23,000) $262,000

$122,000 3,100 (10,500) $114,600

$4,000 (500) $ 3,500

$38,500 (9,800) $28,700

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EXERCISE 1728 CHARRON INC. Cash Flow Statement (partial)—Direct Method Year Ended December 31, 2011 Operating activities Cash receipts Cash receipts from customers 1.............................. $614,000 Cash payments To suppliers 2 ........................................ $(369,500) For operating expenses 3 .................... (92,700) 4 For trading investments .................... (10,000) 5 For income taxes ............................... (34,000) (506,200) Net cash provided by operating activities ......... $107,800 1. Cash receipts from customers Sales .................................................................... Less: Increase in accounts receivable............. 2. Cash payments to suppliers Cost of goods sold ............................................. Less: Decrease in inventory .............................. Increase in accounts payable .................. 3. Cash payments for operating expenses Operating expenses ........................................... Add: Increase in prepaid expenses ................... Decrease in accrued expenses payable ..

$625,000 (11,000) $614,000 $390,000 (13,500) (7,000) $369,500 $88,000 1,700 3,000 $92,700

4. Cash payments for trading investments Gain on fair value adjustment............................ Add: Increase in trading investments ............... 5. Cash payments for income taxes Income tax expense............................................ Add: Decrease in income taxes payable ...........

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$(2,000) 12,000 $10,000 $29,000 5,000 $34,000

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EXERCISE 1729 DUPRÉ CORP. Cash Flow Statement (Partial) Year Ended December 31, 2014

Investing activities Sale of equipment* ..................................... $ 5,000 Purchase of equipment .................................. (65,000) Purchase of equipment (Note X) ................... (3,000) Net cash used by investing activities ..................... $(63,000) Financing activities Payment of cash dividends ............................ $(8,000) Repayment of note payable ......................... (10,000) Net cash used by financing activities ..................... $(18,000) Note X: Equipment costing $53,000 was acquired by paying $3,000 cash and issuing a note payable for $50,000.

*Cost of equipment sold .................................. $46,000 Accumulated depreciation............................... 38,000 Net carrying amount ........................................ 8,000 Loss on sale of equipment .............................. 3,000 Cash proceeds from sale................................. $ 5,000 Cash .................................................................. 5,000 Accumulated Depreciation .............................. 38,000 Loss on Sale of Equipment ............................. 3,000 Equipment ......................................................................... 46,000

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EXERCISE 17-9 PREFERRED HOMES LTD. Cash Flow Statement (Partial) Year Ended September 30, 2014

Investing activities Sale of equipment (2) ................................. $ 3,000 Purchase of land (Note X) .............................. (35,000) Purchase of equipment ................................ (20,000) Net cash used by investing activities ..................... $(52,000) Financing activities Payment of cash dividends (3)..................... $(80,000) Issuance of common shares ......................... 100,000 Repurchase of common shares (4) ............... (15,000) Repayment of mortgage note payable (1) . (5,000) Net cash from financing activities .........................

$ 0

Note X: Land costing $100,000 was acquired by paying $35,000 cash and issuing a mortgage note payable for $65,000. (1) Transactions involving Mortgage Note Payable

Repayments

Solutions Manual .

Mortgage Note Payable Oct. 1, 2013 50,000 5,000 Land purchase 65,000 Sept. 30, 2014 110,000

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EXERCISE 17-9 (Continued) (2) Transactions involving Equipment:

Oct. 1, 2013 Purchases Sept. 30, 2014

Disposal

Equipment 125,000 Disposal 20,000 139,000

6,000

Accumulated Depreciation Oct. 1, 2013 5,000 Sept. 30 Sept. 30, 2014

55,000 15,000 65,000

*Cost of equipment sold .................................. Accumulated depreciation............................... Net carrying amount ........................................ Add: Gain on sale of equipment..................... Cash proceeds from sale.................................

$6,000 5,000 1,000 2,000 $3,000

Cash .................................................................. Accumulated Depreciation .............................. Gain on Sale of Equipment .......................... Equipment .....................................................

3,000 5,000 2,000 6,000

(3) Transactions involving Retained Earnings:

Dividends

Retained Earnings Oct. 1, 2013 80,000 70,000 Profit 210,000 Sept. 30, 2014 220,000

Dividends Payable Oct. 1, 2013 Dividends paid 80,000 Dividends Sept. 30, 2014

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20,000 70,000 10,000

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EXERCISE 17-9 (Continued) (4) Transactions involving Common Shares:

Reacquisition

Common Shares Oct. 1, 2013 150,000 25,000 Issuance 100,000 Sept. 30, 2014 225,000

Contributed Surplus—Reacquisition of Common Shares Oct. 1, 2013 0 Reacquisition 10,000 Sept. 30, 2014 10,000 Common Shares ................................................... 25,000 Contributed Surplus—Reacquisition of Common Shares ................................ Cash.............................................................. ($150,000 + $100,000 − $225,000 = $25,000)

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10,000 15,000

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EXERCISE 17-33 SAVARY LIMITED Cash Flow Statement Year Ended December 31, 2014

Operating activities Profit .............................................................................. $200,000 Adjustments to reconcile profit to net cash used by operating activities: Depreciation expense ............................ $ 70,000 Increase in accounts receivable ........... (150,000) Increase in inventory ............................. (170,000) Decrease in prepaid insurance ............. 7,000 Increase in accounts payable................ 26,000 Decrease in salaries payable ................ (10,000) Increase in interest payable .................. 6,000 (221,000) Net cash used by operating activities .............. (21,000) Investing activities Purchase of equipment .............................. $(250,000) Net cash used by investing activities ...................... (250,000) Financing activities Issued note payable..................................... $150,000 Issued preferred shares ................................ 200,000 Payment of cash dividends* ........................ (50,000) Net cash provided by financing activities ............... 300,000 Increase in cash ............................................................... 29,000 Cash, January 1 ................................................................ 85,000 Cash, December 31 ........................................................... $114,000 * Profit was $200,000, and retained earnings only increased by $150,000, so $50,000 in dividends must have been declared and paid.

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EXERCISE 17-11 FLYPAPER AIRLINES INC. Cash Flow Statement Year Ended March 31, 2014 Operating activities Cash receipts Cash receipts from customers ................................ $254,000* Cash from trading investments............................... 5,600 Dividends on investments ...................................... 14,000 273,600 Cash payments To suppliers ........................................... $(110,000) For operating expenses ....................... (28,000) For salaries........................................... (51,000) For interest ........................................... (8,000) For income tax ..................................... (7,500) .......................................................... (204,500) Net cash provided by operating activities ......... 69,100 Investing activities Sale of aircraft ............................................. $212,000 Purchase of land .......................................... (174,000) Purchase of equipment .............................. (22,000) Net cash provided by investing activities................... 16,000 Financing activities Payment of cash dividends ........................ (14,000) Net cash provided by financing activities .............. (14,000) Net increase in cash.............................................................. 71,100 Cash, April 1, 2013 ........................................................... 35,000 Cash, March 31, 2014 ....................................................... $ 106,100 Note X: Land costing $35,000 was acquired by issuing common shares. * $53,000 + $201,000 = $254,000 Solutions Manual .

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EXERCISE 17-12 (a)

STORM ADVENTURES LTD. Cash Flow Statement—Indirect method Year Ended December 31, 2014

Operating activities Profit ................................................................................ $69,900 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................... $50,000 Loss on sale of land .................................... 10,000 Decrease in accounts receivable ........... 9,000 Decrease in inventory ................................. 12,000 Increase in prepaid expenses ................ (7,000) Increase in accounts payable................. 5,000 Decrease in income taxes payable ........ (3,500) 75,500 Net cash provided by operating activities ........... 145,400 Investing activities Sale of land ($25,000 − $10,000 loss) ........... $15,000 Purchase of equipment ................................. (80,000) Net cash used by investing activities ........................ (65,000) Financing activities Payment of cash dividends (1).................... $(30,000) Redemption of bonds ..................................... (60,000) Issue of common shares .............................. 40,000 Net cash used by financing activities ..................... (50,000) Net increase in cash ......................................................... 30,400 Cash, January 1................................................................. 12,600 Cash, December 31 ........................................................... $ 43,000

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EXERCISE 17-12 (Continued) (a) (Continued) (1) Transactions involving Retained Earnings:

Dividends

Dividends paid

Solutions Manual .

Retained Earnings Jan. 1, 2014 32,500 Profit Dec.31, 2014

103,600 69,900 141,000

Dividends Payable Jan. 1, 2014 30,000 Dividends Dec.31, 2014

5,000 32,500 7,500

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EXERCISE 17-12 (Continued) (b) STORM ADVENTURES LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2014

Operating activities Cash receipts Cash receipts from customers (1)........................... $687,000 Cash payments To suppliers (2) ..................................... $(422,800) For operating expenses (3) ................. (87,000) For interest ........................................... (5,000) For income taxes (4) ............................ (26,800) (541,600) Net cash provided by operating activities ........... 145,400 Investing activities Sale of land ($25,000 − $10,000 loss) ........... $15,000 Purchase of equipment ................................ (80,000) Net cash used by investing activities ........................ (65,000) Financing activities Payment of cash dividends (1) ................... $(30,000) Redemption of bonds ..................................... (60,000) Issue of common shares .............................. 40,000 Net cash used by financing activities ..................... (50,000) Net increase in cash ......................................................... 30,400 Cash, January 1................................................................. 12,600 Cash, December 31 ........................................................... $ 43,000 (1) Cash receipts from customers Sales .................................................................... Add: Decrease in accounts receivable.............

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$678,000 9,000 $687,000

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EXERCISE 17-12 (Continued) (b) (Continued)

(2) Cash payments to suppliers Cost of goods sold ............................................. Less: Decrease in inventory .............................. Cost of goods purchased................................... Less: Increase in accounts payable ..................

(3) Cash payments for operating expenses Operating expenses ........................................... Add: Increase in prepaid expenses ...................

(4) Cash payments for income taxes Income tax expense............................................ Add: Decrease in Income taxes payable ...........

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$439,800 (12,000) 427,800 (5,000) $422,800

$80,000 7,000 $87,000

$23,300 3,500 $26,800

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EXERCISE 17-13 Company A is clearly in a better financial position than company B. While both companies experienced similar increases in cash, it should be noted that Company A’s cash flow comes mainly from its operations, while company B’s cash was acquired through debt/equity, as evidenced by the large amount of cash generated through financing activities. By contrast, Company A appears to be paying down debt/equity, as its cash flow from financing activities is negative. Essentially, Company A appears to be self-sustaining (independent of external sources for its financing) to a greater degree than company B.

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EXERCISE 17-14 (a) Cash provided by operating activities Cash used by investing activities Cash provided by financing activities Increase in cash

Bank of Montreal

Scotiabank

$ 572 (12,768)

$ 1,063 (33,778)

13,757 $ 1,561

33,338 $ 623

Bank of Montreal

Scotiabank

$ 572 (12,768) $(12,196)

$ 1,063 (33,778) $(32,715)

(b) ($ in millions)

− =

Cash provided by operating activities Cash used by investing activities Free cash flow

(c)

At first glance, Bank of Montreal appears to be in better shape because it had a larger increase in cash for the year. On the other hand, Scotiabank generated more cash from operations, but spent considerably more cash in investing activities, which appear to have been financed completely from financing activities. This is usually a good sign, showing that the bank is investing its cash in productive assets that will allow it to continue and increase future cash from operations.

(d)

A manufacturing company’s free cash flow would come primarily from its operating activities, not its investing activities. Due to the nature of its operations, banks invariably are more involved in investing activities than a manufacturing company and so larger amount would appear on their statement of cash flow for investing activities compared to operating activities.

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SOLUTIONS TO PROBLEMS PROBLEM 17-1A

Transaction 1. 2. 3. 4.

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

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

Paid telephone bill for the month. Sold equipment for cash, at a loss.* Sold trading investment, at a gain.* Acquired a building by paying 10% in cash and signing a mortgage payable for the balance. Made principal repayments on the mortgage. Paid interest on the mortgage. Sold inventory on account, at a price greater than cost. Paid wages owing (previously accrued) to employees. Declared and distributed a stock dividend to common shareholders. Paid rent in advance. Sold inventory for cash, at a price greater than cost. Wrote down the value of inventory to net realizable value, which was lower than cost. Received semi-annual bond interest. Received dividends on an investment in associate. Issued common shares. Paid a cash dividend to common shareholders. Collected cash from customers on account. Collected service revenue in advance. Solutions Manual .

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(a) Classification O I O I

(b) Cash

− + + −

− − + NE

NC F

NE −

NE NE

O O

− NE

− +

−

O O

− +

NE +

−

O O

+ +

+ NE

F F

+ −

NE NE

NE Chapter 17

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Accounting Principles, Sixth Canadian Edition

PROBLEM 17-1A (Continued) *

Using the indirect method, the loss/gain added/deducted under operating activities.

would

Taking It Further: Operating activities can increase cash without increasing profits in cases where cash is received at a different time from when revenue is earned, for example:  Collection of outstanding receivables (Dr) Cash, (Cr) Accounts Receivable — profit was increased when the sale was recognized and not when cash is collected;  Cash received in advance of being earned (Dr) Cash, (Cr) Unearned Revenue — profit will be increased when the revenue is earned and not when cash is collected.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 17-2A (a)

MOLLOY INC. Cash Flow Statement (Partial)—Indirect Method Year Ended September 30, 2014

Operating activities Profit ......................................................... $116,000 Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ......................... $25,000 Gain on sale of land ............................ (35,000) Decrease in accounts receivable ....... 15,000 Increase in inventory .......................... (7,000) Decrease in prepaid expenses ........... 5,000 Increase in accounts payable............. 10,000 Increase in accrued expenses payable 4,000 Decrease in income taxes payable .... (6,000) 11,000 Net cash provided by operating activities $127,000 (b) MOLLOY INC. Cash Flow Statement (Partial)—Direct Method Year Ended September 30, 2014

Operating activities Cash receipts From customers (1)..................................... $595,000 Cash payments To suppliers ................................ $(337,000) (2) For operating expenses ......... (87,000) (3) For income taxes.................... (44,000) (4) (468,000) Net cash provided by operating activities $127,000

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PROBLEM 17-2A (Continued) (b) (Continued) Calculations (1)

(2)

(3)

(4)

Cash receipts from customers Sales ............................................................ Add: decrease in accounts receivable ..... Cash receipts from customers ..................

$580,000 15,000 $595,000

Cash payments to suppliers Cost of goods sold ..................................... Add: Increase in inventory ......................... Cost of purchases ...................................... Less: increase in accounts payable ......... Cash payments to suppliers ......................

$340,000 7,000 347,000 (10,000) $337,000

Cash payments for operating expenses Operating expenses .................................. Less: Increase in accrued expenses payable Decrease in prepaid expenses ......... Cash payments for operating expenses ...

$96,000 (4,000) (5,000) $87,000

Cash payments for income taxes Income tax expense.................................... Add: Decrease in income tax payable ...... Cash payments for income taxes ..............

$38,000 6,000 $44,000

Taking It Further: The direct method of preparing the operating activities section will always produce the same amount of cash provided (used) by operations as the indirect method. The two methods differ in presentation format only and present the same cash inflows and outflows.

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PROBLEM 17-3A (a) HANALEI INTERNATIONAL INC. Cash Flow Statement (Partial)—Indirect Method Year Ended December 31, 2014

Operating activities Profit .............................................................................. $123,750 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense .............................. $35,000 Loss on sale of equipment ........................ 25,000 Increase in accounts receivable .............. (12,000) Decrease in prepaid expenses .............. 3,000 Decrease in accounts payable ................. (11,000) Increase in interest payable .................. 750 Decrease in income taxes payable ....... (1,500) Increase in unearned revenue............... 4,000 43,250 Net cash provided by operating activities $167,000 (b) HANALEI INTERNATIONAL INC. Cash Flow Statement (Partial)—Direct Method Year Ended December 31, 2014

Operating activities Cash receipts from customers (1) ......................... $472,000 Cash payments For operating expenses .................... $(253,000) (2) For interest ...................................... (9,250) (3) For income tax..................................... (42,750) (4) (305,000) Net cash provided by operating activities $167,000

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PROBLEM 17-3A (Continued) (b) (Continued) Calculations: (1) Cash receipts from customers Service revenue................................................... Less: Increase in accounts receivable ............ Add: Increase in unearned revenue ................ Cash receipts from customers ...........................

$480,000 (12,000) 4,000 $472,000

(2) Cash payments for operating expenses Operating expenses ............................................ Less: Decrease in prepaid insurance ............... Add: Decrease in accounts payable ............... Cash payments for operating expenses ............

$245,000 (3,000) 11,000 $253,000

(3) Cash payments for interest Interest expense .................................................. Less: Increase in interest payable .................... Cash payments for interest ................................

$10,000 (750) $ 9,250

(4) Cash payments for income tax Income tax expense ............................................ Add: Decrease in income tax payable................ Cash payments for income tax...........................

$41,250 1,500 $42,750

Taking It Further: The direct method of preparing the operating activities section shows the specific cash receipts and payments related to operations. This information is usually more meaningful to users. The preparation of the operating activities section using the direct method is more complex and provides more details to the company’s competitors. Solutions Manual .

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PROBLEM 17-4A

BIRD CORP. Cash Flow Statement (Partial) Year Ended December 31, 2014 (a) Investing activities Sale of equipment (1) ................................. $ 3,875 Sale of building (2)...................................... 22,500 Purchase of land ............................................. (40,000) Purchase of building (2) ............................... (150,000) Purchase of equipment (Note X) ................. (10,000) Net cash used by investing activities .................... $(173,625)

(b) Profit reported by Bird Corp. In 2014 is $125,000. See calculation (4) (c) Financing activities Repayment of mortgage note (3) ................. $(35,000) Payment of cash dividends (4) ...................... (21,250) Issuance of common shares (6) ................ 90,000 Repurchase of common shares (6) .......... (8,000) Net cash provided from financing activities $ 25,750 (d) Note X: Equipment costing $75,000 was acquired by paying $10,000 cash and issuing a mortgage note payable for $65,000. Note Y: During the year, 500 preferred shares were converted into 5,000 common shares at a book value of $50,000.

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PROBLEM 17-4A (Continued) (1) Transactions involving Equipment:

Jan. 1, 2014 Purchases Dec. 31, 2014

Equipment 340,000 Disposal 75,000 393,000

22,000

Accumulated Depreciation—Equipment Jan. 1, 2014 94,000 Disposal 19,125 Depreciation 49,125 Dec. 31, 2014 124,000 Cost of equipment sold ................................... Accumulated depreciation (derived above) ... Net carrying amount ........................................ Add: Gain on sale of equipment...................... Cash proceeds from sale.................................

$22,000 19,125 2,875 1,000 $ 3,875

Cash .................................................................. Accumulated Depreciation .............................. Gain on Sale of Equipment ......................... Equipment .....................................................

3,875 19,125

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1,000 22,000

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PROBLEM 17-4A (Continued) (2) Transactions involving Buildings:

Jan. 1, 2014 Purchases Dec. 31, 2014

Buildings 750,000 Disposal 150,000 850,000

50,000

Accumulated Depreciation—Buildings Jan. 1, 2014 300,000 Disposal 17,500 Depreciation 25,000 Dec. 31, 2014 307,500 Cost of building sold........................................ Accumulated depreciation (derived above) ... Net carrying amount ........................................ Less: Loss on sale of building ........................ Cash proceeds from sale.................................

$50,000 17,500 32,500 10,000 $22,500

Cash .................................................................. Accumulated Depreciation .............................. Loss on Sale of Building ................................. Building ........................................................

22,500 17,500 10,000 50,000

(3) Transactions involving Mortgage Notes Payable: Mortgage Notes Payable Jan. 1, 2014 Repayments 35,000 New Notes Dec. 31, 2014

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310,000 65,000 340,000

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PROBLEM 17-4A (Continued)

(4) Transactions involving Retained Earnings:

Closing div.

Dividends decl. Dec. 31, 2014

Retained Earnings Jan. 1, 2014 25,000 Profit (b) Dec. 31, 2014 Cash Dividends 25,000 Closing entry 0

100,000 125,000 200,000

25,000

Dividends Payable Jan. 1, 2014 2,500 Dividends paid 21,250 Dividends decl. 25,000 Dec. 31, 2014 6,250 (5) Transactions involving Bonds Payable:

Prem. Amort.

Bonds Payable Jan. 1, 2014 5,000 Dec. 31, 2014

585,000 590,000

Interest Expense ...................................................... $48,250 Less: Amortization of bond discount ..................... 5,000 Cash paid for interest .............................................. $43,250 Cash paid for interest will be reflected under operating activities.

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PROBLEM 17-4A (Continued) (6) Transactions involving Common Shares:

Reacquisition

Common Shares Jan. 1, 2014 10,000 Conv. Pref. Issuance Dec. 31, 2014

410,000 50,000 90,000 540,000

Contributed Surplus—Reacquisition of Common Shares Jan. 1, 2014 0 Reacquisition 2,000 Dec. 31, 2014 2,000 Common Shares (1,000 × $10) .................... Contributed Surplus—Reacquisition of Common Shares ......................... Cash.................................................... (e)

Cash December 31, 2014 Cash December 31, 2013 Net increase in cash for fiscal year 2014 Add: Cash used in investing activities (a) Cash used in financing activities (c) Cash provided from operating activities

10,000 2,000 8,000 $ 22,125 10,000 12,125 173,625 25,750 $211,500

Taking It Further: A net cash outflow from investing activities is usually seen as favourable since it signifies investment in the company’s productive capacity (net purchases of long-term assets). The net cash outflow from investing activities indicates purchasing in anticipation of future efficiencies, productivity and profitability. However, this does not guarantee that the company’s plans and predictions will be realized or that the purchases are economical or efficient.

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PROBLEM 17-5A COYOTE LTD. Cash Flow Statement—Indirect Method Year Ended May 31, 2014

Operating activities Profit ................................................................................$108,000 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense (1) .......................... $28,250 Loss on sale of land .................................... 20,000 Increase in accounts receivable ................. (9,000) Increase in inventory ................................. (12,000) Decrease in prepaid expenses ..................... 2,500 Increase in accounts payable ....................... 5,000 Decrease in income taxes payable .......... (3,500) 31,250 Net cash provided by operating activities 139,250 Investing activities Sale of land ($50,000 – $20,000) ................. $ 30,000 Purchase of equipment (2) ........................... (135,000) Purchase of land (Note X) ............................ (55,000) Net cash used by investing activities .......................(160,000) Financing activities Sale of common shares.................................. $50,000 Payment of cash dividends (4) .................... (59,650) Net cash used by financing activities ....................... (9,650) Net decrease in cash............................................................ (30,400) Cash, June 1, 2013 ............................................................. 43,000 Cash, May 31, 2014 ............................................................. $ 12,600 Note X: Land with as cost of $100,000 was purchased by paying $55,000 cash and issuing a mortgage note payable for $45,000.

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PROBLEM 17-5A (Continued) (1) Increase in accumulated depreciation ($68,250 – $40,000) (2) Increase in equipment ($325,000 – $190,000) (3) Beginning balance of mortgage notes payable Add: New note issued for land purchase Ending balance of mortgage notes payable

$ 80,000 45,000 125,000

(4) Transactions involving Retained Earnings:

Div. (derived)

Retained Earnings June 1, 2013 62,150 Profit May 31, 2014

215,500 108,000 261,350

Dividends Payable June 1, 2013 5,000 Dividends paid 59,650 Dividends decl. 62,150 May. 31, 2014 7,500 Taking It Further: A net cash outflow from financing activities is usually seen as favourable since it signifies repayment of debt and payment of dividends to owners. On the other hand, a net cash inflow from financing activities can be either favourable or unfavourable. It is favourable if the company is acquiring financing through debt or issue of shares to finance production or acquire long-term assets. It is unfavourable when the company is seeking to generate cash it cannot obtain otherwise. When combined with low or negative cash from operating activities and cash inflows from investing activities, the company may be sacrificing long-term profitability for short-term survival.

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PROBLEM 17-6A COYOTE LTD. Cash Flow Statement—Direct Method Year Ended May 31, 2014

Operating activities Cash receipts From customers (1).......................

$664,250

Cash payments To suppliers (2) ............................. $(410,950) For operating expenses (3) .......... (69,550) For interest (4) ............................... (5,000) For income tax (5) ......................... (39,500) (525,000) Net cash provided by operating activities ........... 139,250 Investing activities Sale of land ($50,000 – $20,000)................... $ 30,000 Purchase of equipment (6) ........................... (135,000) Purchase of land (Note X) ............................ (55,000) Net cash used by investing activities .......................(160,000) Financing activities Sale of common shares.................................. $50,000 Payment of cash dividends (7) .................... (59,650) Net cash used by financing activities ....................... (9,650) Net decrease in cash............................................................ (30,400) Cash, June 1, 2013 ............................................................. 43,000 Cash, May 31, 2014............................................................. $ 12,600 Note X: Land with as cost of $100,000 was purchased by paying $55,000 cash and issuing a mortgage note payable for $45,000.

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PROBLEM 17-6A (Continued) Calculations: (1) Cash receipts from customers Sales..................................................................... Less: Increase in accounts receivable ............. (2) Cash payments to suppliers Cost of goods sold .............................................. Add: Increase in inventory ............................... Cost of goods purchased ................................... Less: Increase in accounts payable................... (3) Cash payments for operating expenses Operating expenses ............................................ Less: Depreciation expense (7) .......................... Less: Decrease in prepaid expenses ................. (4) Cash payments for interest Interest expense .................................................. (5) Cash payments for income tax Income tax expense ............................................ Add: Decrease in income tax payable................

$673,250 (9,000) $664,250 $403,950 12,000 415,950 (5,000) $410,950 $100,300 (28,250) (2,500) $ 69,550 $5,000

$36,000 3,500 $39,500

(6) Increase in equipment ($325,000 – $190,000)

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PROBLEM 17-6A (Continued) (7) Transactions involving Retained Earnings:

Div. (derived)

Retained Earnings June 1, 2013 62,150 Profit May 31, 2014

215,500 108,000 261,350

Dividends Payable June 1, 2013 5,000 Dividends paid 59,650 Dividends decl. 62,150 May. 31, 2014 7,500

Taking It Further: If Coyote Inc. was reporting under IFRS instead of ASPE, the interest paid could be classified as financing activities.

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PROBLEM 17-7A E-PERFORM LTD. Cash Flow Statement—Indirect Method Year Ended December 31, 2014

Operating activities Profit ................................................................................$141,180 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................... $46,500 Loss on sale of equipment ........................... 7,500 Increase in accounts receivable ............... (32,800) Increase in inventory ................................. (29,650) Increase in prepaid expenses ................... (12,400) Increase in accounts payable ..................... 15,700 Increase in accrued expenses payable ... 4,500 ... (650) Net cash provided by operating activities ................ 140,530 Investing activities Sale of equipment* ...................................... $ 1,500 Purchase of equipment (Note X) ................... (25,000) Net cash used by investing activities ........................ (23,500) Financing activities Sale of common shares.................................. $45,000 Retirement of note payable** ........................(100,000) Payment of cash dividends*** ........................(12,630) Net cash used by financing activities ....................... (67,630) Net increase in cash.............................................................. 49,400 Cash, January 1 .................................................................. 48,400 Cash, December 31 ............................................................ $ 97,800

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PROBLEM 17-7A (Continued) Note X: Equipment was purchased by paying $25,000 cash and issuing a note payable for $60,000. *

Cash ................................................................... 1,500 Accumulated Depreciation ............................. 48,500 Loss on Sale of Equipment .............................. 7,500 Equipment ................................................

57,500

* Cost of equipment sold $242,500 + $85,000 − $270,000 = $57,500 Accumulated depreciation removed from accounts ($52,000 + $46,500 depreciation expense) − $50,000 = $48,500 NBV = Cost $57,500 − Accumulated depreciation $48,500 = $9,000 Cash proceeds = NBV $9,000 − Loss on sale $7,500 = $1,500 ** Note payable, 2013 .............................................. Note issued for equipment.................................. Note payable retired ............................................ Note payable, 2014 .............................................. *** Retained earnings, 2013...................................... Profit ..................................................................... Dividends declared and paid .............................. Retained earnings, 2014......................................

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$150,000 60,000 210,000 (100,000) $110,000 $105,450 141,180 246,630 (12,630) $234,000

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PROBLEM 17-7A (Continued) Taking It Further: A loss does not necessarily mean the company has a reduction in cash from operating activities. For example, a loss may be created (or increased) by noncash expenses such as deprecation which do not use cash. Or the company may have significant operating expenses which have not used cash because the company has not paid for the expenses yet, and has instead increased its liabilities. Finally, the company may be collecting its accounts receivables, which increases cash, but this will not increase profit.

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PROBLEM 17-8A E-PERFORM LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2014

Operating activities Cash receipts from customers ............................... $459,980 (1) Cash payments To suppliers................................. $(199,410) (2) For operating expenses .............. (70,310) (3) For income tax ............................ (45,000) For interest .................................. (4,730) (319,450) Net cash provided by operating activities ...... 140,530 Investing activities Sale of equipment* .......................... $ 1,500 Purchase of equipment (Note X)..... (25,000) Net cash used by investing activities ....................(23,500) Financing activities Sale of common shares .................. $45,000 Retirement of note payable*................ (100,000) Payment of cash dividends* ............... (12,630) Net cash used by financing activities ................. (67,630) Net increase in cash......................................................... 49,400 Cash, January 1 ............................................................. 48,400 Cash, December 31 ....................................................... $ 97,800 Note X: Equipment was purchased by paying $25,000 cash and issuing a note payable for $60,000. * See calculations in P17-7A.

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PROBLEM 17-8A (Continued) Calculations: (1)

Cash receipts from customers Sales ............................................................ Less: Increase in accounts receivable......

(2)

Cash payments to suppliers Cost of goods sold ..................................... Add: Increase in inventory ........................ Cost of goods purchased........................... Less: Increase in accounts payable ..........

(3)

$492,780 (32,800) $459,980

$185,460 29,650 215,110 (15,700) $199,410

Cash payments for operating expenses Operating expenses ................................... Add: Increase in prepaid expenses.......... Less: Increase in accrued expenses payable

$62,410 12,400 (4,500) $70,310

Taking It Further: The company generated significant amounts of cash from its operations through cash received from customers. Most of this cash has been reinvested in the company through the purchase of equipment and by paying down the company’s debts and paying dividends to its owners.

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PROBLEM 17-9A WETASKIWIN LTD. Cash Flow Statement—Indirect Method Year Ended December 31, 2014

Operating activities Profit ................................................................................ $36,000 Adjustments to reconcile profit to net cash used by operating activities: Depreciation expense ............................. $11,000 (1) Loss on sale of equipment ..................... 2,000 Increase in accounts receivable ............... (14,000) Increase in inventory .............................. (4,000) Decrease in accounts payable .................. (18,000) Decrease in income tax payable ............ (17,000) (40,000) Net cash used by operating activities ................ (4,000) Investing activities Collection of notes receivable ...................... $23,000 Issue of notes receivable ............................... (14,000) Sale of equipment ........................................ 8,000 (2) Net cash provided by investing activities................... 17,000 Financing activities Repayment of note payable ......................... $ (5,000) (3) Payment of cash dividends .......................... (9,000) (4) Net cash used by financing activities ..................... (14,000) Net decrease in cash......................................................... Cash, January 1................................................................. Cash, December 31 ...........................................................

(1,000) 10,000 $ 9,000

Note Equipment costing $10,000 was purchased by issuing a note payable.

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PROBLEM 17-9A (Continued) Calculations: (1) Depreciation expense Accumulated depreciation, beginning of year............ $24,000 Less: Accumulated depreciation of equipment sold ($15,000 − $10,000) ............................... (5,000) Accumulated depreciation, end of year ............ (30,000) Depreciation expense .................................................. $11,000 (2) Cash from the sale of equipment Equipment Carrying amount ....................................... $10,000 Less: Loss on Sale… ................................................... (2,000) Cash Received ............................................................. $8,000 (3) Note Payable Note Payable, beginning of year.................................. $10,000 Add: Issue of note for equipment .............................. 10,000 20,000 Less: Repayment of note (calculated) ....................... (5,000) Note Payable, end of year ............................................ $15,000 (4) Cash dividends Retained earnings, beginning of year ......................... $28,000 Add: Profit ................................................................... 36,000 64,000 Less: Dividends (calculated) ...................................... (9,000) Retained earnings, end of year .................................... $55,000

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PROBLEM 17-9A (Continued) Taking It Further: Yes. A small change is the result of offsetting balances. For Wetaskiwin, the cash flow statement shows that operating activities used cash of $4,000 during the year. This is important information since the company’s main source of sustainable cash is operating activities. A negative cash flow from operations is a strong indicator of financial difficulties, unless the company is in its start-up phase. The cash flow statement also shows that the company’s negative cash flow from operations was counterbalanced by cash inflows from the collection of outstanding notes receivable. This is a nonrenewable source of cash for the following year (the notes outstanding at the end of 2014 are lower at $14,000).

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PROBLEM 17-10A WETASKIWIN LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2014

Operating activities Cash receipts From customers ...................................................... $272,000 (1) From interest ........................................................... 1,000 Cash payments To suppliers..................................... $(216,000) (2) For operating expenses .................. (27,000) (3) For interest ...................................... (2,000) For income tax ................................ (32,000) (4) (277,000) Net cash used by operating activities ................ (4,000) Investing activities Collection of notes receivable ...................... $23,000 Issue of notes receivable ............................... (14,000) Sale of equipment ........................................ 8,000 (5) Net cash provided by investing activities................... 17,000 Financing activities Repayment of note payable ........................ $ (5,000) (6) Payment of cash dividends ......................... (9,000) (7) Net cash used by financing activities ..................... (14,000) Net decrease in cash......................................................... Cash, January 1................................................................. Cash, December 31 ...........................................................

(1,000) 10,000 $ 9,000

Note Equipment costing $10,000 was purchased by issuing a note payable.

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PROBLEM 17-10A (Continued) Calculations: (1) Cash receipts from customers Sales..................................................................... Less: Increase in accounts receivable ............. (2) Cash payments to suppliers Cost of goods sold .............................................. Add: Increase in inventory ............................... Cost of goods purchased ................................... Add: Decrease in accounts payable ................ (3) Cash payments for operating expenses Operating expenses ............................................ Less: Depreciation expense ............................... (4) Cash payments for income tax Income tax expense ............................................ Add: Decrease in income tax payable ............. (5) Cash from the sale of equipment Equipment Carrying amount………………… Less: Loss on Sale…………………………… Cash Received…………………………………

$286,000 (14,000) $272,000 $194,000 4,000 198,000 18,000 $216,000 $38,000 (11,000) $27,000 $15,000 17,000 $32,000 $10,000 (2,000) $8,000

(6) Note Payable Note Payable, beginning of year ............................... $10,000 Add: Issue of note for equipment ........................... 10,000 20,000 Less: Repayment of note (calculated) ..................... (5,000) Note Payable, end of year .......................................... $15,000

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PROBLEM 17-10A (Continued) (7) Cash dividends Retained earnings, beginning of year ................. Add: Profit .......................................................... Less: Dividends (calculated) .............................. Retained earnings, end of year ...........................

$28,000 36,000 64,000 (9,000) $55,000

Taking It Further: Yes. Depending on the timing of the cash payments and receipts, it is entirely possible that the company could have had a negative cash balance at one or more times during the year.

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PROBLEM 17-11A DIATESSARON INC. Cash Flow Statement – Indirect Method Year Ended December 31, 2014 Operating activities Profit ................................................................................ $68,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $43,500 (1) Loss on sale of equipment ..................... 3,000 Amortization of premium on long-term debt investment .................. 500 (2) Increase in accounts receivable ............ (26,000) Increase in inventory .............................. (49,500) Increase in accounts payable................. 10,500 Decrease in income tax payable ............ (1,000) (19,000) Net cash provided by operating activities ............. 49,000 Investing activities Acquisition of long-term debt investment $(102,000) Sale of equipment........................................ 6,000 (3) Net cash used by investing activities ........................ (96,000) Financing activities Issue of note payable ................................... $ 28,000 Payment of dividends ($15,000 − $6,000)... (9,000) Repayment of note payable ........................ (3,000) Net cash provided by financing activities ..............

16,000

Net decrease in cash......................................................... (31,000) Cash, January 1................................................................. 98,000 Cash, December 31 ........................................................... $67,000 Note: Common shares were issued to purchase equipment costing $105,000. Solutions Manual .

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PROBLEM 17-11A (Continued) Calculations: (1) Depreciation expense Accumulated depreciation, end of year .................... $162,500 Plus: Accumulated depreciation of equipment sold ($30,000 − $9,000) ..................................... 21,000 Accumulated depreciation, beg. of year ......... (140,000) Depreciation expense ................................................. $ 43,500 (2) Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year ................... $101,500 Less: Purchase price ................................................. (102,000) Premium amortization .............................................. $ 500 (3) Cash from sale of equipment Carrying amount of equipment ...................................... $9,000 Less: Loss on sale ....................................................... (3,000) Cash received ................................................................. $6,000 Taking It Further: Both the proceeds and the repayment should be shown separately. Information in financial statements is usually condensed and regrouped so that proceeds from issuing a note and repayments do not necessarily relate to the same debt instrument. Showing both separately allows the user to tie the amounts to note disclosure about the various debt instruments.

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PROBLEM 17-12A DIATESSARON INC. Cash Flow Statement – Direct Method Year Ended December 31, 2014

Operating activities Cash receipts From customers ...................................................... $637,000 (1) From interest ........................................................... 5,000 (2) Cash payments To suppliers..................................... $(471,000) (3) For operating expenses .................. (104,000) (4) For interest ...................................... (3,000) For income tax ................................ (15,000) (5) (593,000) Net cash provided by operating activities ......... 49,000 Investing activities Acquisition of long-term debt investment . $(102,000) Sale of equipment ........................................ 6,000 (6) Net cash used in investing activities ......................... (96,000) Financing activities Issue of note payable .................................... $ 28,000 Payment of dividends ($15,000 − $6,000)... (9,000) Repayment of note payable ........................ (3,000) Net cash provided by financing activities ..............

16,000

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PROBLEM 17-12A (Continued) Calculations: (1) Cash receipts from customers Sales..................................................................... Less: Increase in accounts receivable ............. (2) Cash receipts from interest Interest revenue................................................... Add: amortization of premium on long-term debt investment** .................................. (3) Cash payments to suppliers Cost of goods sold .............................................. Add: Increase in inventory ............................... Cost of goods purchased ................................... Less: Increase in accounts payable.................. (4) Cash payments for operating expenses Operating expenses ............................................ Less: Depreciation expense* .............................. (5) Cash payments for income tax Income tax expense ............................................ Add: Decrease in income tax payable ............. (6) Cash from sale of equipment Carrying amount of equipment.................................. Less: Loss on sale .................................................... Cash received .............................................................

$663,000 (26,000) $637,000 $4,500 500 $5,000 $432,000 49,500 481,500 (10,500) $471,000 $147,500 (43,500) $104,000 $14,000 1,000 $15,000 $9,000 (3,000) $6,000

Depreciation expense Accumulated depreciation, end of year .................... $162,500 Plus: Accumulated depreciation of equipment sold ($30,000 − $9,000) ..................................... 21,000 Accumulated depreciation, beg. of year ......... (140,000) Depreciation expense .................................................. $43,500

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PROBLEM 17-12A (Continued) **

Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year ................... $101,500 Less: Purchase price ................................................. (102,000) Premium amortization................................................ $ (500)

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PROBLEM 17-12A (Continued) Taking It Further: Accounts payable can arise from various expenditures. The information that accounts payable is used for purchases is necessary to calculate cash payments to suppliers. Accounts payable can also relate to operating expenses and the information is necessary to properly match the accrual to the related expense. If payments to suppliers and payments for operating expenses are grouped together on the cash flow statement, the information would not be necessary.

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PROBLEM 17-13A (a)

Net cash provided (used) by operating activities − net cash (provided) used by investing activities = free cash flow ($ in U.S. millions)

(b)

Potash:

$3,485 − $2,251 = $1,234

Agrium:

$1,350 − $151 = $1,199

Potash appears to be in the stronger financial position. It generates more cash from operating activities, is investing in property, plant, and equipment, and is also paying down its debt. It also has a higher profit, and a higher free cash flow.

Taking It Further: Potash Corporation appears to be in growth stage as considerably more cash is being spent on investing activities, compared to its competitor, Agrium. Potash is also borrowing from creditors and/or investors to finance its purchases of property, plant, and equipment, or other businesses.

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PROBLEM 17-1B

Transaction 1. Paid wages to employees. 2. Sold land for cash, at a gain.* 3. Acquired land by issuing common shares. 4. Paid a cash dividend to preferred shareholders. 5. Performed services for cash. 6. Performed services on account. 7. Purchased inventory for cash. 8. Purchased inventory on account. 9. Paid income tax. 10. Made principal repayment on a trade note payable. 11. Paid semi-annual bond interest. 12. Received rent from a tenant in advance. 13. Recorded depreciation expense. ** 14. Reacquired common shares at a price greater than the average cost of the shares. 15. Issued preferred shares for cash. 16. Collected cash from customers on account. 17. Issued a non-trade note payable. 18. Paid insurance for the month.

(a) Classification O I

(b) Cash

− +

−

O O O O O

+ NE − NE −

+ + NE NE −

−

F O

+ −

NE −

* The gain on sale of land would appear in the operating section of the cash flow statement if the indirect method was used.

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PROBLEM 17-1B (Continued) ** Depreciation expense is added to cash from operating activities when using the indirect method, not because it is a source of cash, but rather to cancel the deduction from profit because there is no source of cash from depreciation expense. Taking It Further: Operating activities can decrease cash without decreasing profit in the following cases:  Prepayments in excess of consumption of goods or services;  Payments on current liabilities (related to operating activities) in excess of current year’s expenses.

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PROBLEM 17-2B (a)

LUI INC. Cash Flow Statement (Partial)—Indirect Method Year Ended May 31, 2014

Operating activities Profit ......................................................... $90,500 Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ......................... $28,500 Loss on sale of equipment ................. 9,500 Decrease in accounts receivable ....... 21,000 Increase in inventory .......................... (32,000) Decrease in prepaid expenses ........... 7,000 Decrease in accounts payable ........... (5,000) Increase in accrued expenses payable 8,500 Increase in interest payable ............... 3,500 Decrease in income taxes payable .... (6,500) 34,500 Net cash provided by operating activities $125,000 (b) LUI INC. Cash Flow Statement (Partial)—Direct Method Year Ended May 31, 2014

Operating activities Cash receipts From customers (1)..................................... $841,000 Cash payments To suppliers ................................ $(529,000) (2) For operating expenses ......... (146,500) (3) For interest ............................. (4,000) (4) For income taxes.................... (36,500) (5) (716,000) Net cash provided by operating activities $125,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 17-2B (Continued) (b) (Continued) Calculations (1)

(2)

(3)

(4)

(5)

Cash receipts from customers Sales ............................................................ Add: decrease in accounts receivable ..... Cash receipts from customers ..................

$820,000 21,000 $841,000

Cash payments to suppliers Cost of goods sold ..................................... Add: Increase in inventory ......................... Cost of purchases ...................................... Add: decrease in accounts payable ......... Cash payments to suppliers ......................

$492,000 32,000 524,000 5,000 $529,000

$162,000 (8,500) (7,000) $146,500

Cash payments for interest Interest expense ............................................... Less: increase in interest payable................... Cash payments for interest ..................................

7,500 (3,500) $4,000

Cash payments for income taxes Income tax expense.................................... Add: Decrease in income tax payable ...... Cash payments for income taxes ..............

$30,000 6,500 $36,500

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PROBLEM 17-3B (a) SABLE ISLAND LTD. Cash Flow Statement (Partial)—Indirect Method Year Ended December 31, 2014

Operating activities Profit .............................................................................. $169,500 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense .............................. $50,000 Gain sale of equipment............................ (23,000) Decrease in accounts receivable ............ 8,000 Increase in prepaid insurance................. (2,500) Increase in accounts payable.................. 5,000 Decrease in income taxes payable ......... (5,250) Increase in interest payable .................... 450 Increase in unearned revenue................. 3,750 36,450 Net cash provided by operating activities $205,950 (b) SABLE ISLAND LTD. Cash Flow Statement (Partial)—Direct Method Year Ended December 31, 2014

Operating activities Cash receipts from customers ............................... $911,750 (1) Cash payments For operating expenses .............. $(639,500) (2) For interest .................................. (4,550) (3) For income tax ............................ (61,750) (4) (705,800) Net cash provided by operating activities ..... $205,950

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PROBLEM 17-3B (Continued) (b) (Continued) Calculations: (1)

Cash receipts from customers Fees Earned.............................................. $900,000 Add: Decrease in accounts receivable .. $ 8,000 Add: Increase in unearned revenue ....... 3,750 11,750 Cash receipts from customers ................................ $911,750

(2)

(3)

(4)

Cash payments for operating expenses Operating expenses ........................................... Add: Increase in prepaid expenses ................. Less: Increase in accounts payable ................. Cash payments for operating expenses ...........

$642,000 2,500 (5,000) $639,500

Cash payments for interest expense Interest expense ....................................................... Less: Increase in interest payable .......................... Cash payments for income tax................................

$5,000 (450) $4,550

Cash payments for income tax Income tax expense ................................................. Add: Decrease in income tax payable .................. Cash payments for income tax................................

$56,500 5,250 $61,750

Taking It Further: The indirect method of preparing the operating activities section focuses on the differences between profit and net cash flow from operating activities. It is also easier to prepare than the direct method and provides fewer details to the company’s competitors. It is usually considered less meaningful to users than the direct method since it does not show the specific cash receipts and payments related to operations.

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PROBLEM 17-4B

BIRD CORP. Cash Flow Statement (Partial) Year Ended December 31, 2014 (a) Investing activities Sale of equipment (1) ................................. $ 1,000 Sale of building (2)...................................... 35,500 Purchase of land and buildings (Note X) .. (25,000) Purchase of equipment (1) ........................... (40,000) Net cash used by investing activities ..................... $(28,500) (b) Profit reported by Bird Corp. In 2014 is $66,250 calculation (4).

see

(c) Financing activities Issuance of long-term notes (3)................. $ 60,000 Repayment of long-term notes (3) ............. (170,000) Payment of cash dividends (4) .................. (6,250) Issuance of preferred shares ..................... 50,000 Repurchase of common shares (5) ........... (29,300) Net cash used by financing activities ... $ (95,550) (d) Note X: Land costing $50,000 and buildings costing $130,000 were acquired by paying $25,000 cash and issuing a mortgage note payable for $155,000.

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PROBLEM 17-4B (Continued) (1) Transactions involving Equipment:

Jan. 1, 2014 Purchases Dec. 31, 2014

Equipment 480,000 Disposal 40,000 492,000

28,000

Accumulated Depreciation—Equipment Jan. 1, 2014 192,000 Disposal 22,000 Depreciation 48,000 Dec. 31, 2014 218,000 Cost of equipment sold ................................... Accumulated depreciation (derived above) ... Net carrying amount ........................................ Less: Loss on sale of equipment .................... Cash proceeds from sale.................................

$28,000 22,000 6,000 5,000 $ 1,000

Cash .................................................................. Accumulated Depreciation .............................. Loss on Sale of Equipment ............................. Equipment .....................................................

1,000 22,000 5,000

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PROBLEM 17-4B (Continued) (2) Transactions involving Buildings:

Jan. 1, 2014 Purchases Dec. 31, 2014

Buildings 1,250,000 Disposal 130,000 1,310,000

70,000

Accumulated Depreciation—Buildings Jan. 1, 2014 600,000 Disposal 52,500 Depreciation 31,250 Dec. 31, 2014 578,750 Cost of building sold (derived)........................ Accumulated depreciation (derived above) ... Net carrying amount ........................................ Add: Gain on sale of building.......................... Cash proceeds from sale.................................

$70,000 52,500 17,500 18,000 $35,500

Cash .................................................................. Accumulated Depreciation .............................. Gain on Sale of Building ............................. Equipment .....................................................

35,500 52,500

(3) Transactions involving Notes Payable: Long-Term Notes Payable Jan. 1, 2014 Repayments 170,000 New Notes Dec. 31, 2014

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18,000 70,000

350,000 60,000 240,000

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PROBLEM 17-4B (Continued)

(4) Transactions involving Retained Earnings:

Closing div.

Retained Earnings Jan. 1, 2014 6,250 Profit (b) Dec. 31, 2014

Cash Dividends—Preferred Dividends decl. 6,250 Closing entry Dec. 31, 2014 0

240,000 66,250 300,000

6,250

Since there are no dividends payable reported at the end of either fiscal year, the amount of the dividends declared for preferred shares is the amount of dividends paid. (5) Transactions involving Common Shares:

Reacquisition

Common Shares Jan. 1, 2014 30,800 Dec. 31, 2014

154,000 123,200

Contributed Surplus—Reacquisition of Common Shares Jan. 1, 2014 0 Reacquisition 1,500 Dec. 31, 2014 1,500 Common Shares ................................................... 30,800 Contributed Surplus—Reacquisition of Common Shares ................................ Cash..............................................................

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1,500 29,300

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Accounting Principles, Sixth Canadian Edition

PROBLEM 17-4B (Continued) (6) Transactions involving Bond Payable:

Prem. Amort.

Bond Payable Jan. 1, 2014 2,000 Dec. 31, 2014

216,000 214,000

Interest Expense ........................................................ $23,000 Add: Amortization of bond premium ....................... 2,000 Cash paid for interest ................................................ $25,000 Cash paid for interest expense will be captured under operating activities. (e)

$ 21,000 5,000 16,000 28,500 95,550 $140,050

Taking It Further: A net cash inflow from investing activities can be either favourable or unfavourable. It is only favourable if the company is disposing of assets it no longer needs, and is not disposing of long-term assets to generate cash it cannot obtain otherwise.

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PROBLEM 17-5B KING CORP. Cash Flow Statement—Indirect Method Year Ended July 31, 2014

Operating activities Profit ................................................................................$106,500 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense (1) .......................... $51,000 Gain on sale of land .................................. (30,000) Loss on sale of equipment (1).................. 6,000 Increase in accounts receivable .............. (14,000) Increase in inventory ................................ (12,000) Increase in prepaid expenses .................. (1,500) Decrease in accounts payable ................. (9,000) Increase in accrued expenses payable ... 2,700 Increase in income taxes payable............ 4,500 (2,300) Net cash provided by operating activities 104,200 Investing activities Sale of land Note X ...................................... $ 55,000 Sale of equipment (1) ...................................... 14,000 Purchase of land ........................................... (100,000) Purchase of equipment (1) ............................ (80,000) Net cash used by investing activities (111,000) Financing activities Sale of common shares .............................. $35,000 Payments on mortgage note payable (2) ... (15,000) Net cash used by financing activities

20,000

Net increase in cash ......................................................... 13,200 Cash, Aug. 1, 2013............................................................. 11,000 Cash, July 31, 2014 ........................................................... $ 24,200

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PROBLEM 17-5B (Continued) Note X: Land was sold for $90,000 and the proceeds from the sale were cash of $55,000 and a note receivable for $35,000. (1) Transactions involving Equipment:

Aug. 1, 2013 Purchases July 31, 2014

Equipment 170,000 Disposal 80,000 225,000

25,000

Accumulated Depreciation—Equipment Aug. 1, 2013 35,000 Disposal 5,000 Depreciation 51,000 July 31, 2014 81,000 Cost of equipment sold ................................... Carrying value – given ..................................... Accumulated depreciation...............................

$25,000 20,000 $ 5,000

Carrying value .................................................. Less: Cash proceeds from the sale ................ Loss on sale of equipment ..............................

$20,000 14,000 $ 6,000

14,000 5,000 6,000

(2) Beginning balance of mortgage notes payable Less: Principal repayments during year Ending balance of mortgage notes payable

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25,000

$ 80,000 15,000 $ 65,000

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PROBLEM 17-5B (Continued) Taking It Further: A net cash inflow from financing activities can be either favourable or unfavourable. It is favourable if the company is acquiring financing through debt or issue of shares to finance production or acquire long-term assets. It is unfavourable when the company is seeking to generate cash it cannot obtain otherwise. When combined with low or negative cash from operating activities and cash inflows from investing activities, the company may be sacrificing long-term profitability for shortterm survival.

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PROBLEM 17-6B KING CORP. Cash Flow Statement—Indirect Method Year Ended July 31, 2014 Operating activities Cash receipts From customers (1)....................... From interest (2)............................

$913,250 3,500 $916,750

Cash payments To suppliers (3) ............................. $(573,750) For operating expenses (4) .......... (188,800) For interest (5) ............................... (6,500) For income tax (6) ......................... (43,500) (812,550) Net cash provided by operating activities ........... 104,200 Investing activities Sale of land Note X ...................................... $ 55,000 Sale of equipment (7) .................................. 14,000 Purchase of land.......................................... (100,000) Purchase of equipment (7) .......................... (80,000) Net cash used by investing activities (111,000) Financing activities Sale of common shares.................................. $35,000 Payments on mortgage note payable (8) ...... (15,000) Net cash used by financing activities 20,000 Net increase in cash.............................................................. 13,200 Cash, Aug. 1, 2013.............................................................. 11,000 Cash, July 31, 2014 ............................................................ $ 24,200 Note X: Land was sold for $90,000 and the proceeds from the sale were cash of $55,000 and a note receivable for $35,000.

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PROBLEM 17-6B (Continued) Calculations: (1) Cash receipts from customers Sales..................................................................... Less: Increase in accounts receivable ............. (2) Cash receipts from interest Interest revenue................................................... (3) Cash payments to suppliers Cost of goods sold .............................................. Add: Increase in inventory ............................... Cost of goods purchased ................................... Add: Decrease in accounts payable.................. (4) Cash payments for operating expenses Operating expenses ............................................ Less: Depreciation expense (7) .......................... Add: Increase in prepaid expenses.................... Less: Increase in accrued expenses payable ... (5) Cash payments for interest Interest expense .................................................. (6) Cash payments for income tax Income tax expense ............................................ Less: Increase in income tax payable................

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$927,250 (14,000) $913,250 $3,500

$552,750 12,000 564,750 9,000 $573,750 $241,000 (51,000) 1,500 (2,700) $188,800 $6,500

$48,000 (4,500) $43,500

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PROBLEM 17-6B (Continued) (7) Transactions involving Equipment:

Aug. 1, 2013 Purchases July 31, 2014

Equipment 170,000 Disposal 80,000 225,000

25,000

$25,000 20,000 $ 5,000

(8) Beginning balance of mortgage notes payable Less: Principal repayments during year Ending balance of mortgage notes payable

$ 80,000 15,000 $ 65,000

Taking It Further: If King Corp. was reporting under IFRS instead of ASPE, the interest received could be also be classified as investing activities. As well, the interest paid could be classified as financing activities.

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PROBLEM 17-7B WAYFARER INC. Cash Flow Statement – Indirect Method Year Ended December 31, 2014

Operating activities Profit ................................................................................ $75,600 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $69,300 (1) Loss on sale of equipment ..................... 3,600 Non-cash interest revenue on long-term debt investment ................... (900) (2) Increase in accounts receivable ............... (46,800) Increase in inventory ............................... (111,600) Increase in accounts payable ..................... 40,500 Decrease in income tax payable ............ (3,600) (49,500) Net cash provided by operating activities ........ 26,100 Investing activities Acquisition of long-term debt investment $(175,500) Sale of equipment........................................ 12,600 (3) Net cash used by investing activities ...................... (162,900) Financing activities Issue of note payable ................................... $ 90,000 Repayment of note payable ........................ (9,000) Net cash provided by financing activities ............... 81,000 Net decrease in cash............................................................ (55,800) Cash, January 1 ................................................................. 176,400 Cash, December 31 ........................................................... $120,600 Note: Common shares were issued to purchase equipment costing $225,000.

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PROBLEM 17-7B (Continued) Calculations: (1) Depreciation expense Accumulated depreciation, end of year .................... $292,500 Plus: Accumulated depreciation of equipment sold ($45,000 – $16,200) .............................. 28,800 Accumulated depreciation, beg. of year ......... (252,000) Depreciation expense ................................................. $ 69,300 (2) Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year ................... $176,400 Less: Purchase price ................................................. (175,500) Non-cash interest revenue........................................ $ 900 (3) Cash from sale of equipment Carrying amount of equipment .................................... $16,200 Less: Loss on sale ...................................................... (3,600) Cash received ............................................................... $12,600 Taking It Further: No. For example, cash collections from customers will be lower than sales if the company made more credit sales than cash collections during the year. Also, cash payments will exceed expenses if the company prepaid expenses or reduced its current liability balances. Lastly, there if there are non-cash revenues or gains, these will increase profit but not cash.

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PROBLEM 17-8B WAYFARER INC. Cash Flow Statement – Direct Method Year Ended December 31, 2014

Operating activities Cash receipts From customers ........................... $1,090,800 (1) From interest ................................ 9,000 (2) $1,099,800 Cash payments To suppliers ................................... $(843,300) (3) For operating expenses ....................(196,200) (4) For interest .................................... (5,400) For income tax .............................. (28,800) (5) (1,073,700) Net cash provided by operating activities ............. 26,100 Investing activities Acquisition of long-term debt investment $(175,500) Sale of equipment........................................ 12,600 (6) Net cash used by investing activities ...................... (162,900) Financing activities Issue of note payable ................................... $ 90,000) Repayment of note payable ........................ (9,000) Net cash provided by financing activities ..............

81,000

Net decrease in cash........................................................ (55,800) Cash, January 1................................................................ 176,400 Cash, December 31 .......................................................... $120,600 Note: Common shares were issued to purchase equipment costing $225,000.

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PROBLEM 17-8B (Continued) Calculations: (1) Cash receipts from customers Sales ......................................................................... $1,137,600 Less: Increase in accounts receivable ................ (46,800) $1,090,800 (2) Cash receipts from interest Interest revenue................................................... $9,900 Less: non-cash interest from long-term debt Investments** ........................................... (900) $9,000 (3) Cash payments to suppliers Cost of goods sold .............................................. $772,200 Add: Increase in inventory ............................... 111,600 Cost of goods purchased ................................... 883,800 Less: Increase in accounts payable.................. (40,500) $843,300 (4) Cash payments for operating expenses Operating expenses ............................................ $265,500 Less: Depreciation expense* .............................. (69,300) $196,200 (5) Cash payments for income tax Income tax expense ............................................ $25,200 Add: Decrease in income tax payable ............. 3,600 $28,800 (6) Cash from sale of equipment Carrying amount of equipment .................................... $16,200 Less: Loss on sale ...................................................... (3,600) Cash received ............................................................... $12,600 *

Depreciation expense Accumulated depreciation, end of year .................... $292,500 Plus: Accumulated depreciation of equipment sold ($45,000 – $16,200) ................................ 28,800 Accumulated depreciation, beg. of year ......... (252,000) Depreciation expense ................................................. $ 69,300

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PROBLEM 17-8B (Continued) **

Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year ................... $176,400 Less: Purchase price ................................................. (175,500) Non-cash interest revenue........................................ $ 900

Taking It Further: The decrease in cash during the year has been caused primarily by the purchase of the long-term debt investment. Cash from operating activities yielded a positive amount although substantially less than profit. This could be cause for concern, in particular since a large portion of the difference is due to a large increase in inventory during the year. The purchase of a long-term investment may be cause for concern since the investment amount is large compared to the company’s balance sheet. Long-term debt investments usually yield returns lower than the interest rate on outstanding debt. The purchase of the investment means that the company is investing in an interestbearing investment that likely generates interest revenue at a lower rate than the interest it pays on outstanding debt. The rationale for the purchase is important since the company may be setting aside funds for a future capital project.

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PROBLEM 17-9B GALENTI, INC. Cash Flow Statement—Indirect Method Year Ended December 31, 2014

Operating activities Profit ................................................................................ $90,310 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................... $58,700 Gain on sale of equipment........................... (8,750) Loss on sale of trading investments ........... 7,500 Proceeds from sale of trading investments, net of purchases ............ 5,000 (1) Increase in accounts receivable ............... (43,800) Increase in inventory ................................... (9,250) Decrease in prepaid expenses ..................... 6,000 Increase in accounts payable ....................... 8,420 Decrease in accrued expenses payable .. (6,730) 17,090 Net cash provided by operating activities ................ 107,400 Investing activities Sale of equipment........................................ $15,550 (2) Purchase of equipment (Note X) .................... (71,000) Net cash used by investing activities ....................... (55,450) Financing activities Sale of common shares.................................. $50,000 Retirement of note payable ............................ (10,000) (3) Payment of cash dividends ............................ (36,500) (4) Net cash provided by financing activities ............. 3,500 Net increase in cash ........................................................ 55,450 Cash, January 1................................................................ 47,250 Cash, December 31 .......................................................... $102,700

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PROBLEM 17-9B (Continued) Note X: During the year, the company acquired equipment with a cost of $141,000 by paying $71,000 cash and incurring a note payable. Calculations: (1) Trading investments, end of year.............................. $94,500 Plus: Carrying value of investments sold ($15,000 + $7,500).......................................... 22,500 Less: Trading investments, beginning of year........ (107,000) Payment for purchase of trading investments ......... $ 10,000 Proceeds from the sale of trading investments ....... $ 15,000 Cash transactions involving trading investments for the year shown net ($15,000 – $10,000) ....... $5,000 (2) Accumulated depreciation for equipment sold removed from accounts = $40,000 − ($49,500 − $58,700 depreciation expense) = $49,200 Carrying amount of equipment sold = Cost $56,000 − Accumulated depreciation $49,200 = $6,800 Cash proceeds = Carrying amount $6,800 + Gain on sale $8,750 = $15,550 Cash .......................................................... Accumulated Depreciation—Equipment Gain on Sale of Equipment ................. Equipment ............................................

15,550 49,200 8,750 56,000

(3) Retirement of note payable Note payable, beginning of year............................... $ 80,000 Note issued to purchase equipment ........................ 70,000 Less: Note payable, end of year .............................. (140,000) Retirement of note payable....................................... $ 10,000

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PROBLEM 17-9B (Continued) (4) Payment of cash dividends Retained earnings, beginning of year ...................... $121,790 Add: Profit.................................................................. 90,310 Less: Retained earnings, end of year ..................... (175,600) Dividends declared and paid .................................... $ 36,500 Taking It Further: Galenti’s management should consider investing excess cash in short-term investments that are low risk and easily liquidated to earn a return on the excess cash.

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PROBLEM 17-10B GALENTI, INC. Cash Flow Statement—Direct Method Year Ended December 31, 2014 Operating activities Cash receipts From customers ........................... $263,700 (1) From trading investments (4) ...... 5,000 $268,700 Cash payments To suppliers................................. $(100,290) (2) For operating expenses .............. (25,400) (3) For income tax ............................ (32,670) For interest .................................. (2,940) (161,300) Net cash provided by operating activities ...... 107,400 Investing activities Sale of equipment ................................ $15,550 (4) Purchase of equipment (Note X)..... (71,000) Net cash used by investing activities ................. (55,450) Financing activities Sale of common shares .................. $50,000 Retirement of note payable* ........... (10,000) (5) Payment of cash dividends* .......... (36,500) (6) Net cash provided by financing activities ......... Net increase in cash ................................................ Cash, January 1........................................................ Cash, December 31 ..................................................

3,500

55,450 47,250 $102,700

Note X: During the year, the company acquired equipment with a cost of $141,000 by paying $71,000 cash and incurring a note payable.

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PROBLEM 17-10B (Continued) Calculations: (1)

(2)

(3)

(4)

Cash receipts from customers Sales ............................................................ Less: Increase in accounts receivable.....

$307,500 (43,800) $263,700

$ 99,460 9,250 108,710 (8,420) $100,290

Cash payments for operating expenses Operating expenses ................................... Less: Decrease in prepaid expenses ....... Add: Decrease in accrued expenses payable

$24,670 (6,000) 6,730 $25,400

Accumulated depreciation for equipment sold removed from accounts = $40,000 − ($49,500 − $58,700 depreciation expense) = $49,200 Carrying amount of equipment sold = Cost $56,000 − Accumulated depreciation $49,200 = $6,800 Cash proceeds = Carrying amount $6,800 + Gain on sale $8,750 = $15,550 Cash .......................................................... Accumulated Depreciation—Equipment Gain on Sale of Equipment ................. Equipment ............................................

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PROBLEM 17-10B (Continued) (5) Retirement of note payable Note payable, beginning of year............................... $ 80,000 Note issued to purchase equipment ........................ 70,000 Less: Note payable, end of year .............................. (140,000) Retirement of note payable....................................... $ 10,000

(6) Payment of cash dividends Retained earnings, beginning of year ...................... $121,790 Add: Profit.................................................................. 90,310 Less: Retained earnings, end of year ..................... (175,600) Dividends declared and paid .................................... $ 36,500

Taking It Further: Increases and decreases in current assets and current liabilities related to operations are not shown directly on the cash flow statement prepared using the direct method. These changes are shown indirectly by matching them against the related revenue or expense item from the income statement. Inventory and accounts payable changes are matched against cost of goods sold to report cash payments to suppliers. An increase in inventory means more goods were purchased than sold, and an increase in accounts payable means that during the year, credit purchases exceeded payments to creditors.

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PROBLEM 17-11B MILK RIVER LTD. Cash Flow Statement – Indirect Method Year Ended December 31, 2014

Operating activities Profit ................................................................................ $29,750 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense*........................... $ 9,500 Gain on sale of equipment .................... (2,000) Impairment loss on goodwill................. 11,000 Increase in accounts receivable ........... (8,000) Increase in inventory ............................. (13,000) Increase in accounts payable................ 3,000 Decrease in income taxes payable ....... (2,000) (1,500) Net cash provided by operating activities ............. 28,250 Investing activities Sale of equipment ............................................$ 10,500 Purchase of equipment (Note X) ........................ (8,000) Net cash provided by investing activities 2,500 Financing activities Issue of common shares ...................................$ 4,000 Repayment of note payable ** ......................... (26,750) Net cash used by financing activities ....................... (22,750) Net increase in cash................................................................ 8,000 Cash, January 1 .................................................................. 5,000 Cash, December 31 ............................................................. $13,000 Note X: During the year, the company acquired equipment with a cost of $24,000 by paying $8,000 cash and incurring a note payable of $16,000.

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PROBLEM 17-11B (Continued) *Depreciation expense Cost of equipment...................................................... $12,000 Accumulated depreciation (calculated).................... (3,500) Carrying amount ....................................................... $ 8,500 Accumulated depreciation, beginning...................... $24,000 Less: depreciation for equipment sold .................... (3,500) Add: depreciation expense (calculated) ................... 9,500 Accumulated depreciation, ending ........................... $30,000 ** Repayment of note payable Notes payable, beginning ......................................... $52,750 Add: notes issued for purchase of equipment....... 16,000 68,750 Less: repayment of notes (calculated) .................... (26,750) Notes payable, ending .............................................. $42,000 Taking It Further: Purchases and sales of equipment should be shown separately. The usefulness of the information is enhanced by showing sources of cash from selling equipment separately from cash used to purchase equipment. Purchases of equipment indicate reinvestment in the productive capacity of the company, whereas sales of equipment indicate disposal of old equipment and/or selling capital assets to generate cash. If the purchases and sales are netted, the detail of this type of information is lost.

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PROBLEM 17-12B MILK RIVER LTD. Cash Flow Statement – Direct Method Year Ended December 31, 2014

Cash flows from operating activities Cash receipts from customers (1) ... Cash payments To suppliers (2) ............................ $(150,000) For operating expenses (3).......... (54,500) For interest ................................... (4,000) For income tax (4) ........................ (11,250) Net cash provided by operating activities

$248,000

(219,750) 28,250

Investing activities Sale of equipment ............................. $10,500 Purchase of equipment (Note X) ...... (8,000) Net cash provided by investing activities

2,500

Financing activities Issue of common shares .................. $4,000 Repayment of notes payable .................(26,750) Net cash used by financing activities

(22,750)

Net increase in cash ............................................... Cash, January 1....................................................... Cash, December 31 .................................................

8,000 5,000 $ 13,000

Note X During the year, the company acquired equipment with a cost of $24,000 by paying $8,000 cash and incurring a note payable of $16,000.

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PROBLEM 17-12B (Continued) Calculations: (1)

Cash receipts from customers Sales ............................................................. Less: Increase in accounts receivable ....... Cash receipts from customers....................

$256,000 (8,000) $248,000

(2) Cash payments to suppliers Cost of goods sold....................................... Add: Increase in inventory ......................... Cost of goods purchased ............................ Less: Increase in accounts payable .......... Cash payments to suppliers........................

$140,000 13,000 153,000 (3,000) $150,000

(3) Cash payments for operating expenses Accumulated depreciation, beginning........ Less: depreciation for equipment sold ...... Add: depreciation expense.......................... Accumulated depreciation, ending .............

$24,000 (3,500) 9,500 $30,000

Operating expenses..................................... Less: Depreciation expense ...................... Cash payments for operating expenses.....

$64,000 (9,500) $54,500

(4) Cash payments for income tax Income tax expense ..................................... Add: Decrease in income tax payable ........ Cash payments for income tax ...................

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$ 9,250 2,000 $11,250

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PROBLEM 17-12B (Continued) Taking It Further: Payments for purchases of equipment need to be shown as uses of cash in the investing activities section. If equipment is purchased, but financed with debt or shares, there is no cash flow involved. These transactions can be omitted from the cash flow statement since they did not affect the company’s cash position. Users still need to reconcile the changes in equipment, debt and share capital. Non-cash transactions are therefore disclosed in the notes to the financial statements.

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PROBLEM 17-13B (a)

Net cash provided (used) by operating activities − net cash (provided) used by investing activities = free cash flow The Gap: $1,363 − $454 = $909 Million Le Château: $(11,304) + $6,545 = $(4,759) Thousands

(b)

The Gap appears to be in the stronger financial position. It generates cash from operating activities and has a positive free cash flow. It also shows a profit.

Taking it Further: Le Château appears to be downsizing. Typically, companies that are growing have net cash outflows from investing activities. In the case of Le Château, the lack of profitability and negative cash flows from operating activities likely led to the need to sell off non-current assets to general cash.

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CONTINUING COOKIE CHRONICLE Koebel’s Family Bakery Ltd. Year Ended July 31, 2015

(a)

Cash provided by operating activities Cash used by investing activities Cash (used) provided by financing activities Increase in cash Cash at the end of the year Cash at the beginning of the year

Net cash provided by operating activities Net cash (used) by investing activities Free cash flow (c)

235,279 (157,833)

1,137,650 (4,545,728)

(37,071) 40,375 199,443 $ 159,068

7,406,647 3,998,569 4,469,552 $ 470,983

Koebel’s Family Bakery Ltd. Year Ended July 31, 2015

(b)

Coffee Beans Ltd. Year Ended November 30, 2014

$235,279 (157,833) $ 77,446

Coffee Beans Ltd. Year Ended November 30, 2014

$1,137,650 (4,545,728) $(3,408,078)

Koebel’s and Coffee Bean’s cash performance, although not similar are both very strong. Koebel’s cash provided by operating activities exceeds cash used in investing activities by 49%. In comparison, Coffee Beans’ cash used in investing activities exceed cash obtained from operating activities by 300%. On the other hand Coffee Beans was able to obtain cash from financing activities 63% greater than the amount of the cash used in investing activities. The financing activities of Koebel were modest in comparison.

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CONTINUING COOKIE CHRONICLE (Continued) Coffee Beans’ long-term liabilities increased year by close to $3.2 million in 2014 from 2013. At the same time the cash provided from financing activities totalled $7.4 million. This means there has been a substantial equity investment into Coffee Beans in the last year. In spite of that large increase in investment by shareholders, no dividends were paid during the year. It appears that with the substantial equity investment and its strong cash position Coffee Beans is in a good position to expand and diversify. (d)

Koebel’s is a profitable company that generated $235,279 cash from operations which was greater than the profit reported by the company. The cash generated from operating activities was more than the amount required for both investing activities and financing activities. While meeting its investing requirements Koebel’s was able to pay a dividend of $120,000 to its shareholders and still increase its cash. Investing in Koebel’s will provide Coffee Beans the opportunity to diversify and while increasing the company’s cash flow.

(e)

Before selling shares and/or becoming employed by Coffee Beans Ltd. the Koebel’s should obtain a full set of financial statements. The financial statement and accompanying notes to the financial statements might give some insights as to what were the main activities and transactions that lead to such a substantial increase in cash and debt, yet only marginally improved profit performance. If the Koebel’s sell their business, they should insist on getting paid in cash instead of in shares of Coffee Beans, as their share ownership in the combined business would be far too small to have any meaningful influence over the whole operations. Given the fact that no dividends were paid by Coffee Beans in the last two years, it would be difficult for the Koebel’s to get a return on their investment as shareholders.

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BYP 17-1 FINANCIAL REPORTING PROBLEM

(a)

Cash and cash equivalents consist of cash on hand, bank balances and short-term deposits with original maturities of three months or less.

(b) Per Reitmans’ 2012 cash flow statement, cash and cash equivalents decreased by $33,199,000. (c)

The one significant investing activity reported in Reitmans’ cash flow statement was the purchase of property and equipment and intangible assets in the amount of $59,154,000.

(d) The most significant financing activities on Reitmans’ cash flow statement was the payment of dividends in the amount of $52,654,000. (e)

As indicated in note 25 to the financial statements, Reitmans’ had two non-cash transactions: (1) additions to property and equipment and intangible assets included in trade and other payables in the amount of $3,028,000 and (2) ascribed value credited to share capital from exercise of share options in the amount of $2,228,000.

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BYP 17-2 INTERPRETING FINANCIAL STATEMENTS (a)

Cash from operating activities Cash used in investing activities Cash from financing activities Increase in cash for the year

$7.0 (9.2) 2.2 $ 0

(b) Andrew Peller Limited’s creditors should not be too worried about the absence of cash on the balance sheet. This is a perfectly normal situation for a large number of businesses who use operating lines of credit instead of cash to deal with the cash demands of day to day operations. The company generated $7 million in cash from operating activities in 2012. The fact that operating activities are generating a significant cash flow means there is less cause for concern. However, $57.5 million of bank indebtedness is 8.2 times the cash flow generated from operations, and 4.4 times the profit. (c) The profit for the year was calculated using accrual accounting. Decreases in non-cash current assets and increases in non-cash current liabilities can result in cash provided from operations lower than the amount of profit reported in the income statement. (d) Free Cash Flow = Cash provided by operating activities − Cash used in investing activities = $7.0 million − $9.2 million = $(2.2) million Free cash flow indicates the amount of discretionary cash flow which Andrew Peller Limited has at its disposal. In this case free cash flow is negative, so there is no discretionary cash flow.

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BYP 17-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

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BYP 17-4 COMMUNICATION ACTIVITY MEMO To:

Investors

From:

Accountant

Re:

Cash flow statement

It is more difficult to manipulate cash-based data than accrualbased data, but it is not impossible. It is possible to manipulate cash flows from operating activities by reclassifying operating cash flows as investing or financing activities. As well, it is possible to manipulate cash balances. For example, management could delay payment of accounts payable. This would improve operating cash flows from operating activities. Which statement provides a better measure of the company’s performance will depend upon the investor. For example, shareholders investing in the company’s common shares for the long-term will find the accrual-based income statement more useful as it provides a better indication of the long-term profitability of the company. Short-term creditors will find the cash flow statement more useful as it provides a better indication of the company’s ability to generate cash and repay its current obligations. The cash flow statement can sometimes provide an early warning of liquidity or solvency problems.

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BYP 17-5 ETHICS CASE

(a)

Other signs of positive performance besides the figure for cash provided by operating activities should be considered by the board in setting the dividend policy. Availability of cash is an important condition for paying a dividend. Profitability is another consideration. The amount of the dividend can be reduced if the dividend payout ratio is too high. Looking into the future, Paradis should also look into addressing any possible contingent liabilities outstanding which could impact the profitability and liquidity of the business.

(b) The stakeholders in this situation are: Phil Monat, president of Paradis Corporation Rick Kwan, controller Rick’s assistant The Board of Directors The shareholders of Paradis Corporation (c)

The president's statement, "We must get that amount above $1 million," puts undue pressure on the controller. This, along with his other statement, "I know you won't let me down, Rick," encourages Rick to do something biased but not necessarily unethical. The president is biased in his request to get a specific accounting result. Controller Rick Kwan's intentional reclassification of interest paid from the operating activities section of the financing activities is biased but also not unethical. The classification of interest paid in the financing activities is allowed under IFRS. On the other hand, it is clear that the intention is to engineer the results to fit a specific criteria to satisfy the President. The classification adopted in prior fiscal years should be followed in the current year for reasons of consistency.

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BYP 17-5 (Continued) (d) If the reclassification between cash flow categories is adopted and applied to all prior years reported on the comparative financial statements, it is unlikely that someone will notice because the comparative cash flow statement will be presented on a consistent basis. Any retroactive change in the classification will warrant a note disclosure to the financial statements to that effect. This disclosure will flag the change and may attract inquiries as to the reason for the implementation of the change. An explanation for the need for the change will be necessary to satisfy not only board members but also outside users of the financial statements such as Paradis’ bank. (e)

If Paradis were reporting under ASPE, it would not have the choice to classify interest paid as a financing activity on the cash flow statement. If implemented, the change would be unethical as it is known to be a violation of GAAP. In that case, the request by the President and suggestion by the Controller show unethical behaviour.

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BYP 17-6 “ALL ABOUT YOU”– ACTIVITY (b) My Cash Flow Statement Year Ended August 31, 2014 Operating activities Cash received from summer job Cash contribution from parents Cash paid for rent, utilities, cable, internet Cash paid for groceries Cash paid for clothes Cash paid for gas, insurance, parking Cash paid for miscellaneous Cash paid for interest on credit card Cash used in operating activities Investing activities Tuition and books Laptop and printer Cash used in investing activities

2013

$ 8,000 4,000 (4,000) (3,600) (3,000) (4,600) (500)

$ 8,000 3,600 (4,000) (3,200) (3,000) (4,420) (500) (180) (3,700)

(3,700)

(7,500) (7,500)

Financing activities Student loan Loan from parents Repayment of credit card Purchases on credit card Cash provided from financing activities Decrease in cash Cash, September 1, 2013 Cash, August 31, 2014

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7,500

(7,000) (1,200) (8,200)

7,500 1,500

(1,000) 6,500

1,000 10,000

(4,700) 2,100 ($2,600)

(1,900) 4,000 $2,100

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BYP 17-6 (Continued) (a)

Your cash position at August 31, 2013 is close to half of the cash you had at September 1, 2012. If you were to maintain the same spending patterns over the next year you could be completely out of cash by August 31, 2014.

(c)

The projected cash flow statement indicates that without any additional loans from your parents, you will have a cash deficiency of $2,600.

(d) The projected cash flow statement and the resulting ending cash deficiency indicate that you will need to borrow the additional $1,500 from your parents. (e)

Unless there are reductions in the level of spending, it is not realistic at this time to expect that you will be able to pay off your credit card debt immediately. This means that additional interest charges will have to be added to a revised projected cash flow statement.

(f)

Actions to improve your cash flow could include: 1. Getting a part-time job while at school. 2. Curtailing some expenses, particularly those that are somewhat discretionary, such as clothes. 3. Taking the bus instead of using a car.

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CHAPTER 18 Financial Statement Analysis ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

1. Identify the need for, and tools of, financial analysis.

1, 2

Brief Exercises 1, 2

2. Explain and apply horizontal analysis.

3, 4, 5, 6

3. Explain and apply vertical analysis.

Exercises 12

Problems Set A 3, 5

Problems Set B 3, 5

3, 4, 5

1, 2, 4,

1, 2

5, 6, 7, 8

5, 6

3, 4, 5

2, 3

4. Identify and use ratios to analyze liquidity.

9, 10, 11,12, 19

7, 8, 9, 16, 17, 18

6, 7, 12, 13, 14, 15

4, 5, 6, 7, 8, 9

5. Identify and use ratios to analyze solvency.

13, 14, 15, 19

10, 11, 12, 16

8, 9, 12, 13, 14, 15

4, 5, 6, 7, 8, 9

6. Identify and use ratios to analyze profitability.

16, 17, 18, 19

13, 14, 15, 16, 17

10, 11, 12, 13, 14, 15, 16

3, 4, 5, 6, 7, 8, 9

7. Recognize the limitations of financial statement analysis.

20, 21, 22,

1, 2, 6

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare horizontal analysis and identify changes.

Moderate

60-70

Interpret horizontal and vertical analysis.

Moderate

25-30

Prepare vertical analysis, calculate profitability ratios, and compare.

Moderate

50-60

Calculate ratios.

Moderate

35-40

Calculate and evaluate ratios.

Moderate

70-80

Calculate and evaluate ratios.

Moderate

45-55

Evaluate ratios.

Moderate

25-35

Evaluate ratios.

Moderate

15-20

Calculate missing information.

Complex

25-35

Prepare horizontal analysis and identify changes.

Moderate

60-70

Interpret horizontal and vertical analysis.

Moderate

25-30

Prepare vertical analysis, calculate profitability ratios, and compare.

Moderate

50-60

Calculate ratios.

Moderate

35-40

Calculate and evaluate ratios.

Moderate

70-80

Calculate and evaluate ratios.

Moderate

45-55

Evaluate ratios.

Moderate

25-35

Evaluate ratios.

Moderate

15-20

Calculate missing information.

Complex

25-35

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objectives 1. Identify the need for, and tools of, financial analysis. 2. Explain and apply horizontal analysis. 3. Explain and apply vertical analysis. 4. Identify and use ratios to analyze liquidity.

Knowledge BE18-1

Comprehension Q18-1 Q18-2 BE18-2 E18-12

Application

Analysis P18-3A P18-5A P18-3B P18-5B

Q18-3

Q18-4 Q18-5 Q18-6

Q18-7

Q18-5 Q18-6 Q18-8 Q18-12 Q18-19 BE18-7 E18-12

BE18-3 BE18-4 BE18-5 E18-1 BE18-5 BE18-6 E18-3 BE18-17 E18-6 E18-13 P18-4A P18-4B

Identify and use ratios to analyze solvency.

Q18-13 BE18-16

Q18-14 Q18-15 Q18-19 BE18-10 E18-12

BE18-11 E18-8 E18-13 P18-4A P18-4B

Identify and use ratios to analyze profitability.

Q18-16 BE18-16

Q18-19 BE18-13 E18-12

BE18-14 BE18-17 E18-10 E18-13 P18-4A P18-4B

Recognize the limitations of financial statement analysis.

Q18-20 Q18-22

E18-2 E18-4 P18-1A P18-2A E18-4 E18-5 P18-2A Q18-10 Q18-11 BE18-8 BE18-9 BE18-18 E18-7 E18-14 E18-15 P18-5A BE18-12 E18-9 E18-14 E18-15 P18-5A P18-6A P18-7A Q18-17 Q18-18 BE18-15 E18-11 E18-14 E18-15 E18-16 P18-3A P18-5A P18-6A Q18-21 BE18-18 E18-16 P18-1A P18-2A

Broadening Your Perspective

BYP18-4

Q18-9 BE18-16

BYP18-5

BYP18-1 BYP18-2 BYP18-3

Synthesis

Evaluation

P18-1B P18-2B

P18-3A P18-2B P18-3B P18-6A P18-7A P18-8A P18-9A P18-5B P18-6B P18-7B P18-8B P18-9B P18-8A P18-9A P18-5B P18-6B P18-7B P18-8B P18-9B P18-7A P18-8A P18-9A P18-3B P18-5B P18-6B P18-7B P18-8B P18-9B P18-6A P18-1B P18-2B P18-6B

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Continuing Cookie Chronicle

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

(a) An intracompany basis of comparison compares the same item with prior periods, or with other financial items in the same period, for one company. A store may compare this year’s sales to last year’s sales, for example. (b) An intercompany basis of comparison compares the same item with one or more other company’s financial statements. A store may compare its current year’s sales with another company’s sales for the same period, for example. The intercompany basis of comparison can provide insight into a company's competitive position in relation to other companies.

(a) The three common tools used in analysis are: horizontal analysis, vertical analysis and ratio analysis. (b) Horizontal analysis is used mainly in intracompany comparisons. Vertical analysis is used in both intra- and intercompany comparisons. Ratio analysis can be used in both types of comparisons.

Percentage of base-period amount: The amount for the period in question is divided by the base-year amount, and the result is multiplied by 100 to express the answer as a percentage. Percentage change for a period: The amount from the previous period is subtracted from the current period amount. The result is divided by the amount from the previous period and then multiplied by 100 to express the answer as a percentage.

(a) An answer cannot be calculated when there is no value in a base year, because division by 0 is mathematically impossible. (b) An answer cannot be calculated when there is a negative value in a base year and a positive value in the next year.

Solutions Manual .

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 5.

Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one financial statement is compared with the amount of that same item on one or more earlier financial statements. Vertical analysis (also called common size analysis) expresses each item within a financial statement in terms of a percent of a relevant total or other common basis within the same statement, for the same time period. Horizontal and vertical analysis differ in that horizontal analysis compares data across more than one year, vertical analysis compares data within the same year. Horizontal and vertical analysis are similar in that they both use percentages to demonstrate number relationships.

Analysis of Facebook’s 2012 results, its first year’s results after it became a public company, will be limited at best. A vertical analysis of the income statement and balance sheet might be useful to determine the company’s performance for the current year. However, any horizontal analysis would not be useful as there are no comparative prior years as a public company and caution would have to be exercised in comparing Facebook as a public company in 2012 to its performance as a private company in prior years.

(a) On a balance sheet, total assets and total liabilities plus shareholders’ equity are both assigned a value of 100%. (b) On an income statement, the figure for net sales or revenue is assigned a value of 100%.

Yes, it can. By converting the accounting numbers to percentages, companies of vastly different sizes can be more readily compared.

(a) Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. (b) Short-term creditors such as suppliers would be the type of users who would be most interested in liquidity ratios.

10.

A high current ratio might be hiding liquidity problems with regards to inventory or accounts receivable. For example, a high level of inventory will cause the current ratio to increase. Increases in inventory can be due to the fact that inventory is not selling and may be obsolete. Increases in the current ratio will also occur if the company’s accounts receivable increase. An increase in accounts receivable could indicate the company is having trouble collecting its overdue accounts, which again would mean liquidity problems for the business.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 11.

Aubut Corporation could have a liquidity problem in comparison to its competition. Before sounding the alarm, it should be established that Aubut’s nearest competitor is truly comparable in all respects to Aubut. For example, Aubut could be selling to customers on account using Aubut credit cards and this would increase accounts receivable. The competitor might have very little accounts receivables if they only accept national credit cards and debit cards. As well, the nature of the inventory being sold should be comparable. If the competitor sells food, and Aubut does not, this could render the comparisons concerning inventory turnover unfair. Finally, despite the comparisons, it must be noted that an operating cycle of 30 days, albeit worse than that of the competition, is still an excellent operating cycle and is not necessarily indicative of an overall liquidity problem.

12.

From the list of liquidity ratios given in your textbook, three ratios provide a calculation where a lower result is considered a better result. The three ratios include the collection period, days sales in inventory and the operating cycle. The operating cycle adds the number of days for the collection period and the number of days sales in inventory. The fewer the number of days in the cycle, the better off the business can be from the point of view of liquidity.

13.

(a) Solvency ratios measure the ability of the company to survive over a long period of time and be able to pay off all of its debt. (b) Long-term lenders such as banks, mortgage companies, and leasing companies would be the most interested users of solvency ratios.

14.

Wong’s solvency is better than that of its competitor. It is carrying a slightly lower percentage of debt than its competitor (37% versus 39%) and has a higher interest coverage ratio (3 versus 2.5).

15.

One of the solvency ratios, the debt to total assets ratio generates a percentage which, when the result is low, it is interpreted as desired result. Since fewer of the business’ assets are financed with debt and instead financed with equity, the business is not burdened to service the debt and meet the deadlines for repayments on large amounts of debt.

16.

(a) Profitability ratios measure the profit or operating success of a company for a specific period of time. (b) Shareholders and potential investors would be most interested in profitability ratios.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 17.

Yes, McDonald’s has made effective use of leverage. McDonald’s earned a higher rate of return using borrowed money than it cost them to service the debt. This increased the return to the shareholders.

18.

An investor interested in growth would want to invest in a company with a high price-earnings ratio and a low dividend payout. The high price-earnings ratio indicates that investors expect this company’s profits to grow and are willing to pay for this anticipated future growth. A low payout ratio generally indicates that the company has growth opportunities and is choosing to reinvest profits to finance this future growth rather than paying earnings out as dividends to the shareholders. An investor interested in shares with income potential would likely choose a company that pays out more of its profits as dividends and therefore has a higher dividend payout ratio.

19.

(a) Asset turnover (b) Acid-test ratio (c) Operating cycle (d) Return on equity (e) Interest coverage

20.

Alternative accounting policies. Differences in accounting policies can make intercompany comparisons difficult and misleading.

Comprehensive income. Comprehensive income, if significant, should not be ignored in financial analysis yet few, if any, ratios include it.

Quality of information. The information used for financial analysis is only good if it is of high quality—fulsome, relevant, transparent, and easily understood.

Economic factors. It is important to understand the impact of the economy on the financial results and to separate, where possible, changes resulting from general economic conditions and those resulting from management influences.

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Accounting Principles, Sixth Canadian Edition

QUESTIONS (Continued) 21.

McCain Foods has chosen to adopt IFRS, although this adoption was not mandatory. McCain Foods’ management likely wishes to report financial results which have been prepared using the accounting policies that are consistent with its global competitors. Cavendish, on the other hand might not perceive any additional benefit in adopting IFRS and so it chooses to follows ASPE as do the vast majority of private companies. Certain accounting policies differ under ASPE and IFRS, which may lead to distortions for comparative purposes.

22.

Other comprehensive income is the gains and losses that are not included in profit, but still affect shareholders’ equity. Other comprehensive income is added to profit to determine comprehensive income. Most financial analysis ratios exclude other comprehensive income. For example, profitability ratios generally use data from the income statement and not the statement of comprehensive income. In fact, there are no standard ratio formulas incorporating comprehensive income. In cases where other comprehensive income is significant, and depending on the source of the income, some analysts will adjust profitability ratios to incorporate the effect of total comprehensive income.

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18-1 1. 2. 3. 4. 5.

Intracompany Intercompany Horizontal analysis Vertical analysis Ratio analysis

(e) (c) (d) (b) (a)

BRIEF EXERCISE 18-2

1. Analysis of a company's dividend history 2. Comparison of differentsized companies 3. Comparison of gross profit to net sales among competitors 4. Calculation of a company’s sales growth over time

Basis of Comparison

Tool of Analysis

intracompany

horizontal

intercompany

vertical

intercompany

vertical

intracompany

horizontal

BRIEF EXERCISE 18-3 2014 80% 136% 126% 220% 129%

Cash Accounts receivable Inventory Prepaid expenses Total current assets

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18-9

2013 150% 115% 122% 0% 119%

2012 100% 100% 100% 100% 100%

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-4 Cash Accounts receivable Inventory Prepaid expenses Total current assets

2014 (47%) 18% 4% n/a 8%

2013 50% 15% 22% (100%) 19%

2014 125%

2013 96%

2012 100%

110% n/a 117%

98% n/a 100%

100% 0% 100%

BRIEF EXERCISE 18-5 (a) Current assets Property, plant, and equipment Goodwill Total assets (b) 2014 Current assets Property, plant, and equipment Goodwill Total assets

Amount $1,530,000 3,130,000

Percentage 32.2% 65.9%

90,000 $4,750,000

1.9% 100.0% 2013

Current assets Property, plant, and equipment Goodwill Total assets

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18-10

Amount $1,175,000 2,800,000

Percentage 28.8% 68.7%

100,000 $4,075,000

2.5% 100.0%

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-5 (Continued) (b) 2012 Amount Percentage $1,225,000 30.1% 2,850,000 69.9%

Current assets Property, plant, and equipment Goodwill

$4,075,000

Total assets

0.0% 100.0%

BRIEF EXERCISE 18-6

Net sales Cost of goods sold Gross profit Operating expenses Profit before income tax Income tax expense Profit

Income Statement Amount Percent $1,934 100.0% 1,612 83.4% 322 16.6% 218 11.3% 104 5.4% 31 1.6% $ 73 3.8%

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-7 (a)

Deterioration: A decrease in the receivables turnover would be viewed as deterioration. It is taking longer to collect the accounts receivable.

(b)

Improvement: A decrease in the collection period would be viewed as an improvement. It takes a fewer number of days to collect accounts receivable.

(c)

Deterioration: The increase in the days sales in inventory would be viewed as deterioration. It is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence, delays in obtaining cash inflows, and higher carrying costs.

(d) Improvement: An increase in the inventory turnover would be viewed as an improvement. It takes a fewer number of days to sell inventory. (e)

Deterioration: A decrease in the acid-test ratio would be viewed as deterioration because the company has fewer liquid assets to pay off liabilities in the very near future.

(f)

Deterioration: An increase in the operating cycle would be viewed as deterioration because it is taking longer for the business to purchase inventory, sell it on account and collect the cash.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-8 (a) (1) and (2) Receivables turnover Collection period

Receivables turnover Collection period

2014 $6,420,000 = = ($850,000 + $750,000) ÷ 2 =

365 ÷

8.0

2013 $6,240,000 = = ($750,000 + $650,000) ÷ 2 =

365 ÷

8.9

8.0

times

days

8.9

times

days

4.5

times

days

5.0

times

days

(3) and (4)

Inventory turnover

2014 $4,540,000 = = ($1,020,000 + $980,000)÷2

Days sales in = inventory

Inventory turnover

4.5

2013 $4,550,000 = = ($980,000 + $840,000) ÷ 2

Days sales in = inventory

Solutions Manual .

365 ÷

18-13

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-8 (Continued) (a) (Continued) (5) Operating cycle = Days sales in inventory + Collection period 2014: 127 days = 81 days + 46 days 2013: 114 days = 73 days + 41 days (b) Management should be concerned with the fact that inventory is moving more slowly in 2014 than it did in 2013, by an extra 8 (81 – 73) days. As for receivables turnover, it is taking an extra 5 (46 – 41) days to collect accounts. Taken together, the company’s operating cycle has increased (deteriorated) by 13 (127 – 114) days in 2014. The decrease in the receivables turnover ratio could be caused by taking on bad credit risks or because less attention is being paid to collecting accounts. The decrease in inventory turnover may be because of poor pricing decisions or because the company has obsolete inventory. Or the company may have decided to increase the amount of inventory that is kept on hand. Management needs to review and address each of these.

BRIEF EXERCISE 18-9 Holysh’s liquidity is deteriorating even though its current and acid-test ratios are higher. The receivables are being collected more slowly, and it is taking longer to sell the inventory. These less-liquid assets are a higher proportion of the current assets than last year.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-10 (a)

Improvement: The decrease in debt to total assets would be viewed as an improvement because it means that the company has reduced its obligations to creditors and has raised its equity "buffer."

(b) Deterioration: A decrease in interest coverage would be viewed as deterioration because it means that the company's ability to meet interest payments as they come due has weakened. (c)

Improvement: An increase in free cash flow would be viewed as an improvement because it means that the company has more flexibility in using cash for capital expenditures.

(d) Improvements: A decrease in debt to total assets combined with an increase in interest coverage would be viewed as improvements because the company has reduced its obligations to creditors and has raised its equity "buffer and it also means that the company's ability to meet interest payments as they come due has strengthened.

BRIEF EXERCISE 18-11 ($ in thousands) (a)

(b)

Debt to = total assets

$3,032,480 $7,300,310

$910,905* Interest = = coverage $64,038 *$910,905 = $613,934 + $232,933 + $64,038

Solutions Manual .

41.5%

14.2

times

= $973,838 – $349,172 = $624,666

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-12 (a)

The debt to total assets ratio for Culleye Corporation has deteriorated, because there is proportionately more debt compared to total assets than there was in 2013. Colleye’s interest coverage ratio has improved. The business can pay its interest expense more times in 2014 than it did in 2013.

(b) While interest coverage is important, it is a reflection of a single year’s performance. On the other hand, debt, especially non-current debt carries over from year to year. The improvement in the interest coverage ratio is overshadowed by the deterioration in the debt to total assets ratio. Consequently, the overall solvency of Colleye has deteriorated in 2014.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-13 (a)

Improvement: An increase in the gross profit margin would be viewed as an improvement because it means that a greater percentage of net sales is going towards profit.

(b)

Deterioration: A decrease in asset turnover would be viewed as deterioration because it means the company has become less efficient at using its assets to generate sales.

(c)

Improvement: An increase in the return on equity would be viewed as an improvement because it means more profit was generated per dollar of equity investment.

(d)

Deterioration: A decrease in earnings per share would be viewed as deterioration because the profit for each share is smaller amount.

(e)

Deterioration: A decrease in profit margin would be viewed as deterioration because there is less profit as a percentage of net sales compared to the previous year.

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-14 ($ in millions) $31,250 – $23,894 $31,250

(a) Gross profit margin

(b) Profit margin

$31,250 = ($16,841 + $17,428) ÷ 2

(d) Return on assets

$769 = ($16,841 + $17,428) ÷ 2

$769

= 23.5% 2.5%

$31,250 1.8 times

4.5%

BRIEF EXERCISE 18-15 Ignoring all other factors, if an investor wants to purchase shares for growth, Apple would be the better choice of the two. Although Apple does not pay a dividend, as indicated by its dividend payout ratio, it is viewed to have more future earnings potential than Bank of Montreal, based on its higher price-earnings ratio. If instead, the investor is looking for income, Bank of Montreal would be a better choice since the bank pays more than half of its profits as dividends.

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-16 Ratio Acid-test ratio Asset turnover Collection period Debt to total assets Gross profit margin Interest coverage Inventory turnover Operating cycle Profit margin Return on equity

(a) Classification L P L S P S L L P P

(b) Direction Higher Higher Lower Lower Higher Higher Higher Lower Higher Higher

BRIEF EXERCISE 18-17 (a) 2014

Average accounts receivable

$1,090 + $965 2

= $1,027.50

2013

Average accounts receivable

$965 + $880 2

2014

Average total assets

$27,510 + $26,760 = $27,135.00 2

2013

Average total assets

$26,760 + $23,815 = $25,287.50 2

2014

Average shareholders' equity

2013

Average shareholders' equity

Solutions Manual .

$922.50

$12,830 + $12,575 2

$12,702.50

$11,752.50

$12,575 + $10,930 =

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Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-17 (Continued) (b)

The averages calculated in part (a) could be used in the following ratios: 1. Receivables turnover 2. Asset turnover 3. Return on assets 4. Return on equity

(c)

Averages are used in certain ratios calculations. When a figure from the income statement is compared with a figure from the balance sheet in a ratio, the balance sheet figure is averaged by adding together the beginning and ending balances and dividing them by 2. That is because income statement figures cover a period of time (i.e., a year) and balance sheet figures are at a point in time—in this case, the beginning and the end of the year. Comparisons of end-ofperiod figures with end-of-period figures, or period figures with period figures, do not require averaging.

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE 18-18 (a) Stirling Corporation $200,000 Inventory = = 20 turnover $10,000

Inventory turnover

(b)

Bute Inc. $180,000 $12,000

times

In times of falling prices, FIFO will result in a higher cost of goods sold than if the average cost formula were used. As well, the ending inventory under FIFO will be based on the newest inventory purchased at the lower price. This could result in the inventory turnover ratio being higher simply because of the choice of the FIFO cost formula, all other factors being equal. Without converting the inventory turnover ratio to the same cost formula, or fully understanding the effects of the different cost formulas on this ratio, a true comparison of inventory turnover could be difficult.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 18-1 DRESSAIRE INC. Balance Sheet 2014 $120,000 400,000 90,000

2013 $ 80,000 350,000 70,000

2012 $100,000 300,000 65,000

145,000 150,000 135,000

125,000 115,000 120,000

150,000 100,000 85,000

(a) Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings

2014 120% 133% 138%

2013 80% 117% 108%

2012 100% 100% 100%

97% 150% 159%

83% 115% 141%

100% 100% 100%

(b)

2014

Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings

Solutions Manual .

2013

50% 14% 29%

(20%) 17% 8%

16% 30% 13%

(17%) 15% 41%

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-2 Net sales increased by 10% in 2013 but then fell back within 1% of the level of net sales of 2012. Cost of goods sold had essentially the same trend as net sales over the three year period. Operating expenses grew by a larger percentage in 2013 than sales but declined in 2014 below the 2012 level. This means that operating expenses were brought under control in 2014, compared to sales, as they should not rise at a faster rate than sales. As a result, profit from operations (sales less cost of goods sold less operating expenses) also increased over the three year period. Income tax expense increased faster than sales over the total of the three years. However, many factors can affect income tax that are beyond the control of the company and it is hard to draw any further interpretations from this change. Given that profit from operations rose faster than income tax over the three years, we can conclude that profit increased as well. It may help to make up numbers to better understand the direction of the changes over the three years. One possible set of hypothetical numbers follows. Note that the percentages shown in red are taken from your text; the subtotals and 2013 and 2014 numbers are calculated based on the hypothetical numbers from 2012 and the percentages given in the text. Net sales Cost of goods sold Gross profit Operating expenses Profit from operations and before income tax Income tax expense Profit

Solutions Manual .

2014 101% $2,020 100% 1,200 820 99% 495 325

2013 110% $2,200 111% 1,332 868 112% 560 308

2012 100% $2,000 100% 1,200 800 100% 500 300

106%

105%

100%

48 $ 277

18-23

47 $ 261

45 $ 255

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE 18-3 FLEETWOOD CORPORATION Income Statement Year Ended December 31

Sales Cost of goods sold Gross profit Operating expenses Profit before income tax Income tax expense Profit

2014 Amount Percent $800,000 100.0% 550,000 68.8% 250,000 31.3% 175,000 21.9%

2013 Amount Percent $600,000 100.0% 375,000 62.5% 225,000 37.5% 125,000 20.8%

75,000 18,750 $ 56,250

100,000 25,000 $ 75,000

9.4% 2.3% 7.0%

16.7% 4.2% 12.5%

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-4 (a) LULULEMON ATHLETICA INC. Balance Sheet January 29, 2012, and January 30, 2011 (in U.S. thousands)

Assets Current assets Non-current assets Total assets Liabilities and Shareholders' Equity Current liabilities Non-current liabilities Total liabilities Shareholders' equity Total liabilities and shareholders' equity

2012

2011

Increase (Decrease) Amount Percent

$527,093 207,541 $734,634

$389,279 110,023 $499,302

$137,814 97,518 $235,332

35.4% 88.6% 47.1%

$103,439 25,014 128,453 606,181

$85,364 19,645 105,009 394,293

$ 18,075 5,369 23,444 211,888

21.2% 27.3% 22.3% 53.7%

$734,634

$499,302

$235,332

47.1%

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-4 (Continued)

(b) LULULEMON ATHLETICA INC. Balance Sheet January 29, 2012, and January 30, 2011 (in U.S. thousands)

(c)

2012 Amount Percent $527,093 71.7% 207,541 28.3%

2011 Amount Percent $389,279 78.0% 110,023 22.0%

$734,634

100.0%

$499,302

100.0%

$103,439 25,014 128,453 606,181

14.1% 3.4% 17.5% 82.5%

$ 85,364 19,645 105,009 394,293

17.1% 3.9% 21.0% 79.0%

$734,634

100.0%

$499,302

100.0%

The two most significant changes from 2011 to 2012 include: the more than 53% horizontal increase in shareholders’ equity and the nearly double (more than an 88% horizontal increase) of non-current assets. It is interesting that noncurrent assets increased without a commensurate increase in debt; indicating that it was likely financed primarily by the increase in equity. There were also stronger increases in current assets than the increases in current liabilities, improving liquidity.

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Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE 18-5 If we make the assumption that there are no other factors impacting the income statement than those stated in the problem, then we can determine the vertical percentage of profit for each year as follows: 2012: 100.0% – 59.4% – 19.6% – 4.2% = 16.8% 2011: 100.0% – 60.5% – 20.4% – 3.8% = 15.3% 2010: 100.0% – 60.0% – 20.0% – 4.0% = 16.0% It would appear that profit declined as a percentage of net sales between 2010 and 2011, and increased slightly in 2012.

Solutions Manual .

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-6 ($ in millions) (a) 2014 Working capital = $1,430 – $890 = $540

= $1,314 – $825 = $489

Current ratio = 1.61:1 ($1,430  $890)

= 1.59:1 ($1,314  $825)

Acid-test ratio = 0.86:1 [($30 + $55 + $676)  $890]

= 0.89:1 [($91 + $60 + $586)  $825]

Receivables turnover = 6.6 times ($4,190  [($676 + $586) ÷ 2])

= 7.3 times ($3,940  [($586 + $496) ÷ 2])

Collection period = 55 days (365 ÷ 6.6 times)

= 50 days (365 ÷ 7.3 times)

Inventory turnover = 5.0 times ($2,900  [($628 + $525) ÷ 2])

= 4.8 times ($2,650  [($525 + $575) ÷ 2])

Days sales in inventory = 73 days (365 ÷ 5.0 times)

= 76 days (365 ÷ 4.8 times)

Operating cycle = 128 days (73 + 55)

= 126 days (76 + 50)

(b) Working capital Current ratio Acid-test ratio Receivables turnover Collection period Inventory turnover Days sales in inventory Operating cycle

Solutions Manual .

2013

Better Better Worse Worse Worse Better Better Worse

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Chapter 18

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-7 (a)

The company’s collection of its accounts receivable has deteriorated over the past three years. It is taking the company longer to collect its outstanding receivables as evidenced by the decrease in the receivables turnover.

(b)

The company is selling its inventory more slowly since the inventory turnover is declining.

(c)

Overall, the company’s liquidity has deteriorated. The increase in the current ratio is most likely caused by the increase in inventory and receivables due to the slowdown in the movement of these assets. The acid-test ratio is also likely inflated because of the slow moving receivables. In total, the increase in the operating cycle indicates deteriorating liquidity.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-8 (a)

Debt to total = assets Free cash flow Interest coverage

Debt to total = assets Free cash flow

Interest coverage

2014 $2,177 $3,886

56.0%

$400

$450

($406 + $14 + $174) $14

42.4 times

$850

2013 $1,959 $3,708

52.8%

– $300

$280

($375 + $27 + $152) $27

20.5 times

= $580

(b) Debt to total assets Free cash flow Interest coverage

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Worse Better Better

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-9 (a)

The debt to total assets has weakened over the past three years.

(b)

The interest coverage has improved over the past three years.

(c)

The company’s solvency initially appears to be worsening as evidenced by its increased reliance on debt. However, its interest coverage ratio is improving, so the company appears to be able to handle the increased level of debt. Overall, its solvency appears to be relatively stable given the differing directions of the company’s debt to total assets and interest coverage ratios. However, the trend of an increasing debt to total assets ratio is not a good one and should be watched carefully particularly because the interest coverage is still quite low.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-10 (a) ($ in thousands) 2014 Gross profit margin

2013

$500 – $375 = 25.0% $500

Profit margin

$33.5 $500

Asset turnover

$500 ($350 + $275) 2

Return on assets

$33.5 ($275 + $350) 2

= 6.7%

1.6 times

= 10.7%

Profit margin Asset turnover Return on assets Return on equity

Solutions Manual .

= 27.5%

$30.0 $400

= 7.5%

$400 1.5 = times ($275 + $274.467) 2

$30.0 = 10.9% ($275 + $274.467) 2

$33.5 Return on = 28.7% equity ($133.5 + $100) 2

(b) Gross profit margin

$400 – $290 $400

$30.0 ($100 + $50) 2

= 40.0%

Worse Worse Better Worse Worse

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-11 (a)

Talisman Energy is more profitable. Its profit margin of 16.6% is significantly higher than that of Suncor’s, at 11.7%. In addition, its return on equity of 14.6% is also much larger than that of Suncor’s, at 11.7%. Note that earnings per share are not comparable between companies because of differing capital structures.

(b)

Investors favour Talisman Energy over Suncor. Talisman has a higher price-earnings ratio—11.6 times earnings compared to Suncor’s 9.6 times. Talisman’s higher profitability picture in the current period leads investors to believe it has a better opportunity for future profitability than Suncor.

(c)

Investors would purchase shares in Talisman for growth purposes. The payout ratio is also higher with Talisman and so investors expecting higher dividend income would invest in Talisman over Suncor.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-12 Ratio Acid-test Asset turnover Current ratio Debt to total assets Gross profit margin Interest coverage Inventory turnover Operating cycle Profit margin Receivables turnover Return on assets Return on equity (c)

(a) (b) Classification Higher Result L B P B L W S B P B S B L B L B P B L B P B P W

The comparison that was done in part (b) was intercompany comparison.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-13 ($ in thousands except for share price) (a) 1.

(b) Asset turnover

Current ratio

Debt to total assets

Earnings per share

Free cash flow

$342,373 = 1.4

$246,713 $516,180

= 47.8%

$11,346 24,874

$18,441

$11,346 + $212 + $2,682 67.1 = times $212

Priceearnings ratio P

Interest coverage

= 2.0 times

$238,434

$1,017,325 ($516,180 + $519,842) ÷ 2

Profit margin

Return on assets

$12.29

$ 43,201

= ($24,760)

= 27 times

$0.46

$11,346 $1,017,325

$11,346 = ($516,180 + $519,842) ÷ 2

2.2%

$11,346 = ($263,120 + $258,969) ÷ 2

4.3%

Return on 10. equity

Solutions Manual .

–

$0.46

18-35

= 1.1%

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE 18-14 (a)

Asset turnover is calculated as: Net sales ÷ average total assets. So 3 × total assets of $100,000 = Net sales of $300,000.

(b)

If gross profit is 40%, then cost of goods sold is 60% of net sales. $300,000 × 60% = $180,000.

(c)

Gross profit is 40% of net sales of $300,000 or $120,000 or sales of $300,000 less cost of goods sold calculated in (b) of $180,000 = $120,000.

(g)

Profit margin is 15% of net sales of $300,000 or $45,000.

(e)

The income taxes rate is 25% and so profit before income taxes is profit of $45,000 ÷ .75 or $60,000.

(f)

The income taxes rate is 25% × profit before income taxes of $60,000 = $15,000 or Profit before income taxes of $60,000 less profit of $45,000 = income tax expense of $15,000.

(d)

Operating expense is derived from deducting from gross profit of $120,000 profit before income taxes of $60,000 = $60,000.

Summary of results: RIVERDANCE LIMITED Income Statement Year Ended December 31, 2014 Net sales Cost of goods sold Gross profit Operating expenses Profit before income taxes Income tax expense Profit

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18-36

$300,000 180,000 120,000 60,000 60,000 15,000 $ 45,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-15 (a)

Receivables turnover is calculated as net sales ÷ average accounts receivable. Net credit sales of $1,950,000 ÷ 13 = accounts receivable of $150,000.

(b)

Inventory turnover is calculated as cost of goods sold ÷ average inventory. So cost of goods sold of $1,267,500 ÷ 6.5 = $195,000. Or total current assets of $365,000 – cash of $20,000 – accounts receivable of $150,000 = inventory of $195,000.

(c)

Current assets of $365,000 + non-current assets of $435,000 = total assets of $800,000.

(d)

Current ratio is current assets ÷ current liabilities = 2:1. So current assets of $365,000 ÷ 2 = current liabilities $182,500.

(f)

Debt to total assets ratio = 70% so total assets of $800,000 × 70% = $560,000.

(e)

Non-current assets = total liabilities of $560,000 less current assets of $182,500 = $377,500.

(h)

Total liabilities and shareholders’ equity = total assets of $800,000.

(g)

Shareholders’ equity = Total liabilities and shareholders’ equity of $800,000 – total liabilities (f) above of $560,000 = $240,000.

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-15 (Continued) Summary of results: MAIN RIVER CORP. Balance Sheet December 31, 2014 Assets Current assets Cash Accounts receivable Inventory Total current assets Non-current assets Total assets

$ 20,000 150,000 195,000 365,000 435,000 $800,000

Liabilities and Shareholders’ Equity Current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity

$182,500 377,500 560,000 240,000 $800,000

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Accounting Principles, Sixth Canadian Edition

EXERCISE 18-16 Most financial analysis ratios exclude other comprehensive income. There are no standard ratio formulas incorporating comprehensive income. Nevertheless, other comprehensive income (loss) should not be ignored in assessing the profitability performance of a company. If we analyse the change in the profit, we can see that over the three-year period it has declined, although it has seen a small increase in 2014. If, however, we analyse the change in the total comprehensive income, we see a significant increase in 2013, compared to a significant decrease in profit. Total comprehensive income declined significantly in 2014 while profit increased slightly. By its nature, other comprehensive income is often volatile. Consequently, further analysis as to the sources of comprehensive income and reasons for the changes between years would be worthwhile.

Solutions Manual .

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Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 18-1A (a) WESTJET AIRLINES LTD. Income Statement Horizontal Analysis Year Ended December 31 2011 2010 Revenue 120% 102% Operating expenses 125% 107% Profit for operations 88% 65% Other expenses 129% 153% Profit before income taxes 82% 52% Income tax expense 77% 56% Profit 84% 51%

2009 89% 92% 72% 195% 54% 51% 55%

2008 100% 100% 100% 100% 100% 100% 100%

2009

2008

139% 89% 103%

122% 94% 102%

100% 100% 100%

114% 85% 95% 120%

102% 94% 97% 113%

100% 100% 100% 100%

103%

102%

100%

WESTJET AIRLINES LTD. Balance Sheet Horizontal Analysis December 31 2011 2010 Assets Current assets 154% Non-current assets 87% Total assets 106% Liabilities & Shareholders’ Equity Current liabilities 127% Non-current liabilities 80% Total liabilities 96% Shareholders' equity 126% Total liabilities and shareholders' equity 106%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-1A (Continued) (b) In a horizontal analysis of the income statement over the last four years, WestJet’s increase in revenue has not translated into increased profit. The 25% growth in operating expenses was higher than the 20% growth in revenue over the four years. This is not a positive trend and expenses should be carefully reviewed. Other expenses varied widely over the same period, although these are smaller in dollar amount and by their nature can often vary. Nonetheless, after a significant increase in other expenses in 2009, it is positive to see a reduction of other expenses occurring in subsequent years. The income tax rate, as a percentage of profit before income taxes, has also increased. This is not a controllable expense by the company however, but it does have an impact on overall profit growth. Because of the impact of all of the factors identified above, profit for WestJet has declined 16% over the four year period. In a horizontal analysis of the balance sheet, current assets have increased by 54%, outpacing the increase the 27% increase in current liabilities over the same period. It is interesting to note that current assets have grown faster than revenue. Further analysis as to the reason for this increase (that is, an increase in cash, receivables, etc.) would be helpful. Both non-current assets and non-current liabilities have declined over the four-year period, while shareholders’ equity has increased.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-1A (Continued) (c) Similar to a horizontal analysis of the base-year amount, a horizontal analysis of the percentage change for each year is limited to condensed information available on the financial statements. While these percentages can show a number of meaningful facts and indicators, the detailed composition of each category and the interrelationship between these various percentages would also be of importance. In addition, after considering the additional information provided in the Taking It Further section, it is unlikely that meaningful percentage changes could be assessed between 2009 and 2010 without a full understanding of the impact of the move to IFRS. This is even more important when interpreting trends in a horizontal percentage of the base-year amount.

Taking It Further: The horizontal analysis should be interpreted with additional information and disclosure provided in the notes to the financial statements concerning the impact the implementation of IFRS had on financial statement elements. Without this in hand, the user of the analysis risks drawing conclusions from information that has not been prepared using consistent accounting practices and standards, which could in turn lead to the wrong conclusions.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-2A (a)

The horizontal and vertical analysis statements demonstrate that the company’s control over its cost of goods sold was relatively steady in 2012 and 2013. However, cost of goods sold increased significantly as a percentage of net sales in 2014, and is increasing faster than net sales. Operating expenses also increased, but a slower pace than that exhibited by cost of goods sold, although the trend of increasing costs faster than the increase in sales is worrisome.

(b)

Most expenses have grown as much or more than revenue. This is not the case for interest expense. Interest expense has reduced substantially over the four year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the balance sheet. Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. That statement reveals that in absolute terms, the amount of other revenue involved is very small and so a major increase of 140% over a three year period turns out to have a modest effect on the profit.

(c)

Horizontal and vertical analysis of the balance sheet, as well as the financial statements themselves, would also be useful in assessing the company’s performance and financial position. In addition, ratio analysis would help complete the picture. Finally, understanding any external economic or other factors that may be affecting costs would also be useful.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-2A (Continued) Taking It Further: Although the profit before income taxes has remained constant as a percentage of each year’s net sales, over the last four years, the amount of sales has increased in absolute terms each year, as shown in the horizontal analysis statement. Since profit before income taxes is a constant percentage of net sales, profit before income tax has also increased by the same amount, 140%, as shown in the horizontal analysis.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-3A (a)

CHEN AND CHUAN COMPANIES Income Statements Year Ended December 31, 2014

Net sales Cost of goods sold Gross profit Operating expenses Profit from operations Interest expense Profit before income tax Income tax expense Profit

Chen Amount Percent $1,849,035 100.0% 1,060,490 57.4% 788,545 42.6%

Chuan Amount Percent $539,038 100.0% 338,006 62.7% 201,032 37.3%

502,275

27.2%

89,000

16.5%

286,270 6,800

15.5% 0.4%

112,032 1,252

20.8% 0.2%

279,470 83,841 $ 195,629

15.1% 4.5% 10.6%

110,780 27,695 $ 83,085

20.6% 5.1% 15.4%

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place. (b) Gross Profit Margin: Gross profit ÷ Net sales Chen = $788,545 ÷ $1,849,035 = 42.6%

Chuan = $201,032 ÷ $539,038 = 37.3%

Profit Margin: Profit ÷ Net sales Chen = $195,629 ÷ $1,849,035 = 10.6% Solutions Manual .

Chuan = $83,085 ÷ $539,038 = 15.4% 18-45

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-3A (Continued) (b) (Continued) Asset Turnover: Net sales ÷ Average total assets Chen Asset turnover = $1,849,035 ÷ $894,750 = 2.1 times

Chuan Asset turnover = $539,038 ÷ $251,313 = 2.1 times

Return on Assets: Profit ÷ Average total assets Chen = $195,629 ÷ $894,750 = 21.9%

Chuan = $83,085 ÷ $251,313 = 33.1%

Return on Equity: Profit ÷ Average shareholders’ equity Chen Return on Equity = $195,629 ÷ $724,430 = 27.0% (c)

Chuan Return on Equity = $83,085 ÷ $186,238 = 44.6%

Chuan is a more profitable company. Although Chen has a higher gross profit margin, Chuan has a better profit margin, which means it can generate more profit per dollar of sales. Chuan’s assets are returning more even though the asset turnover is the same as Chen’s. Finally Chuan’s investors are enjoying a much better return on their investment.

(d) The analysis in (c) is intercompany comparison.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-3A (Continued) Taking It Further: Ratio analysis helps us compare companies of differing sizes. However, we should be able to see Chen enjoying some economies of scale being the larger business of the two. This does not appear to be the case. The operating expenses as a percentage of sales are much higher in the case of Chen. On the other hand, being a larger company helps it obtain lower prices for the goods that are sold, as is demonstrated by its gross profit margin percentage.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-4A Liquidity Ratios 1. Working capital $318,900 2.

Current ratio

Acid-test ratio

–

$208,500

$318,900 $208,500 $68,100 + $107,800 $208,500

$110,400

1.5

0.8

$1,948,500 Receivables = = turnover ($113,200* + $107,900**)÷2 * $113,200 = $107,800 + $5,400 ** $107,900 = $102,800 + $5,100

Collection period

Inventory turnover

Days sales in inventory

Operating cycle

Solutions Manual .

365

17.6

17.6 times

21 days

$1,025,500 = ($143,000 + $115,500) ÷ 2

7.9 times

365

7.9

46 days

21 days

67 days

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-4A (Continued) Solvency Ratios Debt to 9. total assets

10.

$312,500 $998,200

$407,000* Interest = = coverage $28,000 * $407,000 = $265,300 + $113,700 + $28,000 =

$ 316,200 –

Profitability Ratios Gross profit 12. = margin

11.

Free cash flow

$161,300

$154,900

$923,000 $1,948,500

47.4%

13.6%

Profit margin

$265,300 $1,948,500

14.

Asset turnover

$1,948,500 = ($998,200 + $852,800) ÷ 2

Solutions Manual .

14.5 times

13.

15. Return on assets

31.3%

$265,300 = ($998,200 + $852,800) ÷ 2 =

18-49

2.1 times

28.7%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-4A (Continued) Profitability Ratios (Continued) 16.

Return on equity

$265,300 ($685,700 + $465,400) ÷ 2

= 46.1%

17.

Earnings per share

$265,300 [60,000 − (4,000 ÷ 2)]

= $4.57

$5,000

= 1.9%

18. Payout ratio =

$265,300

Taking It Further: The Cable Company’s liquidity appears to be strong mainly because of the high receivables and inventory turnover ratios. Its operating cycle of 67 days is likely reasonable, depending on what the norm is amongst the Cable Company’s competitors. With respect to solvency, since a significant percentage of its assets are financed with equity, the debt to total assets and interest coverage ratios are strong. Finally, profitability also appears to be very good mainly because of the high gross profit margin and return on equity ratios. Industry averages would be useful to confirm this assessment, as would comparative ratios for the Cable Company for prior years.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5A (a) and (b) 2013

(b) Change

$343,000 – $182,000 = $161,000

$343,000 $182,000

2014

Liquidity Ratios 1. Working capital $364,000

– $187,000 = $177,000

2. Current ratio

$364,000 $187,000

3. Acid-test ratio

$209,000* $195,000* = 1.1 = 1.1 $187,000 $182,000 * $209,000 = $70,000 + $45,000 + $94,000 *$195,000 = $65,000 + $40,000 + $90,000

4. Receivables turnover =

5. Collection period

= 1.9

$675,000 = 7.0 ($98,000* + $95,000**)÷2 *$98,000 = $94,000 + $4,000 **$95,000 = $90,000 + $5,000

times

= 1.9

$630,000 = 6.8 ($95,000* + $91,000**)÷2 *95,000 = $90,000 + $5,000 **$91,000 = $88,000 + $3,000

times

days

= 365

Solutions Manual

7.0

= 52

18-51 .

days

365

6.8

= 54

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5A (Continued) (a) and (b) (Continued) Liquidity Ratios 2014 (Continued) $620,000 Inventory 6. = = 4.9 times turnover ($130,000 + $125,000) ÷ 2

Days sales in inventory

Operating = cycle

365

4.9

74 days

52 days

Solutions Manual

= 74

= 126 days

18-52 .

days

(b) Change

2013 $575,000 = 5.2 times ($125,000 + $97,000) ÷ 2

365

5.2

70 days

54 days

= 70

days

= 124 days

Chapter 18

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5A (Continued) (a) and (b) (Continued)

2014 Solvency Ratios Debt to 9. = total assets

10.

Interest coverage

11.

Free cash flow

$377,000 $754,000

(b) Change

2013 = 50.0%

$332,000 $648,000

51.2%

$121,000* $105,000* = 3.5 times = 5.3 times U $35,000 $20,000 *$121,000 = $64,000 + $22,000 + $35,000 *$105,000 = $65,000 + $20,000 + $20,000

$73,500

Solutions Manual

– $115,500

= $(42,000)

18-53 .

$129,000 – $35,000 =

$94,000

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5A (Continued) (a) and (b) (Continued)

2014

(b) Change

2013

Profitability Ratios Gross profit 12. = margin

$280,000 $900,000

= 31.1%

$265,000 $840,000

= 31.5%

13.

Profit margin

$64,000 $900,000

= 7.1%

$65,000 $840,000

= 7.7%

14.

Asset turnover

$900,000 $840,000 = 1.3 times = 1.3 times NC ($754,000 + $648,000) ÷ 2 ($648,000 + $630,000) ÷ 2

15.

Return on assets

$64,000 = 9.1% ($754,000 + $648,000) ÷ 2

$65,000 = 10.2% ($648,000 + $630,000) ÷ 2

$64,000 = ($377,000 + $316,000) ÷ 2 = 18.5%

$65,000 ($316,000 + $259,000) ÷ 2 = 22.6%

Return on 16. equity

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5A (Continued) (a) and (b) (Continued) Profitability Ratios (Continued) Earnings 17. = per share

$64,000 20,000

18. Payout ratio =

$3,000

2014

(b) Change

2013 = $3.20

$65,000 20,000

$64,000 = 4.7%

$8,000

$65,000

= $3.25

= 12.3%

(c) (1) Liquidity: Stayed essentially the same The overall liquidity of Click and Clack is slightly better with respect to the receivables turnover, but worse for inventory turnover than the previous year, but the changes are small. (2) Solvency: Deteriorated Although the debt to total assets ratio improved slightly, the interest coverage ratio worsened. A large amount of cash was used in investing activities during 2014 which in turn increased the debt and corresponding interest charges. Free cash consequently turned negative and the interest coverage ratio has deteriorated. (3) Profitability: Deteriorated Profitability has decreased slightly. Profit was mostly affected by the large increase in interest charges. This explains why the gross profit margin decreased slightly but the profit margin decreased dramatically. The return on assets declined correspondingly. Solutions Manual

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PROBLEM 18-5A (Continued) Taking It Further: The problem is employing intracompany comparison. It is hard to say which is more useful— intercompany or intracompany comparisons—as both provide valuable information. When two companies in the same industry are compared, then intercompany comparisons can be very useful. A business might obtain feedback that they are doing well from an intracompany analysis, but may not be doing as well on an intercompany comparison, possibly failing to keep pace with pricing increases or cost control opportunities that the company’s competitors are taking advantage of.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-6A (a) ($ in millions of CAD dollars for Tim Hortons and US dollars for Starbucks) Liquidity Ratios

Tim Hortons

Starbucks

Current ratio

$1,009.1 $491.5

= 2.1

Receivables turnover

$2,536.5 $181.0

= 14

times

Collection period

= 26.0

days

Inventory turnover

= 16.9

times

Days sales in inventory

365

÷ 16.9 = 21.6

days

365

21.6

+ 26.0 = 47.6

days

55.3

Operating cycle =

Solutions Manual

365

$1,527.4 $90.6

18-57 .

$3,794.9 $2,075.8

= 1.8

$11,700.4 $344.6

= 34

times

= 10.7

days

= 6.6

times

= 55.3

days

+ 10.7 = 66.0

days

365

$4,949.3 $754.6 6.6

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-6A (Continued) (a) (Continued) Solvency Ratios Debt to total 5. assets

Tim Hortons =

$1,039.1 $2,481.5

= 41.9%

Starbucks $2,973.1 $7,360.4

= 40.4%

= Interest $647.1 + $26.6 +$200.9 32.9 $1,248.0 + $33.3 +$563.1 55.4 = = coverage times times $26.6 $33.3 Profitability Ratios Gross profit 7. margin $1,009.1 $6,751.1 = = 39.8 % = 57.7% $2,536.5 $11,700.4 Profit 8. margin = $647.1 $1,248.0 = 25.5% = 10.7% $2,536.5 $11,700.4 Asset 9. turnover = $2,536.5 $11,700.4 = 1.1 times = 1.7 times $2,287.9 $6,873.2 Return on 10. assets = 6.

Return on 11. equity

Solutions Manual

$647.1 $2,287.9

= 28.3%

$1,248.0 $6,873.2

= 18.2%

$647.1 $1,349.1

= 48.0%

$1,248.0 $4,034.8

= 30.9%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-6A (Continued) (b)

Liquidity: When looking at the liquidity ratios, one can conclude that Tim Hortons is far more liquid than Starbucks. Where there is a larger discrepancy in the performance is in the collection of accounts receivable. It is taking Tim Hortons more than twice as much time to collect accounts receivable compared to Starbucks. However, Tim Hortons is still collecting its receivables in less than 30 days. Since the receivables are from franchisees, the difference might be caused by a different credit policy offered to franchisees between the two businesses. Tim Horton has also outpaced Starbucks for its inventory turnover, although this might be caused by the items that are not food related that are held in inventory by Starbucks. Solvency: The debt to total assets ratio is similar between Tim Hortons and Starbucks. Where Starbuck’s is noticeably better, is in its ability to pay interest. Profitability: Tim Hortons is more profitable than Starbucks on all profitability ratios except its gross profit margin and asset turnover.

Taking It Further: Most financial analysis ratios exclude other comprehensive income. There are no standard ratio formulas incorporating comprehensive income. Nevertheless, other comprehensive income (loss) should not be ignored in assessing the profitability of a company. Key profitability ratios should be recalculated including other comprehensive income if it is significant and depending on its composition.

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PROBLEM 18-7A (a) Fournitures Ltée’s accounts receivable management can be assessed by reviewing the company’s receivables turnover, which indicates how often the company is “turning” over its receivables; that is, how long the company is taking to collect its accounts receivable. Fournitures Ltée’s receivables turnover of 11.8 times can also be expressed as an average collection period of 31 days (365 ÷ 11.8). This receivables turnover is reasonable when compared to its credit terms of 30 days. As well, Fournitures Ltée’s receivables turnover is better than Supplies Unlimited indicating that Fournitures Ltée’s management is doing a better job at controlling the collection of the company’s receivables. (b) Fournitures Ltée’s ability to manage its inventory can be measured by the inventory turnover ratio. Currently Fournitures Ltée is turning over its inventory 6 times per year which can also be expressed as approximately every 61 days (365 ÷ 6 times). When compared to the turnover for Supplies Unlimited, it appears that Fournitures Ltée is turning over its inventory much faster than its competition. (c) Supplies Unlimited’s current ratio could be higher than Fournitures Ltée’s because, in spite of its slower inventory turnover. It could also have a higher level of prepaid expenses or similar type of current assets.

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PROBLEM 18-7A (Continued) (d) Fournitures Ltée’s is the less solvent company of the two companies as it has a higher proportion of assets financed with debt, as demonstrated by its debt to total asset ratio of 35%. This percentage is still very good in general. The other ratio that pinpoints solvency is the times interest earned ratio. In this case, since Fournitures Ltée has proportionately more debt, it is not surprising to note that it has a lower times interest earned ratio. (e) Fournitures Ltée’s lower gross profit margin may be attributable to a number of factors:  The company may be selling its products at a lower price hoping to increase its sales volume and hence profit.  The company may be paying more for the cost of its inventory than the competition. This may occur if, for example, Fournitures Ltée is not able to purchase inventory in the same quantity for the same price as its competition.  Fournitures Ltée might not be able to take advantage of reduced costs from bulk purchases because it has overextended its credit and is unable to obtain additional debt financing. Fournitures’ higher profit margin could be the result of lower operating expenses or more other income than Supplies Unlimited. (f)

The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by its higher price-earnings ratio, investors appear to believe that Fournitures Ltée has the better possibility for growing its profit.

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PROBLEM 18-7A (Continued) Taking It Further: Financial leverage is said to be positive if a company is able to earn a higher return on equity by using borrowed money in its operations than it has to pay on the borrowed money. A quick measure of leverage is calculated by comparing the amount the percentage of return on equity exceeds return on assets. Fournitures Ltée’s return on equity exceeds its return on assets by a 5.2% return while Supplies Unlimited has an excess of 3.5% return.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-8A

(a) Potash is more liquid. Its inventory and receivables turnover much faster than do Agrium’s. Consequently, its operating cycle is also much better than Agrium’s. Its current ratio is not as strong as that of Agrium, but it is possible that Agrium’s current ratio is somewhat inflated by slow moving receivables and/or inventory. (b) Agrium is more solvent with a lower debt to total assets ratio and a much better interest coverage ratio than Potash. (c) Overall, Potash is far more profitable. It has a much higher gross profit margin, profit margin, return on assets, and return on equity. The only ratio that is not in support of Potash’s superior profitability is its asset turnover which is half of Agrium’s. Taking It Further: Based on its higher price-earnings ratio, investors favour Potash over Agrium. This is consistent with Potash’s superior profitability. Investors are likely keeping an eye on short-term returns for their investment.

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PROBLEM 18-9A (e)

Income tax rate is 20%. Profit after income tax is $124,600 so profit before income tax $124,600 ÷ .8 (100% – 20%) = $155,750.

(f)

Income tax is profit before income taxes of (e) $155,750 × 20% = $31,150 or profit after income tax is $124,600 × .25 = $31,150, or more simply profit before income taxes of (e) $155,750 less profit of $124,600 given = $31,150.

(d) Profit before income taxes $155,750 plus interest expense $10,500 = profit from operations of $166,250. (c)

Profit from operations of $166,250 plus operating expenses of $333,750 = gross profit of $500,000.

(a)

Gross profit margin is 40% so gross profit of $500,000 (c) ÷ 40% = net sales of $1,250,000.

(b)

Net sales of $1,250,000 less gross profit of $500,000 = cost of goods sold of $750,000.

Summary of results: SCHWENKE CORPORATION Income Statement Year Ended December 31, 2014 Net sales Cost of goods sold Gross profit Operating expenses Profit from operations Interest expense Profit before income taxes Income tax expense Profit

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18-64

$1,250,000 750,000 500,000 333,750 166,250 10,500 155,750 31,150 $ 124,600

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-9A (Continued) (h) Inventory turnover is 8 times and so cost of goods sold of $750,000 ÷ 8 = inventory of $93,750. (k)

Asset turnover is 1.5 times so net sales of $1,250,000 ÷ 1.5 = total assets and (n) total liabilities and shareholders’ equity of $833,333.

(m) Total liabilities and shareholders’ equity of $833,333 less shareholders’ equity of $650,000 = total liabilities of $183,333. (l)

Total liabilities of $183,333 less non-current liabilities of $120,000 = current liabilities of $63,333.

(i)

Current ratio is 3:1 so current liabilities of $63,333 × 3 = current assets of $190,000.

(j)

Total assets of $833,333 less current assets of $190,000 = property, plant and equipment of $643,333.

(g) Current assets of $190,000 less cash of $7,500 less inventory of $93,750 = accounts receivable of $88,750.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-9A (Continued)

Summary of results: SCHWENKE CORPORATION Balance Sheet December 31, 2014 Assets Current assets Cash Accounts receivable Inventory Total current assets Property, plant, and equipment Total assets Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ Equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity

7,500 88,750 93,750 190,000 643,333 $833,333 $ 63,333 120,000 183,333 250,000 400,000 650,000 $833,333

Taking it Further: Because of the large number of figures that are omitted at the beginning of each of the financial statements, it is necessary to work backwards, using totals and sub-totals along with the ratios given.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-1B

(a) MICRO BREWERY INC. Income Statement Year Ended December 31

Sales revenue Cost of goods sold Gross profit Operating expenses Profit from operations Other income Profit before income taxes Income tax expense Profit

Solutions Manual .

2014 147% 177% 127% 110% 198% 67% 192% 192% 192%

18-67

2013 120% 139% 107% 109% 98% 99% 98% 98% 98%

2012 123% 136% 114% 104% 163% 138% 161% 161% 161%

2011 100% 100% 100% 100% 100% 100% 100% 100% 100%

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-1B (Continued) (a) (Continued) MICRO BREWERY INC. Balance Sheet Horizontal Analysis December 31 2014 Assets Current assets 136% Non-current assets 143% Total assets 141% Liabilities and Shareholders’ Equity Liabilities Current liabilities 98% Non-current liabilities 50% Total liabilities 73% Shareholders’ equity Common shares 1100% Retained earnings 130% Total shareholders’ equity 168% Total liabilities and shareholders' equity 141%

2013

2012

2011

103% 150% 141%

119% 95% 100%

100% 100% 100%

92% 113% 104%

80% 40% 59%

100% 100% 100%

1100% 118% 156%

100% 116% 115%

100% 100% 100%

141%

100%

(b) Micro Brewery has seen some significant changes between 2011 and 2014. In a horizontal analysis of the income statement, other than a slight exception in 2013, we can see that sales revenue has grown over the four-year period. The cost of goods sold also increased during this period, however at a rate faster than sales. That is, sales increased 47% while cost of goods sold increased 77% over the same period. This is not a positive trend and costs and pricing may need to be carefully reviewed.

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PROBLEM 18-1B (Continued) (b) (Continued) Operating expenses on the other hand, only increased by 10% during the four years, resulting in a large increase in the profit from operations between 2011 and 2014. Other income is not a significant dollar amount and by its nature can be expected to vary over the years. Income tax expense increased at the same rate as profit before income taxes, indicating that the company experienced a constant tax rate. The horizontal analysis of the balance sheet adds additional insight into Micro Brewery’s financial performance and position. Current assets have increased by 36% during the period. Further analysis to determine the composition of this increase (that is, an increase in cash, receivables or inventory) would be helpful. However, we can note that this increase is less than the rate of increase in sales revenue over the same four-year period which is positive. It is also more than the increase in current liabilities (36% current assets growth compared to −2% current liabilities growth). There was a significant increase in non-current assets in 2013 indicating that an expansion or acquisition of new equipment likely occurred. This supports the increased revenue we saw in 2014. Total assets increased by 41% during the period. On the liability side, the current liabilities have stayed relatively constant varying only by 2% over the four years. There has been considerable fluctuation in noncurrent liabilities; however, 2012 saw a considerable drop as debt was paid down while 2013 saw a significant increase. This is consistent with the increase in assets during the same period likely requiring an increase in financing. In 2014, the company’s growth supported further repayment of debt.

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PROBLEM 18-1B (Continued) (b) (Continued) Common shares experienced a significant increase in 2013 as new equity was invested into the business; these funds were likely used to finance part of the expansion we speculated about above. Retained earnings have also grown significantly during the period. A reconciliation of this account with the change in profit indicates that dividends must have been paid and these were also increasing each year. (c)

Similar to a horizontal analysis of the base-year amount, a horizontal analysis of the percentage change for each year is limited to condensed information available on the financial statements. While these percentages can show a number of meaningful facts and indicators, the detailed composition of each category and the interrelationship between these various percentages would also be of importance. In addition, after considering the additional information provided in the Taking It Further section, it is unlikely that meaningful percentage changes could be assessed between 2012 and 2013 without a full understanding of the impact of the move from ASPE to IFRS.

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PROBLEM 18-1B (Continued) Taking It Further: Micro Brewery completed a major expansion and share issue in 2013 as it went from being a closely held private corporation to a public corporation. This information helps explain some of the significant variations we saw in our above analysis in 2013. Consequently, horizontal analysis percentages should be interpreted in light of the additional information and disclosure provided in the notes to the financial statements concerning the impact the move to IFRS had on the financial statement elements. Without this information, the user of the analysis risks drawing conclusions from information that has not been prepared using consistent accounting practices and standards, which could in turn lead to the wrong conclusions.

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-2B (a)

Although the operating expenses have been increasing over the last four years, when these are expressed as a percentage of revenues in the vertical analysis, it is clear that in spite of the fact that the absolute amounts are greater over time, their proportion as a percentage of revenue is smaller, demonstrating that the company has control over the operating expenses.

(b)

Interest expense is decreasing over the four year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the balance sheet. Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. That statement that reveals that in absolute terms, the amount of other revenue involved is very small and so an increase of 240% over a three year period turns out to have a modest effect on the profit.

(c)

Horizontal and vertical analysis of the balance sheet, as well as the financial statements themselves would be useful in assessing the company’s performance and financial position. In addition, ratio analysis would help complete the picture. Finally, understanding any external economic or other factors would also be useful.

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PROBLEM 18-2B (Continued) Taking It Further: The change in the percentage increase in profit before tax and income tax expense is the same in a horizontal analysis of the income statement, reflecting that the income tax expense is calculated at the same income tax rate from year to year. Therefore the absolute amount of the tax expense is changing in the same proportion as the change in profit before income taxes. As demonstrated in the vertical analysis of the income statement, when compared to revenues, the absolute amount of income tax expense will change since other variables, such as operating expenses, reduce revenues in different amounts and proportions each year.

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PROBLEM 18-3B (a)

Income Statement Year Ended June 30, 2014

Manitou Amount Percent Net sales $360,000 100.0% Cost of goods sold 200,000 55.6% Gross profit 160,000 44.4% Operating expenses 60,000 16.7% Profit from operations 100,000 27.8% Rental income 12,000 3.3% Profit before income tax 112,000 31.1% Income tax expense 22,400 6.2% Profit $ 89,600 24.9%

Muskoka Amount Percent $1,400,000 100.0% 720,000 51.4% 680,000 48.6% 272,000 19.4% 408,000 24,000

29.1% 1.7%

432,000 95,040 $ 336,960

30.9% 6.8% 24.1%

Muskoka = $680,000 ÷ $1,400,000 = 48.6%

Profit Margin: Profit ÷ Net sales Manitou = $89,600 ÷ $360,000 = 24.9%

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Muskoka = $336,960 ÷ $1,400,000 = 24.1%

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PROBLEM 18-3B (Continued) Asset Turnover: Net sales ÷ Average total assets Manitou: Asset Turnover $360,000 ÷ $457,500 = 0.8 times

Muskoka Asset Turnover $1,400,000 ÷ $1,725,000 = 0.8 times

Return on Assets: Profit ÷ Average total assets Manitou: $89,600 ÷ $457,500 = 19.6%

Muskoka $336,960 ÷ $1,725,000 = 19.5%

Return on Equity: Profit ÷ Average shareholders’ equity Manitou: Return on Equity $89,600 ÷ $204,800 = 43.8%

Muskoka Return on Equity $336,960 ÷ $743,480 = 45.3%

(c)

Muskoka is slightly more profitable. Muskoka has a better gross profit margin, but a slightly lower profit margin than does Manitou. This is primarily because Manitou has a lower amount of rental income. Manitou has lower operating expenses, compared to Muskoka. Muskoka’s return on equity is also better. Its asset turnover is the same and its return on assets slightly lower than that of Manitou.

(d)

The comparison in (c) above is intercompany comparison.

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PROBLEM 18-3B (Continued) Taking It Further: Ratio analysis helps us compare companies of differing sizes. However, we should be able to see Muskoka enjoying some economies of scale being the larger business of the two. This does not appear to be the case. The operating expenses as a percentage of sales are higher in the case of Muskoka compared to Manitou. On the other hand, Muskoka has better buying power and can obtain lower prices for the goods that it purchases, as is demonstrated by its gross profit percentage.

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PROBLEM 18-4B

Liquidity Ratios 1. Working capital 2.

Current ratio

Acid-test ratio

Receivables turnover

Collection period

Inventory turnover

Days sales in inventory

– $180,150

$250,500 $180,150

= $70,350 = 1.4

$154,100* $180,150 *$154,100 = $23,100 + $26,280 + $104,720

$790,000 = ($110,220* + $98,300**)÷2 * $110,220 = $104,720 + $5,500 ** $98,300 = $93,800 + $4,500

= 8.

$250,500

365

7.6

0.9

7.6

times

= 48

days

$540,000 = ($96,400 + $74,000) ÷ 2

6.3

times

365

6.3

= 58

days

= 106

days

Operating cycle =

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PROBLEM 18-4B (Continued) Solvency Ratios Debt to total 9. assets

10.

Interest coverage

11.

Free cash flow

$270,150 $715,800

= 37.7%

$73,270 + $12,930 + $3,200 = 27.9 times $3,200

$116,780

Profitability Ratios Gross profit 12. = margin

–

$51,660

$65,120

$250,000 $790,000

= 31.6%

13.

Profit margin

$73,270 $790,000

= 9.3%

14.

Asset turnover

$790,000 ($715,800 + $672,000) ÷ 2

= 1.1 times

15.

Return on assets

$73,270 ($715,800 + $672,000) ÷ 2

= 10.6%

16.

Return on equity

$73,270 ($445,650 + $396,000) ÷ 2

= 17.4%

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PROBLEM 18-4B (Continued) Profitability Ratios (Continued) 17.

Earnings per share

$73,270 15,000

Payout ratio

$23,620

= $4.88 ÷

$73,270

= 32.2%

Taking It Further: Rose Packing’s liquidity appears to be a bit weak, based on its acid-test ratio of less than 1 and collection period of 48 days. However, it is hard to assess its collection period without knowing the company’s credit terms. Its inventory turnover ratio may be reasonable, depending on what the norm is amongst its competitors and the packing industry. With respect to solvency, since a significant percentage of its assets are financed with equity, the debt to total assets and interest coverage ratios are strong. Finally, profitability also appears to be reasonable based on ratios. Industry averages would be useful to confirm this assessment, as would comparative ratios for Rose Packing for prior years.

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PROBLEM 18-5B

Liquidity Ratios Working = 1. capital

2014 $415,000

– $337,750 = $77,250

Current ratio

$415,000 $337,750

= 1.2

Acid-test ratio

$50,000 + $100,000 $337,750

= 0.4

Receivables turnover =

Collection period

Change

2013 $360,000 –

$315,000 = $45,000

$360,000 $315,000 $42,000 + $87,000 $315,000

$1,000,000 = 10.2 times ($105,000* + $91,000**)÷2 * $105,000 = $100,000 + $5,000 ** $91,000 = $87,000 + $4,000

= 1.1

= 0.4

$940,000 = 11.0 ($91,000* + $80,000**)÷2) * $91,000 = $87,000 + $4,000 ** $80,000 = $77,000 + $3,000

times

days

= 365

Solutions Manual

10.2

= 36

days

18-80 .

365

11.0

= 33

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PROBLEM 18-5B (Continued) Liquidity Ratios (Continued) 2014 6.

Inventory turnover

Days sales in inventory =

Operating cycle

Chan -ge

2013

$650,000 = 3.0 ($240,000 + $200,000) ÷ 2

times

$635,000 = 3.6 ($200,000 + $150,000) ÷ 2

times

365

3.0

= 122

days

365

3.6

= 101

days

122

= 158

days

101

= 134

days

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PROBLEM 18-5B (Continued) Solvency Ratios 2014 9.

Debt to total assets

10.

Interest coverage

11.

Free cash flow

$437,750 $1,240,000

Chan -ge

2013 = 35.3%

$415,000 $1,135,000

= 36.6%

$150,000* $125,000* = 4.3 times = 3.6 times $35,000 $35,000 *$150,000 = $97,750 + $17,250 + $35,000 *$125,000 = $76,500 + $13,500 + $35,000 $133,500 –

Solutions Manual

$110,000 = $23,500

18-82 .

$180,500 –

$56,000

= $124,500

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Accounting Principles, Sixth Canadian Edition

PROBLEM 18-5B (Continued) Profitability Ratios 2014 Gross 12. profit margin

$350,000 $1,000,000

13. Profit margin

$97,750 $1,000,000

14. Asset turnover

15. Return on assets

Chan -ge

2013 = 35.0%

$305,000 $940,000

= 32.4%

= 9.8%

$76,500 $940,000

= 8.1%

$1,000,000 0.8 = times ($1,240,000 + $1,135,000)÷2

$940,000 =0.9 times ($1,135,000 + $1,075,000)÷2

$97,750 = 8.2% ($1,240,000 + $1,135,000)÷2

$76,500 = 6.9% ($1,135,000 + $1,075,000)÷2

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PROBLEM 18-5B (Continued) Profitability Ratios (Continued)

16. Return on equity

17. Earnings per share

2014 $97,750 = 12.8% ($802,250 + $720,000) ÷ 2 $97,750 − $15,500 100,000

= $0.82

2013 $76,500 ($720,000 + $659,000) ÷ 2 $76,500 − $15,500 100,000

Chan -ge

= 11.1%

= $0.61

= 20.3%

18. Payout ratio = $15,500

Solutions Manual

$97,750

= 15.9%

18-84 .

$15,500

$76,500

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PROBLEM 18-5B (Continued) (c) (1) Liquidity: Deteriorated Track’s overall liquidity has deteriorated in 2014 compared to 2013 in spite of a modest improvement in the current ratio. Both the receivables and inventory turnover ratios have deteriorated and consequently the operating cycle worsened by 24 days. (2) Solvency: Improved The debt to total assets ratio improved slightly. The interest coverage ratio improved even more so; consequently, overall solvency improved. A larger amount of cash was used in investing activities during 2014 compared to 2013 which resulted in a large decrease in free cash flow. (3) Profitability: Improved Profitability, with the exception of the asset turnover ratio which decreased slightly, has improved overall.

Taking It Further: The problem is employing intracompany comparison. It is hard to say which is more useful— intercompany or intracompany comparisons—as both provide valuable information. When two companies in the same industry are compared, then intercompany comparisons can be very useful. A business might obtain feedback that they are doing well from an intracompany analysis, but may not be doing as well on an intercompany comparison, possibly failing to keep pace with pricing increases or cost control opportunities that the company’s competitors are taking advantage of.

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PROBLEM 18-6B (a) ($ in thousands) The Brick

Liquidity Ratios

Leon's

Current ratio =

$388,087 $280,005

= 1.4

$343,772 $139,123

= 2.5

Receivables turnover

$1,351,648 $72,760

= 18.6 times

$682,836 $28,753

= 23.7 times

Collection period

365

= 20

days

365 ÷

= 15

days

Inventory turnover

= 4.5

times

$394,099 $86,627

= 4.5

times

Days sales in inventory

Operating cycle

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18.6

$753,977 $167,264 365

4.5

= 81

days

365

÷ 4.5

= 81

days

= 101

days

= 96

days

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PROBLEM 18-6B (Continued) The Brick

Solvency Ratios 5.

Debt to total assets

Interest coverage

= =

Profitability Ratios: 7. Gross profit = margin 8. 9.

Profit margin

Asset turnover

10. Return on assets

$674,836 $766,482

Leon's

$35,873 + $30,979 +$14,443 = $30,979

$597,671 $1,351,648

$169,878 $595,339

= 88.0% 2.6

= 44.2%

$35,873 $1,351,648

= 2.7%

$1,351,648 $750,182

= 1.8

$35,873 $750,182 $35,873 $82,584

= 28.5%

N/A — no interest expense

$288,737 $682,836

= 42.3%

$56,666 $682,836

= 8.3%

$682,836 $581,007

= 1.2

= 4.8%

$56,666 $581,007

= 9.8%

= 43.4%

$56,666 $417,874

= 13.6%

times

11. Return on equity

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PROBLEM 18-6B (Continued) (b) Liquidity: Leon’s Leon’s has a much stronger current ratio than The Brick. It also collects its receivables more quickly than The Brick. That said, both companies’ collection periods are still very good at fewer than 30 days. The inventory turnovers of the two companies are identical. As a result, Leon’s operating cycle is also better than The Brick. Solvency: Leon’s The level of debt is what sets these two companies apart. Whereas The Brick has more than half the value of its assets in non-current liabilities, Leon’s is less than 5%. As a result, Leon’s debt to total assets ratio is significantly better than than of The Brick. Profitability: Leon’s Although The Brick has a higher gross profit margin, it is not translating into a higher profit margin. The main culprits explaining this result are the high interest expense and the correspondingly high other non-operating expenses. Although the return on assets of The Brick is about half of that of Leon’s, its return on equity is more than triple that of Leon’s. This is likely because of The Brick’s higher use of leverage.

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PROBLEM 18-7B

(a) Accounts receivable management can be assessed by reviewing each company’s receivables turnover ratio and average collection period. Refresh’s average collection period of 35 days (365 ÷ 10.4) days is reasonable when compared to its credit terms of 30 days. Flavour’s average collection period of 37 days (365 ÷ 9.8) days is marginally worse than that of Refresh. (b) Each company’s ability to manage its inventory can be measured by the inventory turnover ratio. Currently Refresh is turning over its inventory 5.8 times per year, which can also be expressed as days in inventory of approximately 63 days (365 ÷ 5.8 times). When compared to the turnover of 9.9 times for Flavour, it appears that Refresh is turning over its inventory at a much slower rate than the competition. (c) Refresh’s current ratio could be higher than Flavour’s because of its slower inventory turnover. It could also have a higher level of prepaid expenses or similar type of current assets. (d) Refresh is the more solvent of the two companies. Refresh has a much lower debt to total assets ratio, indicating that Refresh has a lower percentage of its assets financed by debt. As well, Refresh has a higher interest coverage ratio indicating that Refresh has a better ability to service its debt as interest payments become due.

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PROBLEM 18-7B (Continued) (e) Refresh’s higher gross profit margin may be attributable to a number of factors:  The company may be selling its products at a higher price.  The company may be paying less for the cost of its inventory than the competition. This may occur if, for example, Refresh is able to purchase inventory in large volumes and receives purchase discounts.  Flavour might not be able to take advantage of reduced costs from bulk purchases because it has overextended its credit and is unable to obtain additional debt financing. Refresh’s lower profit margin is most likely the result of higher operating expenses or less other income. (f)

The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by its higher price-earnings ratio, investors appear to believe that Refresh has the better possibility for growing its profit.

Taking It Further: Financial leverage is said to be positive if a company is able to earn a higher return on equity by using borrowed money in its operations than it has to pay on the borrowed money. A quick measure of leverage is calculated by comparing the amount the percentage of return on equity exceeds return on assets. Flavour Corp’s return on equity exceeds its return on assets by an astounding 19.7% return while Refresh Ltd. has an excess of 14.5% return.

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PROBLEM 18-8B

(a)

Snap-On is more liquid than Stanley. It has a very strong higher current and acid-test ratio. The strength of these two ratios outweighs the fact that Snap-On is turning over receivables and inventory more slowly than Stanley. A detailed composition of the current assets and current liabilities of each company would help confirm this initial assessment.

(b) Stanley is more solvent, but only marginally. Stanley has less debt to total assets than Snap-On. On the other hand, Snap-On has a better interest coverage ratio than Stanley but Snap-On’s interest coverage is still quite strong. (c)

Snap-On has a much stronger profitability demonstrated by its higher gross profit margin and higher profit margin. It also has considerably better returns on assets and equity compared to Stanley.

Taking It Further: Investors seem to favour Stanley as it has a higher priceearnings ratio. This is inconsistent with (c) as investors would likely favour a company with a better profitability.

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PROBLEM 18-9B (b) Gross profit is 40% of net sales of $11,000,000 or $4,400,000. (a)

Cost of goods sold is net sales of $11,000,000 less gross profit of $4,400,000 = $6,600,000 or 60% of net sales.

(c)

Gross profit of $4,400,000 less operating expenses of $1,600,000 equal profit from operations of $2,800,000.

(f)

Profit margin is 15% of sales. Net sales × 15% equals profit of $1,650,000.

(e)

Profit of $1,650,000 plus income tax expense of $707,000 equals profit before income taxes of $2,357,000.

(d) Profit from operations of $2,800,000 less profit before income taxes of $2,357,000 equals interest expense of $443,000. Summary of results: VIEUX CORPORATION Income Statement Year ended December 31, 2014 Net sales Cost of goods sold Gross profit Operating expenses Profit from operations Interest expense Profit before income taxes Income tax expense Profit

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$11,000,000 6,600,000 4,400,000 1,600,000 2,800,000 443,000 2,357,000 707,000 $ 1,650,000

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PROBLEM 18-9B (Continued) (h)

Receivables turnover is 10 times and so net sales of $11,000,000 ÷ 10 = inventory of $1,100,000.

(i)

Inventory turnover is 8 times and so cost of goods sold of $6,600,000 ÷ 8 = inventory of $825,000.

(k)

Return on assets is 22% so profit of $1,650,000 ÷ 22% equals total assets of $7,500,000.

(j)

Total assets of $7,500,000 less property, plant, and equipment of $4,420,000 and long-term investments of $430,000 equal current assets of $2,650,000.

(g)

Total current assets of $2,650,000 less accounts receivable (h) of $1,100,000 and inventory (i) of $825,000 equals cash of $725,000.

(o) Total liabilities and shareholders’ equity is equal to total assets of $7,500,000. (n) Total liabilities and shareholders’ equity of $7,500,000 less shareholders’ equity of $3,400,000 equals total liabilities of $4,100,000. (l)

Current ratio is 2:1 and so current assets (g) of $2,650,000 ÷ 2 equals current liabilities of $1,325,000.

(m) Total liabilities of $4,100,000 less current liabilities (l) of $1,325,000 equals non-current liabilities of $2,775,000.

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PROBLEM 18-9B (Continued) Summary of results: VIEUX CORPORATION Balance Sheet December 31, 2014 Assets Current assets Cash Accounts receivable Inventory Total current assets Long-term investments Property, plant, and equipment Total assets Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ Equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity

$ 725,000 1,100,000 825,000 2,650,000 430,000 4,420,000 $7,500,000 $1,325,000 2,775,000 4,100,000 1,500,000 1,900,000 3,400,000 $7,500,000

Taking It Further: Because of the large number of figures that are omitted at the beginning of each of the financial statements, it is necessary to work backwards, using totals and sub-totals along with the ratios given.

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CONTINUING COOKIE CHRONICLE

(a)

Koebel’s Family Bakery is far more liquid than the public company Cookies and Cream. Of course, its current ratio is very high, consistent with the excess cash it has on hand. Its receivables turnover is much higher than Cookies and Cream; however, it is unlikely that Koebel’s has as many receivables as the larger, public company. Its inventory turnover is much lower, but it likely only produces what it can sell most days. A larger bakery would be expected to have more inventory to meet its larger distribution requirements.

(b) Both companies have good debt to total asset ratios, and correspondingly strong times interest earned ratios. Overall, Koebel’s Family Bakery Ltd. remains in the better solvency position. (c)

From a profitability point of view, Koebel’s Family Bakery’s performance is far better than that of Cookies and Cream. Koebel’s gross profit margin, profit margin, return on common shareholders’ equity and return on assets ratios are multiples of those experienced by Cookies and Cream. Again, this is not unusual as Koebel’s business model is quite different than that of Cookie and Cream. It can adjust its pricing as more of a specialty baker and is likely also doing less volume. Its families’ salaries and other expenses also might not be reflective of those of a much larger, public company such as Cookies and Cream.

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CONTINUING COOKIE CHRONICLE (Continued) (d)

Compared to 2013, Cookies and Cream’s ratios in 2014 are generally worsening. All three liquidity ratios have declined. The debt to total assets ratio has deteriorated slightly, but the times interest earned ratio has improved significantly, leading to an overall improvement in solvency. As for profitability, all profitability ratios are declining, with the exception of the dividend payout ratio and the price earnings ratio. Investors may be bidding up the market value of Cookies and Cream’s common shares because of the increase in the dividend payout ratio.

(e)

Overall, Koebel’s is stronger than Cookies and Cream in liquidity, solvency and profitability. This is likely because of differences in the size and flexibility of the company’s business model as outlined in parts (a) and (c).

(f)

Because of market volatility, it is possible that the market price of the Cookies and Cream common shares could decline at a time when Koebel’s needs the cash for operations and is forced to sell the investment at a loss. Consequently, considering an equity investment by investing in the shares of another company for a short-term return may not be the most appropriate option. To maintain liquidity and reduce its risk, Koebel’s should instead consider investing in a debt (fixed income) investment to ensure that they don’t experience a loss on their investment.

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BYP 18-1 FINANCIAL REPORTING PROBLEM (a)

ASSETS Current Cash and cash equivalents Marketable securities Trade and other receivable Derivative financial assets Income taxes recoverable Inventories Prepaid expenses Total current assets Property and equipment Intangible assets Goodwill Deferred income taxes Total assets

Solutions Manual

REITMANS (CANADA) LIMITED Balance Sheets (in thousands) January 28, 2012 Amount Percentage $196,835 71,442 3,033 751 4,735 78,285 11,902 366,983 184,221 17,057 42,426 23,174 $633,861

18-97 .

31.0% 11.3% 0.5% 0.1% 0.7% 12.4% 1.9% 57.9% 29.0% 2.7% 6.7% 3.7% 100.0%

January 29, 2011 Amount Percentage $230,034 70,413 2,866

34.9% 10.7% 0.4%

73,201 12,491 389,005 193,064 13,841 42,426 21,021 $659,357

11.1% 1.9% 59.0% 29.3% 2.1% 6.4% 3.2% 100.0%

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BYP 18-1 (Continued) (a) (Continued)

Accounting Principles, Sixth Canadian Edition

REITMANS (CANADA) LIMITED Balance Sheets (in thousands) January 28, 2012 Amount Percentage

LIABILITIES Current Trade and other payables Derivative financial liability Deferred revenue Income taxes payable Current portion of long-term debt Total current liabilities Other payables Deferred revenue Deferred lease credits Long-term debt Pension liabilities Total liabilities SHAREHOLDERS’ EQUITY Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Total shareholders' equity Total liabilities and shareholders' equity

Solutions Manual

$ 63,875 1,505 22,278

10.1% 0.2% 3.5%

1,474 89,132 11,110

0.2% 14.1% 1.8%

17,317 8,573 14,877 141,009 39,890 5,158 439,067 8,737 492,852 $633,861

18-98 .

January 29, 2011 Amount Percentage $ 64,093

9.7%

2.7% 1.4% 2.3% 22.2%

19,834 5,998 1,384 91,309 10,180 2,384 19,011 10,047 13,626 146,557

3.0% 0.9% 0.2% 13.8% 1.5% 0.4% 2.9% 1.5% 2.1% 22.2%

6.3% 0.8% 69.3% 1.4% 77.8% 100.0%

29,614 6,266 468,777 8,143 512,800 $659,357

4.5% 1.0% 71.1% 1.2% 77.8% 100.0%

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BYP 18-1 (Continued) (a) (Continued) REITMANS (CANADA) LIMITED Statements of Earnings Years Ended January 28 and January 29 (in thousands) 2012 Amount Percentage Sales $1,019,397 100.0% Cost of sales 363,333 35.6% Gross margin 656,064 64.4% Selling and distribution expenses 547,367 53.7% Administrative expenses 46,878 4.6% 594,245 58.3% Results from operating activities 61,819 6.1% Finance income 5,562 0.5% Finance costs (1,509) -0.1% Earnings before income taxes 65,872 6.5% Income taxes 18,333 1.8% Net earnings $ 47,539 4.7%

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2011 Amount $1,059,000 350,671 708,329 528,676 55,511 584,187 124,142 4,505 (845) 127,802 38,817 $ 88,985

Percentage 100.0% 33.1% 66.9% 49.9% 5.2% 55.2% 11.7% 0.4% -0.1% 12.1% 3.7% 8.4%

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BYP 18-1 (Continued) (b) From a review of Reitmans’ balance sheet, we note that current assets make up 57.9% of total assets in 2012, not significantly different than 2011. Current liabilities on the other hand only amount to 14.1% of total assets. Reitmans’ liquidity would appear to be strong based on these proportions. Its solvency would also appear to be strong, as total liabilities are only 22.3% of total assets, and relatively unchanged in proportion between the two years. On the income statement (or statement of earnings as Reitmans calls it), the gross profit percentage declined by 2.5%. This decline combined with a 3% increase in operating, resulted in a 3.7% decline in profit.

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BYP 18-2 INTERPRETING FINANCIAL STATEMENTS (a) In terms of liquidity, both companies have low current and acid-test ratios, but CP’s is worse. Other liquidity ratios are practically identical, with CP’s receivables and inventory turnover marginally higher than those of CN. (b) CN is more solvent than CP in all of the solvency ratios. (c) CN is more profitable. All of its ratios are better than those of CP, except the asset turnover which is the same. In particular, CN’s profit margin is far superior (almost 2.5 times higher that of CP’s) and drives its higher return on assets and return on equity ratios as its asset turnover is the same as that of CP. (d) 1. A lower ratio is preferable as a lower amount of expenses as a percent of revenues translates into a higher profit. 2. CN has the better operating ratio by a considerable margin. 3. CN’s lower operating ratio reinforces the determination of the higher profit margin, which in turn leads to a higher return on assets and higher return on equity.

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BYP 18-3 COLLABORATIVE LEARNING ACTIVITY All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

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BYP 18-4 COMMUNICATION ACTIVITY Memorandum Re: Limitations of financial statement analysis In evaluating the financial performance of a company, it is important to understand the limitations of financial statement analysis. I have identified the following questions to raise at the audit committee:  Alternative accounting policies: What significant judgements and estimates were required in the choice of IFRS policies by EasyMix? Which key accounting policies have changed in the transition from ASPE to IFRS? Has the effect of the recent implementation to IFRS been adequately explained in the MD&A and notes to the financial statements? How do the policies of this company compare to those used by its key competitors in the cement industry?  Comparability of data: What efforts have been made to explain the impact of the transition from ASPE to IFRS in the ratios reported to the audit committee and the board? Has there been any impact on the calculation or choice of ratios used to meet debt covenants, in particular?  Economic factors: How have the changing prices of commodities and foreign exchange affected this industry? Has the decrease in demand for the construction industry affected this company significantly, and if so, how? Risk assessment: Have all business risks been properly assessed and disclosed?

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BYP 18-5 ETHICS CASE (a)

The stakeholders in this case are:  Sabra Surkis, president of Surkis Industries  Carol Dunn, public relations director  You, as controller of Surkis Industries  Shareholders and creditors of Surkis Industries  Potential creditors and investors in Surkis Industries  Any other readers of the press release

(b)

The president's press release is incomplete, and to that extent the information is not fully disclosed, transparent, or of high quality and could be perceived as unethical.

(c)

As controller you should at least inform Carol, the public relations director, about the biased content of the release. She should be aware that the information she is about to release, while factually accurate, is incomplete. Both the controller and the public relations director (if she agrees) have the responsibility to inform the president of the bias of the about-to-be-released information.

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BYP 18-6 “ALL ABOUT YOU” ACTIVITY (a)

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APPENDIX B Sales Taxes SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE B-1 There are two main types of sales taxes in Canada, the federal Goods and Services Tax (GST) or Harmonized Sales Tax (HST) and the Provincial Sales Tax (PST) sometimes called the Retail Sales Tax. For a business that is a registrant which charges GST/HST to its customers, all GST/HST paid by the business on all purchases is recovered and does not represent a cost to the business. On the other hand, the PST is not recoverable and the amount paid by the business is included as a cost of purchasing an asset or paying for a service. From the perspective of a consumer, the two types of taxes are viewed as the same because neither tax is fully recoverable.

BRIEF EXERCISE B-2 Accounts Receivable..................................... 1,839.60 Sales......................................................... GST Payable ($1,600 × 5%) .................... QST Payable ($1,600 × 9.975%) ............. Cost of Goods Sold ....................................... Merchandise Inventory...........................

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1,600.00 80.00 159.60

900.00 900.00

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BRIEF EXERCISE B-3 Sales Returns and Allowances ................... GST Payable ($800 × 5%) ............................. PST Payable ($800 × 9.975%)....................... Accounts Receivable.............................

800.00 40.00 79.80

Merchandise Inventory................................. Cost of Goods Sold ...............................

450.00

919.80

450.00

BRIEF EXERCISE B-4 Accounts Receivable.................................... 1,839.60 Sales........................................................ GST Payable ($1,600 × 5%) ................... PST Payable ($1,600 × 9.975%)............. Sales Returns and Allowances ................... GST Payable ($800 × 5%) ............................. PST Payable ($800 × 9.975%)....................... Accounts Receivable.............................

1,600.00 80.00 159.60

800.00 40.00 79.80 919.80

BRIEF EXERCISE B-5 Accounts Receivable..................................... Service Revenue .....................................

450 450

BRIEF EXERCISE B-6 Accounts Receivable..................................... Service Revenue ..................................... GST Payable ($700 × 5%) .......................

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735 700 35

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BRIEF EXERCISE B-7 Merchandise Inventory.................................. GST Recoverable ($4,100 × 5%) ................... Accounts Payable ...................................

4,100 205 4,305

BRIEF EXERCISE B-8 Accounts Payable .......................................... GST Recoverable ($500 × 5%) ............... Merchandise Inventory...........................

525 25 500

BRIEF EXERCISE B-9 Merchandise Inventory.................................. HST Recoverable ($4,100 × 13%) ................. Accounts Payable ...................................

4,100 533 4,633

BRIEF EXERCISE B-10 Accounts Payable .......................................... HST Recoverable ($500 × 13%) ............. Merchandise Inventory...........................

565 65 500

BRIEF EXERCISE B-11 Supplies ($600 × 1.05) ................................... GST Recoverable ($600 × 5%) ...................... Cash .........................................................

630 30 660

BRIEF EXERCISE B-12 Supplies .......................................................... HST Recoverable ($600 × 15%) .................... Cash .........................................................

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600 90 690

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BRIEF EXERCISE B-13 Vehicles .......................................................... HST Recoverable ($32,000 × 14%) ............... Accounts Payable ...................................

32,000 4,480 36,480

BRIEF EXERCISE B-14 Vehicles ($32,000 × 1.07) .............................. GST Recoverable ($32,000 × 5%) ................. Accounts Payable ...................................

34,240 1,600 35,840

BRIEF EXERCISE B-15 Merchandise Inventory.................................. Supplies ($300 × 1.07) ................................... GST Recoverable ($5,300 × 5%) ................... Accounts Payable ...................................

5,000 321 265 5,586

BRIEF EXERCISE B-16 GST Payable ................................................... GST Recoverable .................................... Cash .........................................................

6,120

PST Payable ................................................... Cash .........................................................

8,570

940 5,180

8,570

BRIEF EXERCISE B-17 Cash ................................................................ HST Payable ................................................... HST Recoverable ....................................

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690 3,920 4,610

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SOLUTIONS TO EXERCISES EXERCISE B-1 Province of Manitoba GENERAL JOURNAL Account Titles and Explanation May

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Rent Expense ............................................ GST Recoverable ($7,300 × 5%) .............. Cash ....................................................

Debit

Credit

7,300 365 7,665

Accounts Receivable—Marvin ................ 28,000 Sales .................................................... GST Payable ($25,000 × 5%) ............. PST Payable ($25,000 × 7%) ..............

25,000 1,250 1,750

Cost of Goods Sold .................................. 18,600 Merchandise Inventory ......................

18,600

Sales Returns and Allowances ............... GST Payable ($800 × 5%) ......................... PST Payable ($800 × 7%) ......................... Accounts Receivable—Marvin..........

800 40 56 896

Merchandise Inventory ............................ 11,000 GST Recoverable ($11,000 × 5%) ............ 550 Accounts Payable—Macphee ........... Furniture ($600 × 1.07) ............................. GST Recoverable ($600 × 5%) ................. Cash ..................................................

642 30

GST Payable .............................................. GST Recoverable ............................... Cash ...................................................

7,480

B-5

11,550

672 1,917 5,563

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EXERCISE B-2 Province of Alberta GENERAL JOURNAL Account Titles and Explanation

Date May

1 Rent Expense ............................................. GST Recoverable ($7,300 × 5%) ............... Cash ..................................................

Debit

Credit

7,300 365 7,665

3 Accounts Receivable—Marvin.................. 26,250 Sales.................................................. 25,000 GST Payable ($25,000 × 5%) ........... 1,250 Cost of Goods Sold ................................... 18,600 Merchandise Inventory.................... 18,600 5 Sales Returns and Allowances ................ GST Payable ($800 × 5%) .......................... Accounts Receivable—Marvin........

800 40 840

7 Merchandise Inventory.............................. 11,000 GST Recoverable ($11,000 × 5%) ............. 550 Accounts Payable—Macphee .......... 11,550 12 Furniture ..................................................... GST Recoverable ($600 × 5%) .................. Cash ...................................................

600 30

31 GST Payable ............................................... GST Recoverable .............................. Cash ...................................................

7,480

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630

1,917 5,563

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EXERCISE B-3 Province of Ontario GENERAL JOURNAL Account Titles and Explanation

Date May

Debit

Rent Expense ..................................... HST Recoverable ($7,300 × 13%) ..... Cash ..............................................

7,300 949

3 Accounts Receivable—Marvin ......... Sales.............................................. HST Payable ($25,000 × 13%) .....

28,250

Cost of Goods Sold ........................... Merchandise Inventory................

18,600

5 Sales Returns and Allowances ........ HST Payable ($800 × 13%) ................ Accounts Receivable—Marvin ...

800 104

7 Merchandise Inventory...................... HST Recoverable ($11,000 × 13%) ... Accounts Payable—Macphee ......

11,000 1,430

12 Furniture ............................................. HST Recoverable ($600 × 13%)......... Cash ..............................................

600 78

31 HST Payable ....................................... HST Recoverable ......................... Cash ..............................................

7,480

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Credit

8,249

25,000 3,250

18,600

904

12,430

678

1,917 5,563

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EXERCISE B-4 Province of Manitoba

Date May

Solutions Manual .

GENERAL JOURNAL Account Titles and Explanation Rent Expense ............................................ GST Recoverable ($7,300 × 5%) .............. Cash ....................................................

Debit 7,300 365

7,665

Accounts Receivable—Marvin ............... 28,000 Sales .................................................... GST Payable ($25,000 × 5%) ............. PST Payable ($25,000 × 7%) .............. Sales Returns and Allowances ............... GST Payable ($800 × 5%) ......................... PST Payable ($800 × 7%) ......................... Accounts Receivable—Marvin..........

25,000 1,250 1,750

800 40 56 896

Purchases ................................................. 11,000 GST Recoverable ($11,000 × 5%) ............ 550 Accounts Payable—Macphee ............ Furniture ($600 × 1.07) ............................. GST Recoverable ($600 × 5%) ................. Cash .....................................................

642 30

GST Payable .............................................. GST Recoverable ................................ Cash .....................................................

7,480

B-8

Credit

11,550

672 1,917 5,563

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE B-5 Province of Alberta GENERAL JOURNAL Account Titles and Explanation

Date May

1 Rent Expense ............................................. GST Recoverable ($7,300 × 5%) ............... Cash ..................................................

Debit

Credit

7,300 365 7,665

3 Accounts Receivable—Marvin.................. 26,250 Sales.................................................. 25,000 GST Payable ($25,000 × 5%) ........... 1,250 5 Sales Returns and Allowances ................ GST Payable ($800 × 5%) .......................... Accounts Receivable—Marvin........

800 40 840

7 Purchases ................................................... 11,000 GST Recoverable ($11,000 × 5%) ............. 550 Accounts Payable—Macphee .......... 11,550 12 Furniture ..................................................... GST Recoverable ($600 × 5%) .................. Cash ...................................................

600 30

31 GST Payable ............................................... GST Recoverable .............................. Cash ...................................................

7,480

Solutions Manual .

B-9

630

1,917 5,563

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE B-6 Province of Ontario GENERAL JOURNAL Account Titles and Explanation

Date May

Debit

Rent Expense ..................................... HST Recoverable ($7,300 × 13%) ..... Cash ..............................................

7,300 949

3 Accounts Receivable—Marvin ......... Sales.............................................. HST Payable ($25,000 × 13%) .....

28,250

5 Sales Returns and Allowances ........ HST Payable ($800 × 13%) ................ Accounts Receivable—Marvin ...

800 104

7 Purchases........................................... HST Recoverable ($11,000 × 13%) ... Accounts Payable—Macphee ......

11,000 1,430

12 Furniture ............................................. HST Recoverable ($600 × 13%)......... Cash ..............................................

600 78

31 HST Payable ....................................... HST Recoverable ......................... Cash ..............................................

7,480

Solutions Manual .

B-10

Credit

8,249

25,000 3,250

904

12,430

678

1,917 5,563

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE B-7 Date

GENERAL JOURNAL Account Titles and Explanation

Debit

June 1 Freight Out ($200 × 1.07) .................. GST Recoverable ($200 × 5%).......... Cash ..............................................

214.00 10.00

5 Repairs Expense ($800 × 1.07) ....... GST Recoverable ($800 × 5%).......... Cash ..............................................

856.00 40.00

10 Supplies ($250 × 1.07) ...................... GST Recoverable ($250 × 5%).......... Accounts Payable ........................

267.50 12.50

13 Accounts Receivable ........................ Service Revenue .......................... GST Payable ($4,700 × 5%) ......... PST Payable ($4,700 × 7%)..........

5,264.00

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

896.00

22 Travel Expense ($720 × 1.07) ........... GST Recoverable ($720 × 5%).......... Cash ..............................................

770.40 36.00

30 Telephone Expense ($150 × 1.07) ... GST Recoverable ($150 × 5%).......... Accounts Payable ........................

160.50 7.50

Credit

224.00

896.00

280.00 4,700.00 235.00 329.00 896.00

806.40

168.00

30 GST Payable ...................................... 1,890.50 GST Recoverable ......................... Cash ..............................................

741.60 1,148.90

30 PST Payable....................................... 2,640.00 Cash ..............................................

2,640.00

Solutions Manual .

B-11

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE B-8 Date

GENERAL JOURNAL Account Titles and Explanation

Debit

June 8 Equipment ................................................. HST Recoverable ($1,500 × 13%) ............ Accounts Payable...............................

1,500.00 195.00

10 Supplies..................................................... HST Recoverable ($100 × 13%) ............... Cash......................................................

100.00 13.00

12 Accounts Receivable ............................... Service Revenue.................................. HST Payable ($1,250 × 13%) ...............

1,412.50

18 Repairs Expense....................................... HST Recoverable ($220 × 13%) ............... Cash......................................................

220.00 28.60

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

1,412.50

30 HST Payable .............................................. HST Recoverable................................. Cash......................................................

2,520.60

Solutions Manual .

B-12

Credit

1,695.00

113.00

1,250.00 162.50

248.40

1,412.50

820.45 1,700.15

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE B-9 Date

GENERAL JOURNAL Account Titles and Explanation

Debit

June 8 Equipment ................................................. GST Recoverable ($1,500 × 5%) .............. Accounts Payable...............................

1,500.00 75.00

10 Supplies..................................................... GST Recoverable ($100 × 5%) ................. Cash......................................................

100.00 5.00

12 Accounts Receivable ............................... Service Revenue.................................. GST Payable ($1,250 × 5%).................

1,312.50

18 Repairs Expense....................................... GST Recoverable ($220 × 5%) ................. Cash......................................................

220.00 11.00

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

1,312.50

30 GST Payable .............................................. GST Recoverable................................. Cash......................................................

970.50

Solutions Manual .

B-13

Credit

1,575.00

105.00

1,250.00 62.50

231.00

1,312.50

315.55 654.95

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM B-1 Province of Ontario GENERAL JOURNAL Account Titles and Explanation

Date

Debit

Nov 2 Merchandise Inventory ($900 × 3) ............ HST Recoverable ($2,700 × 13%) .............. Accounts Payable—Fender Supply.....

2,700 351

4 Cash............................................................. Sales ...................................................... HST Payable ($2,600 × 13%) ................

2,938

Cost of Goods Sold ($675 × 2) .................. Merchandise Inventory ........................

1,350

5 Accounts Payable—Western Acoustic .... HST Recoverable ($700 × 13%) ............ Merchandise Inventory .........................

791

7 Sales Returns and Allow.($2,600 ÷ 2) ...... HST Payable ($1,300 × 13%) ...................... Cash.......................................................

1,300 169

Merchandise Inventory .............................. Cost of Goods Sold..............................

675

8 Supplies ...................................................... HST Recoverable ($200 × 13%) ................. Cash.......................................................

200 26

Solutions Manual .

B-14

Credit

3,051 2,600 338 1,350 91 700

1,469 675

226

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-1 (Continued) GENERAL JOURNAL Account Titles and Explanation

Date

Debit

Nov. 10 Accounts Receivable—Regional Band .... Sales ...................................................... HST Payable ($5,100 × 13%)................

5,763

Cost of Goods Sold ................................... Merchandise Inventory ........................

2,850

13 Merchandise Inventory ($1,900 × 2) ......... HST Recoverable ($3,800 × 13%).............. Accounts Payable—Yamaha Canada .

3,800 494

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

4,150

16 Accounts Payable—Yamaha Canada ...... HST Recoverable ($1,900 × 13%)......... Merchandise Inventory .........................

2,147

20 Accounts Payable—Fender Supply ......... Cash ......................................................

3,051

Solutions Manual .

B-15

Credit

5,100 663

2,850

4,294

4,150

247 1,900

3,051

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-2 Province of British Columbia GENERAL JOURNAL Account Titles and Explanation

Date Nov

Debit

2 Merchandise Inventory ($900 × 3)............. GST Recoverable ($2,700 × 5%) ................ Accounts Payable—Fender Supply.....

2,700 135

4 Cash ............................................................. Sales ...................................................... GST Payable ($2,600 × 5%) .................. PST Payable ($2,600 × 7%) ..................

2,912

Cost of Goods Sold .................................... Merchandise Inventory ........................

1,350

5 Accounts Payable—Western Acoustic .... GST Recoverable ($700 × 5%) .............. Merchandise Inventory .........................

735

7 Sales Returns and Allow.($2,600 ÷ 2)....... GST Payable ($1,300 × 5%) ........................ PST Payable ($1,300 × 7%) ........................ Cash .......................................................

1,300 65 91

Merchandise Inventory .............................. Cost of Goods Sold ..............................

675

8 Supplies ($200 × 1.07) ................................ GST Recoverable ($200 × 5%) ................... Cash .......................................................

214 10

Solutions Manual .

B-16

Credit

2,835 2,600 130 182 1,350 35 700

1,456 675

224

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-2 (Continued) GENERAL JOURNAL Account Titles and Explanation

Date

Debit

Nov. 10 Accounts Receivable—Regional Band .... Sales ...................................................... GST Payable ($5,100 × 5%) ................. PST Payable ($5,100 × 7%) ..................

5,712

Cost of Goods Sold ................................... Merchandise Inventory ........................

2,850

13 Merchandise Inventory ($1,900 × 2) ......... GST Recoverable ($3,800 × 5%)................ Accounts Payable—Yamaha Canada .

3,800 190

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

4,150

16 Accounts Payable—Yamaha Canada ...... GST Recoverable ($1,900 × 5%)........... Merchandise Inventory .........................

1,995

20 Accounts Payable—Fender Supply ......... Cash ......................................................

2,835

Solutions Manual .

B-17

Credit

5,100 255 357

2,850

3,990

4,150

95 1,900

2,835

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-3 Province of Ontario

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov 2 Purchases ($900 × 3) ................................. HST Recoverable ($2,700 × 13%) .............. Accounts Payable—Fender Supply.....

2,700 351

4 Cash............................................................. Sales ...................................................... HST Payable ($2,600 × 13%) ................

2,938

5 Accounts Payable—Western Acoustic .... HST Recoverable ($700 × 13%) ............ Purchase Returns and Allowances .....

791

7 Sales Returns and Allow.($2,600 ÷ 2) ...... HST Payable ($1,300 × 13%) ...................... Cash.......................................................

1,300 169

8 Supplies ...................................................... HST Recoverable ($200 × 13%) ................. Cash....................................................... 10 Accounts Receivable—Regional Band Sales ...................................................... HST Payable ($5,100 × 13%) ................

200 26

13 Purchases ($1,900 × 2)............................... HST Recoverable ($3,800 × 13%) .............. Accounts Payable—Yamaha Canada ..

Solutions Manual .

B-18

Credit

3,051 2,600 338 91 700

1,469

226 5,763 5,100 663 3,800 494 4,294

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-3 (Continued)

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. 14 Cash ............................................................ Accounts Receivable ...........................

4,150

16 Accounts Payable—Yamaha Canada ...... HST Recoverable ($1,900 × 13%)......... Purchase Returns and Allowances.....

2,147

20 Accounts Payable—Fender Supply ......... Cash ......................................................

3,051

Solutions Manual .

B-19

Credit

4,150

247 1,900

3,051

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-4 Province of British Columbia

Date Nov

GENERAL JOURNAL Account Titles and Explanation

Debit

2 Purchases ($900 × 3).................................. GST Recoverable ($2,700 × 5%) ................ Accounts Payable—Fender Supply.....

2,700 135

2,912

5 Accounts Payable—Western Acoustic .... GST Recoverable ($700 × 5%) .............. Purchase Returns and Allowances .....

735

1,300 65 91

8 Supplies ($200 × 1.07) ................................ GST Recoverable ($200 × 5%) ................... Cash ....................................................... 10 Accounts Receivable—Regional Band Sales ...................................................... GST Payable ($5,100 × 5%) .................. PST Payable ($5,100 × 7%) ..................

214 10

Solutions Manual .

B-20

Credit

2,835 2,600 130 182 35 700

1,456

224 5,712 5,100 255 357

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-4 (Continued)

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. 13 Purchases ($1,900 × 2) .............................. GST Recoverable ($3,800 × 5%)................ Accounts Payable—Yamaha Canada .

3,800 190

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

4,150

16 Accounts Payable—Yamaha Canada ...... GST Recoverable ($1,900 × 5%)........... Purchase Returns and Allowances.....

1,995

20 Accounts Payable—Fender Supply ......... Cash ......................................................

2,835

Solutions Manual .

B-21

Credit

3,990

4,150

95 1,900

2,835

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-5 (a)

Province of Alberta

Date May 1

18 19

Solutions Manual .

GENERAL JOURNAL Account Titles and Explanation

Debit

Rent Expense ....................................... Prepaid Rent ......................................... GST Recoverable ($3,300 × 5%) ......... Cash ................................................

1,650 1,650 165

Furniture ............................................... GST Recoverable ($4,100 × 5%) ......... Accounts Payable—George’s .......

4,100 205

Accounts Payable—George’s ............. GST Recoverable ($800 × 5%)........ Furniture ..........................................

840

Cash ...................................................... Service Revenue ............................ GST Payable ($2,500 × 5%) ...........

2,625

Supplies ................................................ GST Recoverable ($300 × 5%)............. Cash ................................................

300 15

Accounts Receivable—Manson ......... Service Revenue ............................ GST Payable ($1,100 × 5%) ...........

1,155

Accounts Payable—George’s ............. Cash ($4,305 − $840)......................

3,465

Office Expense ..................................... Cash ................................................

B-22

Credit

3,465

4,305 40 800 2,500 125

315 1,100 55 3,465 22

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-5 (Continued) (a) (Continued)

Date May 21

GENERAL JOURNAL Account Titles and Explanation

Debit

Utilities Expense .............................. Accounts Payable .....................

150

Cash .................................................. Accounts Receivable—Manson

1,155

27 Accounts Receivable—Pedneault . Service Revenue ........................ GST Payable ($600 × 5%) ..........

630

(b) Transaction Date May 1 May 4 May 5 May 6 May 10 May 13 May 27

GST Recoverable $165 205 (40)

Credit

150

1,155

600 30

GST Payable

$125 15 55 30 $210

$345

A refund from the Receiver General would be received and recorded as follows: Cash .................................................. GST Payable ..................................... GST Recoverable .......................

Solutions Manual .

B-23

135 210 345

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-6 (a)

Province of Ontario

Date May 1

18 19

Solutions Manual .

GENERAL JOURNAL Account Titles and Explanation

Debit

Rent Expense ....................................... Prepaid Rent ......................................... HST Recoverable ($3,300 × 13%)....... Cash ................................................

1,650 1,650 429

Furniture .............................................. HST Recoverable ($4,100 × 13%)........ Accounts Payable—George’s .......

4,100 533

Accounts Payable—George’s ............. HST Recoverable ($800 × 13%)...... Furniture ..........................................

904

Cash ...................................................... Service Revenue ............................ HST Payable ($2,500 × 13%)..........

2,825

Supplies ................................................ HST Recoverable ($300 × 13%)........... Cash ................................................

300 39

Accounts Receivable—Manson ......... Service Revenue ............................ HST Payable ($1,100 × 13%)..........

1,243

Accounts Payable—George’s ............. Cash ($4,633 − $904)......................

3,729

Office Expense ..................................... Cash ................................................

B-24

Credit

3,729

4,633 104 800 2,500 325

339 1,100 143 3,729 22

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM B-6 (Continued) (a) (Continued)

Date May 21

GENERAL JOURNAL Account Titles and Explanation

Debit

Utilities Expense .............................. Accounts Payable .....................

150

Cash .................................................. Accounts Receivable—Manson

1,243

27 Accounts Receivable—Pednault.... Service Revenue ........................ HST Payable ($600 × 13%) ........

678

(b) Transaction Date May 1 May 4 May 5 May 6 May 10 May 13 May 27

HST Recoverable $429 533 (104)

Credit

150

1,243

600 78

HST Payable

$325 39 143 78 $546

$897

A refund from the Receiver General would be received and recorded as follows: Cash .................................................. HST Payable ..................................... HST Recoverable .......................

Solutions Manual .

B-25

351 546 897

Appendix B

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

APPENDIX C Subsidiary Ledgers and Special Journals SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE C-1 (a)

Date

(b)

Accounts Receivable Subsidiary Ledger

General Ledger

Chiu Co.

Accounts Receivable

Ref.

Debit

Credit Balance

1,800

Jan. 7 17

700

Date

Ref.

1,800 Jan.31 1,100 31

Debit

Credit Balance

11,5001 2

6,400

11,500 5,100

Elbaz Inc. Date

Ref.

Debit Credit Balance 6,000

Jan.15 24

2,000

6,000 4,000

Lewis Co. Date

Ref.

Jan.23 29 1 2

Debit Credit Balance 3,700

3,700 0

3,700

$1,800 + $6,000 + $3,700 = $11,500 $700 + $2,000 + $3,700 = $6,400

BRIEF EXERCISE C-2 1. General ledger 2. Subsidiary ledger 3. General ledger 4. General ledger

Solutions Manual .

5. 6. 7. 8.

General ledger Subsidiary ledger General ledger General ledger

C-1

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE C-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Sales Journal Cash Payments Journal General Journal Cash Receipts Journal Cash Payments Journal Cash Receipts Journal General Journal Purchases Journal Purchases Journal Cash Payments Journal

BRIEF EXERCISE C-4 (a) Journal

(b) Journal Columns

General Journal

Sales Returns and Allowances (Dr.), Accounts Receivable (Cr.), Inventory (Dr.), Cost of Goods Sold (Cr.) *

Cash Receipts

Cash (Dr.), Accounts Receivable (Cr.)

Cash Payments

Cash (Cr.), Merchandise Inventory (Dr.)

Cash Payments

Cash (Cr.), Accounts Payable (Dr.)

Cash Payments

Cash (Cr.), Merchandise Inventory (Dr.)

Cash Payments

Cash (Cr.), Other Accounts (Equipment) (Dr.)

Cash Receipts

Cash (Dr.), Merchandise Inventory (Cr.)

Cash Payments

Cash (Cr.), Other Accounts (Drawings) (Dr.)

Cash Receipts

Cash (Dr.), Sales (Cr.), Cost of Goods Sold (Dr.), Merchandise Inventory (Cr.)

* There are no column titles in the general journal, but these are the account titles that would be used in journalizing.

Solutions Manual .

C-2

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE C-3 Journal

Column Titles

Cash Receipts

Cash (Dr.), Sales (Cr.)

Sales

Accounts Receivable (Dr.), Sales (Cr.)

General

*Sales Returns and Allowances (Dr.), Accounts Receivable (Cr.)

Cash Receipts

Cash (Dr.), Other Accounts (Cr.) (Purchase Returns)

Cash Payments

Other Accounts (Dr.) (Freight Out), Cash (Cr.)

Cash Payments

Other Accounts (Dr.) (Purchases), Cash (Cr.)

Purchases

Supplies (Dr.), Accounts Payable (Cr.)

Cash Payments

Other Accounts (Dr.) (Freight In), Cash (Cr.)

* There are no column titles in the general journal, but these are the account titles that would be used in journalizing.

Solutions Manual .

C-3

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BRIEF EXERCISE C-6 General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Apr. 30 Service Revenue ........................................ Rent Revenue............................................. Income Summary................................

53,800 12,000

30 Income Summary. ...................................... Depreciation Expense ........................ Salaries Expense ................................ Supplies Expense ...............................

30,900

30 Income Summary....................................... B. Willis, Capital .................................

34,900

30 B. Willis, Capital......................................... B. Willis, Drawings .............................

18,000

Credit

65,800 8,000 19,400 3,500

34,900 18,000

BRIEF EXERCISE C-7 General Journal Date

Account Titles and Explanations

J1 Ref.

Nov. 30 Depreciation Expense ............................... Accumulated Depreciation—Furniture

Debit

Credit

6,800 6,800

BRIEF EXERCISE C-8 General Journal Date

Account Titles and Explanations

Feb. 28 Accounts Payable ($960 – $690)............... Cash ..................................................

Solutions Manual .

C-4

J1 Ref.

Debit

Credit

270 270

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE C-1 1. 2. 3. 4. 5. 6. 7.

General Journal Cash Payments Journal Cash Receipts Journal General Journal Purchases Journal Purchases Journal Cash Payments Journal

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

Cash Payments Journal General Journal Cash Receipts Journal General Journal Sales Journal Cash Receipts Journal

EXERCISE C-2 (a) and (b) Date

Account Debited

Sept. 2 T. Lu 26 M. Gafney

Solutions Manual .

WONG COMPANY Sales Journal S1 Invoice Accounts Receivable Cost of Goods Sold Dr. No. Ref. Dr. Merchandise Inventory Sales Cr. Cr.  321 2,720 1,960  322 890 570

C-5

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-2 (Continued) (a) and (c) (Continued)

Date

Purchases Journal Accounts Merchandise Supplies Payable Inventory Account Credited Terms Ref. Cr. Dr Dr.

Sept. 3 Berko Co. 10 Leonard Co. 12 Wells Co.

n/30

Solutions Manual

  

175 800 7,700

Other Accounts Account Debited

Ref. Amount

Equipment

7,700

175 800

C-6 .

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-3

(a) and (b)

WONG COMPANY Cash Receipts Journal

Account Credited

Date

Sept. 16 L. Maille 25 T. Lu

Ref.

Accounts Cash Receivable Dr. Cr.

 

860 2,720

(a) and (c)

Ch. No.

Date Sept. 11 18 24 26 30 30 30

Solutions Manual .

Payee

Sales Cr. 860

CR1 Cost of Goods Other Sold Dr. Merchandise Accounts Cr. Inventory Cr. 490

2,720

WONG COMPANY Cash Payments Journal Merch. Accounts Cash Inventory Payable Account Cr. Dr. Dr. Debited

A&F Shippers Leonard Co. Leonard Co. Freight Co. Employees names

90 450 800 75 2,360

V. Wong Berko Co.

1,250 175

CP1 Other Accounts Ref. Dr.

90 450 800 Freight Out Salaries Expense V. Wong, Drawings

75 2,360 1,250

175

C-7

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-3 (Continued) (a) and (d) WONG COMPANY General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Sept. 11 Accounts Payable—Leonard Co. ............... Merchandise Inventory........................

200

20 Sales Returns and Allowances................... Cash......................................................

860

Inventory ...................................................... Cost of Goods Sold .............................

490

Credit 200

860 490

EXERCISE C-4 (a) and (b) Account Date Debited Sept. 2 T. Lu 26 M. Gafney

Solutions Manual .

WONG COMPANY Sales Journal S1 Invoice Accounts Receivable Dr. No. Ref. Sales Cr.  321 2,720  322 890

C-8

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-4 (Continued) (a) and (c) (Continued)

Date

Purchases Journal Accounts Payable Purchases Account Credited Terms Ref. Cr. Dr

Sept. 3 Berko Co. 10 Leonard Co. 12 Wells Co.

n/30

Solutions Manual

  

175 800 7,700

Supplies Dr.

Other Accounts Account Debited

Ref. Amount

Equipment

7,700

175 800

C-9 .

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-5 (a) and (b) WONG COMPANY Cash Receipts Journal Account Credited

Ref.

Cash Dr.

Sept. 16 L. Maille 25 T. Lu

 

860 2,720

Date

(a) and (c)

Ch. No.

Date Sept. 11 18 24 26 30 30 30

Solutions Manual .

Payee

Accounts Receivable Cr.

CR1 Sales Cr.

Other Accounts Cr.

860 2,720

WONG COMPANY Cash Payments Journal Pur- Accounts Cash chases Payable Account Cr. Dr. Dr. Debited

A&F Shippers Leonard Co. Leonard Co. Freight Co. Employees names

90 450 800 75 2,360

V. Wong Berko Co.

1,250 175

CP1 Other Accounts Ref. Dr.

Freight In

Freight Out Salaries Expense V. Wong, Drawings

450 800 2,360 1,250

175

C-10

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-11 (Continued) (a) and (d) WONG COMPANY General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Sept. 11 Accounts Payable—Leonard Co. ............... Purchase Returns and Allowances ....

200

20 Sales Returns and Allowances................... Cash......................................................

860

Credit 200 860

EXERCISE C-6 (a) Oct.

5 Accounts Payable—Lyden Company ........ Merchandise Inventory .......................

720

7 Sales Returns and Allowances .................. Accounts Receivable—M. Presti........

600

Merchandise Inventory ............................... Cost of Goods Sold ............................

375

720 600 375

Note: The purchase of the equipment from Lifelong Inc. on Oct. 2, for $13,200 would be recorded in the purchases journal.

Solutions Manual .

C-11

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-12 (Continued) (b) Oct. 5 Accounts Payable—Lyden Company ........ Purchase Returns and Allowances ... 7 Sales Returns and Allowances .................. Accounts Receivable—M. Presti........

720 720 600 600

Note: The purchase of the equipment from Lifelong Inc. on Oct. 2, for $13,200 would be recorded in the purchases journal. (c) To:

President, Lee Ltd.

From:

Student

Subject:

Posting to Control and Subsidiary Accounts

The posting to the control and subsidiary ledger accounts varies with the journals used in recording the transactions. Sales and purchases journals—the totals for the month are posted to the control accounts. The individual entries are posted daily to the subsidiary accounts receivable and accounts payable accounts (also to the subsidiary inventory accounts, if maintained). Cash receipts and cash payments journals—the totals for the month are posted to the control account. The individual entries are posted daily to the subsidiary accounts receivable and accounts payable accounts (also to the subsidiary inventory accounts, if maintained). General journal—the individual entries are posted daily. Each entry that pertains to a control and a subsidiary account is dualposted. That is, it is posted to both the control account and the subsidiary account. I hope this memo answers your questions about posting.

Solutions Manual .

C-12

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C13 (a) Debit balance of $156,790. Beginning balance of $137,800 plus $98,670 debit from sales journal less $79,680 credit from cash receipts journal. (b) Credit balance of $141,600. Beginning balance of $144,200 plus $39,700 credit from purchases journal less $42,300 debit from cash payments journal. (c) The column total of $98,670 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger. The column total of $56,440 in the sales journal would be posted to the debit side of the Cost of Goods Sold account and the credit side of the Merchandise Inventory account in the general ledger. (d) The accounts receivable column total of $79,680 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger.

Solutions Manual .

C-13

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-8 (a) and (b) General Ledger Accounts Receivable Date Sept.

1 30 30 30

Explanation

Ref.

Balance

 S1 CR1 J1

Debit

Credit

Balance

7,030 190

10,960 15,150 8,120 7,930

4,190

Accounts Receivable Subsidiary Ledger Zhang Date Sept.

1 30 30 30

Explanation

Ref.

Balance

 S1 CR1 J1

Debit

Credit

800 2,300 190

Balance 3,820 4,620 2,320 2,130

Cavanaugh Date Sept.

1 30 30

Explanation

Ref.

Balance

 S1 CR1

Debit

Credit

1,100 1,310

Balance 2,060 3,160 1,850

Iman Date

Explanation

Ref.

Sept. 30 30

Solutions Manual .

S1 CR1

C-14

Debit

Credit

1,030 380

Balance 1,030 650

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

EXERCISE C-8 (Continued) (a) and (b) (continued) Accounts Receivable Subsidiary Ledger Jana Date Sept.

1 30 30

Explanation

Ref.

Balance

 S1 CR1

Debit

Credit

Balance 2,440 3,700 2,460

1,260 1,240

London Date

Explanation

Ref.

Sept. 1 30

Balance

 CR1

Debit

Credit

Balance 2,640 840

1,800

(c) MAC COMPANY Schedule of Customers September 30 Zhang................................................................................. Cavanaugh ........................................................................ Iman ................................................................................... Jana ................................................................................... London .............................................................................. Total ...........................................................................

$2,130 1,850 650 2,460 840 $7,930

Accounts Receivable (per general ledger account) .......

$7,930

Solutions Manual .

C-15

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM C-1 (a), (b), and (c) Sales Journal

Date

Account Debited

Jan. 4 Wong 9 Tops Corp. 17 NFQ Co. 31 Wong

Invoice Ref. No. 371 372 373 374

   

Accounts Receivable Dr. Sales Cr.

S1 Cost of Goods Sold Dr. Merchandise Inventory Cr.

6,500 2,600 7,500 7,380 23,980 (112)/(401)

3,900 1,560 4,500 4,428 14,388 (505)/(120)

General Journal Date Jan.

Account Titles and Explanations

J1 Ref.

5 Accounts Payable—Sun Distributors....... 201/ Merchandise Inventory ...................... 120

Solutions Manual .

C-16

Debit

Credit

1,450 1,450

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-1 (Continued) (a), (b) and (c) (Continued) Cash Receipts Journal

Account Credited

Date

Ref.

Jan. 6 13 15 Tops Corp. 17 Wong 20 27 30 NFQ Co.

Cash Dr.

2,650 5,290  2,600  6,500 1,400 4,370  7,500 30,310 (101)

Accounts Receivable Sales Cr. Cr.

CR1 COGS Dr. Merch. Other Inventory Accounts Cr. Cr.

2,650 5,290 2,600 6,500

7,500 16,600 (112)

1,400 840 4,370 2,622 _ _ 13,710 8,226 (401) (505)/(120)

Cash Payments Journal

Date

Ch. No.

Jan. 13 15 20 31

Solutions Manual .

Payee Sun Dist.

Merch. Accounts Cash Inv. Payable Dr. Cr. Dr.

6,350 11,300 Irvine Co. 5,400 11,000 34,050 (101)

1,590 3,174

Account Debited

CP1 Other Accounts Ref. Dr.

6,350 Sun Dist.  Salaries Exp. 729 11,300  5,400 Irvine Co. Salaries Exp. 729 11,000 11,750 22,300 (201) (X)

C-17

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-1 (Continued) (a), (b) and (c) (Continued)

Date

Purchases Journal Accounts Merchandise Payable Inventory Supplies Account Credited Terms Ref. Cr. Dr Dr.

P1 Other Accounts Account Debited

Jan. 4 4 8 11 19 23 24

Sun Distributors Moon Inc. Irvine Co. Lewis Co. Mark Corp Sun Distributors Levine Corp.

Solutions Manual

      

7,800 480 5,400 4,300 6,600 4,800 4,690 34,070 (201)

7,800 480 5,400 4,300 Equipment 157 4,800 4,690 26,990 (120)

C-18 .

Ref. Amount

480 (126)

6,600

6,600 X

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-2 (a) , (b), and (c)

Sales Journal

Account Debited

Date Oct.

4 Petro Corp. 17 Trudeau Co. 25 Golden Corp. 30 Trudeau Co.

Invoice Ref. No. 204 205 206 207

S1 Cost of Goods Accounts Sold Dr. Receivable Dr. Merchandise Sales Cr. Inventory Cr.

   

8,600 5,530 5,520 5,200 24,850 (112)/(401)

5,590 3,595 3,588 3,380 16,153 (505)/(120)

General Journal

Date

Account Titles and Explanations

Oct. 13

Accounts Payable—Chen Corp. ............ 201/ Merchandise Inventory ................... 120

Solutions Manual .

C-19

Ref.

Debit

Credit

260 260

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-2 (Continued) (a), (b), and (c) (Continued) Cash Receipts Journal

Date

Account Credited

Oct. 7 12 Petro Corp. 14 16 Land 21 25 Trudeau Co. 28

Date

Payee

Ref.

Cash Dr.

9,610  8,600 8,810 140 45,000 8,640  5,530 9,320 95,510 (101)

Sales Cr.

COGS Dr. Other Merch. Inventory Accounts Cr. Cr.

9,610

6,247

8,810

5,727

8,600 45,000 8,640

5,616

5,530 14,130 (112)

9,320 6,058 36,380 23,648 (401) (505)/(120)

45,000 (X)

Cash Payments Journal

CP1

Merch. Accts. Cash Invent. Payable Cr. Dr. Dr.

Other Accts. Dr. Ref

Oct. 9 Madison Co. 5,800 18 2,215 23 Chen Corp. 4,640 26 45,000 26 30 The Gazette 600 58,255 (101)

Solutions Manual .

A/R Cr.

CR1

Account Debited

5,800 Madison Co.



2,215

 4,640 Chen Corp. 140 26,000 Land 145 19,000 Buildings Advertising 610 600 2,215 10,440 45,600 (120) (201) (X)

C-20

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-2 (Continued) (a), (b) and (c) (Continued)

Account Credited

Date

Terms Ref.

Purchases Journal Merchandise Accounts Inventory Supplies Payable Cr. Dr Dr.

P1 Other Accounts Account Debited Ref. Amount

Oct. 2 5 10 25 27 30

     

Madison Co. Frey Co. Chen Corp. Frey Co. Schmid Co. Madison Co.

Solutions Manual

5,800 315 4,900 260 9,000 16,200 36,475 (201)

C-21 .

5,800 315 4,900 260 9,000 16,200 35,900 (120)

575 (126)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (b) Sales Journal

Date

Account Debited

Jan. 3 24

B. Rohl B. Lu

Cost of Goods Sold Dr. Accounts Invoice Receivable Dr. Merchandise No. Ref. Sales Cr. Inventory Cr.  

3,000 7,800 10,800 (112)/(401)

1,250 3,300 4,550 (505)/(120)

Cash Receipts Journal

Date

Account Credited

Accounts Other COGS Dr. Cash Receivable Sales Merch. Accounts Ref. Dr. Cr. Cr. Cr. Inv. Cr.

Jan. 7 S. Armstrong  4,000  3,000 13 B. Rohl 23 7,700 115 35,000 29 Notes Rec. 49,700 (101)

Solutions Manual .

CR1

4,000 3,000 7,700 7,000 (112)

C-22

4,840

7,700 4,840 (401) (505)/(120)

35,000 35,000 (X)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (b) (Continued)

Date

Purchases Journal Accounts Merchandise Supplies Payable Inventory Account Credited Terms Ref. Cr. Dr Dr.

P1 Other Accounts Account Debited

Jan. 5 Warren Parts 17 Voyer Co.

Solutions Manual

 

2,900 4,900 7,800 (201)

2,900 4,900 7,800 (120)

C-23 .

Ref. Amount

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

ROBLEM C-3 (Continued) (b) (Continued) Cash Payments Journal

Date

Payee

Cash Cr.

Jan.11 15 18 27

Lindon Co. Harms Dist. Employees Warren Parts

350 16,000 3,900 1,150

M. Perrault

1,300 22,700 (101)

Merc. Inv. Dr.

Accts. Payable Dr.

CP1 Account Debited

Other Accts. Ref Dr.

350 16,000 Harms Dist. Salaries Exp. 1,150 Warren Parts M. Perrault, Drawings 350 17,150 (120) (201)

 725 3,900  310

General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Jan. 14 Sales Returns and Allowances.................... 410 Accounts Receivable—R. Goge...........  /112

6,000

20 Accounts Payable—Watson & Co. ..............  /201 Notes Payable ....................................... 200

14,000

30 Accounts Payable—Voyer Co. ....................  /201 Merchandise Inventory......................... 120

400

Solutions Manual .

C-24

1,300 5,200 (X)

Credit

6,000

14,000 400

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c)

General Ledger Cash

Date Jan.

1 31 31

No. 101

Explanation

Ref.

Balance

 CR1 CP1

Debit

Credit

Balance

22,700

17,900 67,600 44,900

49,700

Accounts Receivable Date Jan.

1 14 31 31

Explanation

Ref.

Balance

 J1 S1 CR1

No. 112 Debit

Credit 6,000

10,800 7,000

Notes Receivable Date Jan.

1 31

Explanation

Ref.

Balance

 CR1

Jan.

1 30 31 31 31 31

Solutions Manual .

Explanation

Ref.

Balance

 J1 S1 P1 CR1 CP1

C-25

38,000 32,000 42,800 35,800

No. 115 Debit

Credit

Balance

35,000

45,000 10,000

Merchandis e Inventory Date

Balance

No. 120 Debit

Credit 400 4,550

7,800 4,840 350

Balance 22,600 22,200 17,650 25,450 20,610 20,960

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Land Date Jan.

No. 140

Explanation

Ref.

Balance



Debit

Credit

25,000

Building Date Jan.

No. 145

Explanation

Ref.

Balance



Debit

Credit

Jan.

Explanation

Ref.

Balance



Debit

No. 146 Credit

Jan.

No. 157

Explanation

Ref.

Balance



Debit

Credit

Jan.

Explanation

Ref.

Balance



Debit

No. 158 Credit

No. 200

Explanation

Ref.

Jan. 20

Solutions Manual .

Balance 1,950

Notes Payable Date

Balance 6,450

Accumulated Depreciation—Equipment Date

Balance 38,800

Equipment Date

Balance 75,000

Accumulated Depreciation—Building Date

Balance

C-26

Debit

Credit

Balance

14,000

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Accounts Payable Date Jan.

1 20 30 31 31

Explanation

Ref.

Balance

 J1 J1 P1 CP1

No. 201 Debit

Credit

14,000 400 7,800 17,150

Mortgage Payable Date Jan.

Explanation

Ref.

Balance



Jan.

Date

Debit

Credit

67,400 No. 301

Ref.

Balance



87,600

M. Perrault, Drawings

No. 310

Explanation

Debit

Ref.

Debit

CP1

1,300

Credit

Ref.

Debit

S1 CR1

Credit

Balance

10,800 7,700

10,800 18,500

Sales Returns and Allowances Explanation

Jan. 14

Solutions Manual .

Balance

No. 401

Explanation

Jan. 31 31

Balance

1,300

Sales

Date

Balance

Explanation

Jan. 31

Date

34,200 20,200 19,800 27,600 10,450 No. 275

M. Perrault, Capital Date

Balance

C-27

Ref.

Debit

6,000

No. 410 Credit

Balance 6,000

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Cost of Goods Sold Date

Explanation

Jan. 31 31

No. 505

Ref.

Debit

S1 CR1

4,550 4,840

Credit

4,550 9,390

Salaries Expense Date

Explanation

Jan. 31

Solutions Manual .

C-28

Balance

No. 725

Ref.

Debit

CP1

3,900

Credit

Balance 3,900

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Accounts Receivable Subsidiary Ledger S. Armstrong Date Jan.

1 7

Explanation

Ref.

Balance

 CR1

Debit

Credit

Balance

4,000

6,500 2,500

Credit

Balance

6,000

30,000 24,000

Credit

Balance

R. Goge Date Jan.

1 14

Explanation

Ref.

Balance

 J1

Debit

B. Lu Date Jan.

1 24

Explanation

Ref.

Debit

Balance

 S1

7,800

Ref.

Debit

S1 CR1

3,000

1,500 9,300

B. Rohl Date Jan.

Explanation 3 13

Solutions Manual .

C-29

Credit

Balance

3,000

3,000 0

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Accounts Payable Subsidiary Ledger Denomme Corp. Date Jan.

Explanation

Ref.

Balance



Debit

Credit

Balance 4,000

Harms Distributors Date Jan.

1 15

Explanation

Ref.

Debit

Balance

 CP1

16,000

Ref.

Debit

Credit

Balance 16,000 0

Voyer Co. Date

Explanation

Jan. 17 30

P1 J1

400

Ref.

Debit

Credit

Balance

4,900

4,900 4,500

Credit

Balance

2,900

2,900 1,750

Credit

Balance

Warren Parts Date Jan.

Explanation

P1 CP1

1,150

Explanation

Ref.

Debit

Balance

 J1

5 27

Watson & Co. Date Jan.

1 20

Solutions Manual .

C-30

14,000

14,200 200

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (d) PERRAULT MUSIC CO. Trial Balance January 31, 2014 Debit Cash ..................................................................... Accounts receivable ........................................... Notes receivable .................................................. Merchandise inventory ....................................... Land ..................................................................... Building................................................................ Accumulated depreciation—building ................ Equipment............................................................ Accumulated depreciation—equipment ............ Notes payable ...................................................... Accounts payable................................................ Mortgage payable ................................................ M. Perrault, capital .............................................. M. Perrault, drawings .......................................... Sales..................................................................... Sales returns and allowances ............................ Cost of goods sold .............................................. Salaries expense .................................................

Solutions Manual .

C-31

Credit

$ 44,900 35,800 10,000 20,960 25,000 75,000 $ 38,800 6,450 1,950 14,000 10,450 67,400 87,600 1,300 18,500 6,000 9,390 3,900 $238,700

$238,700

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-3 (Continued) (e) Accounts Receivable Subsidiary Ledger S. Armstrong .................................................................... $ 2,500 R. Goge ............................................................................. 24,000 B. Lu ..................................................................................... 9,300 $35,800 Accounts Receivable control account balance ......................... $35,800

Accounts Payable Subsidiary Ledger Denomme Corp ................................................................ Voyer Co. ......................................................................... Warren Parts..................................................................... Watson & Co.....................................................................

$ 4,000 4,500 1,750 200 $10,450

Accounts Payable control account balance .............................. $10,450

Solutions Manual .

C-32

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (b) Sales Journal

Date

Account Debited

May 3

B. Simone

Invoice Ref. No.

Accounts Receivable Dr. Sales Cr.

COGS Dr. Merch. Inv. Cr

2,400 (112)/(401)

1,050 (505)/(120)



General Journal

Date

Account Titles and Explanations

Ref.

Debit

May 14

Sales Returns and Allowances ................... 410 Accounts Receivable—W. Karasch ....  /112

750

Merchandise Inventory................................ Cost of Goods Sold .............................

120 505

325

20 Accounts Payable—Cobalt Sports. ............  /201 Notes Payable ...................................... 200

15,500

20 Accounts Payable—Lancio Co. ..................  /201 Merchandise Inventory ........................ 120

510

Solutions Manual .

C-33

Credit

750

325

15,500 510

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (b) (Continued)

Date

Purchases Journal Accounts Merchandise Supplies Payable Inventory Account Credited Terms Ref. Cr. Dr Dr.

P1 Other Accounts Account Debited

May 5 WN Shaw 17 Lancio Co. 30 Summers Corp.

Solutions Manual

  

2,600 2,100 4,000 8,700 (201)

2,600 2,100 _ 4,700 (120)

C-34 .

Ref. Amount

Equipment 157

4,000 4,000 X

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (b) (Continued)

Cash Receipts Journal

Date

Account Credited

May 7 G. Parrish 13 B. Simone 23 29 Notes Rec.

Cash Dr.

Ref.

CR1

Accounts Other COGS Dr. Receivable Sales Merch. Inv. Accounts Cr. Cr. Cr. Cr.

 2,800  2,400 9,500 115 40,000 54,700 (101)

2,800 2,400 9,500 5,200 (112)

4,450

9,500 4,450 (401) (505)/(120)

Cash Payments Journal

Date

Payee

Cash Cr.

May 11 12 15 Buttercup 18 27 WN Shaw

318 1,500 17,400 4,700 1,000

31 C. Lee

1,000 25,918 (101)

Solutions Manual .

Merch. Accts. Payable Inv. Dr. Dr.

40,000 40,000 (X)

CP1 Account Debited

Other Accts. Dr. Ref.

318 Rent Expense 730  17,400 Buttercup Salaries Exp. 725  1,000 WN Shaw C. Lee, 310 Drawings 18,400 (201)

318 (120)

C-35

1,500 4,700

1,000 7,200 (X)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c)

General Ledger Cash

Date May

1 31 31

No. 101

Explanation

Ref.

Balance

 CR1 CP1

Debit

Credit

54,700 25,918

Accounts Receivable Date May

1 14 31 31

May

1 31

Explanation

Ref.

Balance

 J1 CR1 S1

Debit

Credit 750 5,200

2,400

Explanation

Ref.

Balance

 CR1

May

1 14 20 31 31 31 31

Solutions Manual .

Explanation

Ref.

Balance

 J1 J1 P1 S1 CR1 CP1

C-36

Balance 15,400 14,650 9,450 11,850 No. 115

Debit

Credit 40,000

Merchandise Inventory Date

36,700 91,400 65,482

No. 112

Notes Receivable—Cole Company Date

Balance

Balance 48,000 8,000

No. 120 Debit

Credit

325 510 4,700 1,050 4,450 318

Balance 22,000 22,325 21,815 26,515 25,465 21,015 21,333

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Equipment Date May

No. 157

Explanation

Ref.

Balance



Debit

Credit

8,200 4,000

12,200

Accumulated Depreciation—Equipment Date May

Explanation

Ref.

Balance



Debit

No. 158 Credit

Explanation

No. 200 Ref.

May 20

Debit

Credit 15,500

Accounts P ayable Date May

1 20 20 31 31

May

Explanation

Ref.

Balance

 J1 J1 P1 CP1

Debit

Credit

15,500 510 8,700 18,400

Explanation

Ref.

Balance



Explanation

Ref.

May 31 Solutions Manual .

CP1 C-37

15,500

Balance 43,400 27,900 27,390 36,090 17,690

No. 301 Debit

Credit

Balance 85,100

C. Lee, Drawings Date

Balance

No. 201

C. Lee, Capital Date

Balance 1,800

Notes Payable Date

Balance

No. 310 Debit 1,000

Credit

Balance 1,000 Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Sales Date

No. 401

Explanation

Ref.

Debit

CR1 S1

May 31 31

Credit 9,500 2,400

Sales Returns and Allowances Date

Explanation

Ref.

May 14

Explanation

Debit

Credit

750

J1 S1 CR1

Debit

Credit 325

1,050 4,450

Salaries Expense Date

Explanation

Ref.

May 31

CP1

Explanation

Solutions Manual .

CP1

C-38

(325) 725 5,175

Debit

Credit

4,700

Balance 4,700 No. 730

Ref.

May 31

Balance

No. 725

Rent Expense Date

Balance

No. 505 Ref.

May 14 31 31

9,500 11,900 No. 410

Cost of Goods Sold Date

Balance

Debit 1,500

Credit

Balance 1,500

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Accounts Receivable Subsidiary Ledger L. Cellars Date May

Explanation

Ref.

Balance



Explanation

Ref.

Balance

 J1

Debit

Credit

Balance 7,400

W. Karasch Date May

1 14

Debit

Credit 750

Balance 3,250 2,500

G. Parrish Date May

1 7

Explanation

Ref.

Balance

 CR1

Debit

Credit 2,800

Balance 4,750 1,950

B. Simone Date May

Explanation

Ref. S1 CR1

3 13

Solutions Manual .

C-39

Debit

Credit

2,400 2,400

Balance 2,400 0

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Accounts Payable Subsidiary Ledger Buttercup Distributors Date May

1 15

Explanation

Ref.

Debit

Balance

 CP1

17,400

Explanation

Ref.

Debit

Balance

 J1

15,500

Ref.

Debit

Credit

Balance 17,400 0

Cobalt Sports Date May

1 20

Credit

Balance 15,500 0

Lancio Co. Date

Explanation

P1 J1

May 17 20

Credit 2,100

510

Balance 2,100 1,590

WN Shaw Date May

Explanation

Ref. P1 CP1

5 27

Debit

Credit 2,600

1,000

Balance 2,600 1,600

Summers Corp. Date May

1 30

Solutions Manual .

Explanation

Ref.

Balance

 P1

C-40

Debit

Credit 4,000

Balance 10,500 14,500

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-4 (Continued) (d) LEE CO. Trial Balance May 31, 2014 Debit Cash ..................................................................... Accounts receivable ........................................... Notes receivable.................................................. Merchandise inventory ....................................... Equipment............................................................ Accumulated depreciation—equipment ............ Notes payable ...................................................... Accounts payable................................................ C. Lee, capital ...................................................... C. Lee, drawings.................................................. Sales..................................................................... Sales returns and allowances ............................ Cost of goods sold .............................................. Salaries expense ................................................. Rent expense .......................................................

(e)

Credit

$ 65,482 11,850 8,000 21,333 12,200 $ 1,800 15,500 17,690 85,100 1,000 11,900 750 5,175 4,700 1,500 $131,990

Accounts Receivable control account balance..............

$131,990 $11,850

Accounts Receivable Subsidiary Ledger account balances: L. Cellars.................................................................... $ 7,400 W. Karasch ................................................................ 2,500 G. Parrish................................................................... 1,950 $11,850 Accounts Payable control account balance ................... Accounts Payable Subsidiary Ledger account balances: Lancio Co................................................................... WN Shaw.................................................................... Summers Corp. .........................................................

Solutions Manual .

C-41

$13,690 $ 1,590 1,600 14,500 $17,690

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-5 (a), (b) and (c) Sales Journal Date

Account Debited

Feb. 4 9 17 28

Gilles Co. Earlton Corp. Lumber Co. Gilles Co.

Invoice No.

Ref.

371 372 373 374

   

S1 Accounts Receivable Dr. Sales Cr. 5,220 2,050 1,800 9,810 18,880 (112)/(401)

GENERAL JOURNAL Date Feb.

Account Titles and Explanations

J1 Ref.

5 Accounts Payable—Zears Co ..................... 201/ Purchase Returns and Allowances..... 512

Solutions Manual .

C-42

Debit

Credit

450 450

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-5 (Continued) (a), (b) and (c) (Continued)

Cash Receipts Journal

Date

Accounts Other Cash Receivable Sales Accounts Ref. Dr. Cr. Cr. Cr.

Account Credited

Feb. 6 13 15 Earlton Corp. 17 Gilles Co. 20 27 28 Lumber Co.

Ch. Date No. Feb. 13 15 20 28

Solutions Manual .

Payee Zears Co. Fell Elect.

CR1

1,950 3,850  2,050  5,220 4,900 4,560  1,800 24,330 (101)

1,950 3,850 2,050 5,220 4,900 4,560 1,800 9,070 15,260 (112) (401)

Cash Payments Journal

CP1

Accounts Payable Dr.

Other Accounts Dr.

Cash Cr. 3,750 14,100 7,200 14,900 39,950 (101)

Account Debited

3,750 Zears Co. Salaries 7,200 Fell Elect. Salaries 10,950 (201)

C-43

Ref.  726  726

14,100 14,900 29,000 (X)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

PROBLEM C-5 (Continued) a), (b) and (c) (Continued)

Date

Purchases Journal Accounts Payable Purchases Account Credited Terms Ref. Cr. Dr

P1 Supplies Dr.

Other Accounts Account Debited

Feb 3 4 8 11 19 23 24

Zears Co. Green Deer Inc. Fell Electronics Thomas Co. Brown Corp. Zears Co. Lewis Co.

Solutions Manual

      

4,200 290 7,200 9,100 16,400 4,800 5,130 47,120 (201)

4,200 290 7,200 9,100 Equipment 157 4,800 _5,130 30,430 (510)

C-44 .

Ref. Amount

290 (126)

16,400

16,400 X

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE: Chapters 2 to 6 and Appendix C (a) Sales Journal

Date Jan. 3 3 11 11 22 22 25 25

Account Debited B. Soto J. Ebel R. Draves S. Tang B. Soto R. Draves B. Jacovetti J. Ebel

Solutions Manual .

Invoice No. Ref. 510  511  512  513  514  515  516  517 

C-45

S1 Accounts Cost of Goods Receivable Sold Dr. Dr. Merch. Inventory Sales Cr. Cr. 3,100 1,240 1,800 720 1,900 760 900 360 1,700 680 800 320 3,500 1,400 6,100 2,440 19,800 7,920 (112)/(401) (505)/(120)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a) (Continued) Cash Receipts Journal CR1 Other Accounts COGS Dr. Accounts Account Cash Sales Date Ref. Cr. Cr. Dr. Jan. 7 S. Tang 5,000 5,000  7 B. Jacovetti  2,000 2,000 10 16,500 16,500 6,600 20 17,500 17,500 7,000 21 S. Tang 900 900  31 19,920 19,920 7,968 31 B. Soto 4,800 4,800  31 J. Ebel 7,500 7,500  74,120 20,200 53,920 21,568 (101) (112) (401) (505)/(120)

Date Jan. 8 9 9 15 23 23 31

Payee

Cash Payments Journal Merch. Accts. Cash Invent. Payable Cr. Dr. Dr.

Freight Co. 180 Liazuk Co. 10,000 Nguyen & Son 11,000 A. Winters 2,000 Nguyen & Son 15,000 Liazuk Co. 13,400 6,900 58,480 (101)

Solutions Manual .

Account Debited

CP1 Other Accts. Ref. Dr.

180

180 (120)

C-46

10,000 Liazuk Co. 11,000 Nguyen & Son A. Winters, Drawings 15,000 Nguyen & Son 13,400 Liazuk Co. Salaries Exp. 49,400 (201)

  310   725

2,000 6,900 8,900 (X)

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a) (Continued)

Date

Account Credited

Terms Ref.

Purchases Journal Merchandise Accounts Inventory Supplies Payable Cr. Dr Dr.

P1 Other Accounts Account Debited Ref. Amount

Jan. 5 Welz Wares 5 Laux Supplies 16 Nguyen & Son 16 Liazuk Co. 16 Welz Wares 17 Laux Supplies 27 Nguyen & Son 27 Laux Supplies 27 Welz Wares 28 Laux Supplies

Solutions Manual

         

3,000 2,700 15,000 13,900 1,500 400 14,500 1,200 2,800 800 55,800 (201)

C-47 .

3,000 2,700 15,000 13,900 1,500 400 14,500 1,200 2,800 54,600 (120)

800 1,200 (125 )

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (d), and (f)

Date Jan.9

General Journal Account Titles and Explanations

Ref.

Sales Returns and Allowances ...... Accounts Receivable—J. Ebel

410 112/

400

Merchandise Inventory ................... Cost of Goods Sold .................

120 505

160

Accounts Payable—Liazuk Co....... Merchandise Inventory ...........

201/ 120

500

Accounts Payable—Mikush Bros. . Notes Payable..........................

201/ 200

15,000

Supplies Expense ........................... Supplies ................................... ($1,000 + $400 + $800 − $700)

728 125

1,500

Insurance Expense (1/9 × $2,000) Prepaid Insurance ...................

722 130

222

Depreciation Expense .................... Accumulated Depreciation— Building (1/12 × $6,000) ... Accumulated Depreciation— Equipment (1/12 × $1,500)

711

625

Debit

J1 Credit

400 160

500 15,000

Adjusting Journal Entries 31

Solutions Manual .

C-48

1,500

222

146

500

158

125

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a) , (d), and (f) (Continued)

Date Jan. 31 31

General Journal Account Titles and Explanations Interest Expense ............................. Interest Payable.......................

Ref. 718 230

Debit 45

505 120

102

Sales ................................................ Income Summary ....................

401 300

73,720

Income Summary............................ Sales Returns and Allowances Cost of Goods Sold .................. Depreciation Expense .............. Interest Expense ....................... Insurance Expense ................... Salaries Expense ...................... Supplies Expense .....................

300 410 505 711 718 722 725 728

39,122

Income Summary............................ A. Winters, Capital ..................

300 301

34,598

A. Winters, Capital .......................... A. Winters, Drawings ..............

301 310

2,000

Cost of Goods Sold ........................ Merchandise Inventory ........... ($44,850 − $44,952)

J2 Credit 45 102

Closing Journal Entries 31 31

31 31

Solutions Manual .

C-49

73,720 400 29,430 625 45 222 6,900 1,500 34,598 2,000

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued)

(b) and (f)

General Ledger Cash

Date Jan. 1 31 31

Explanation Balance

Ref.  CR1 CP1

Date Jan. 1 9 31 31

Accounts Receivable Explanation Ref. Balance  J1 S1 CR1

Date Jan. 1

Notes Receivable Explanation Ref.  Balance

Date Jan. 1 9 18 31 31 31 31 31

Merchandise Inventory Explanation Ref. Balance  J1 J1 S1 P1 CR1 CP1 J2 Adjusting entry

Solutions Manual .

C-50

Debit

Credit

74,120 58,480

Debit

Credit 400

19,800 20,200

Debit

Credit

160 500 7,920 54,600 21,568 180 102

No. 101 Balance 35,050 109,170 50,690 No. 112 Balance 14,000 13,600 33,400 13,200 No. 115 Balance 39,000 No. 120 Balance 20,000 20,160 19,660 11,740 66,340 44,772 44,952 44,850

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Supplies Date Jan. 1 31 31

Date Jan. 1 31

Explanation Balance Adjusting entry

Ref.  P1 J1

Prepaid Insurance Explanation Ref. Balance  Adjusting entry J1

Debit

Credit

1,200 1,500

Debit

Credit 222

Land Date Jan. 1

Explanation Balance

Ref. 

Debit

Explanation Balance

Date Jan. 1 31

Accumulated Depreciation—Building Explanation Ref. Debit Balance  J1 Adjusting entry

Solutions Manual .

Ref. 

C-51

Debit

No. 130 Balance 2,000 1,778

Credit

No. 140 Balance 50,000

Credit

No. 145 Balance 100,000

Credit

No. 146 Balance 25,000 25,500

Building Date Jan. 1

No. 125 Balance 1,000 2,200 700

500

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Equipment Date Jan. 1

Explanation Balance

Ref. 

Debit

Credit

Accumulated Depreciation—Equipment Date Jan. 1 31

Explanation Balance Adjusting entry

Date Jan. 21

Notes Payable Explanation Ref. J1

Date Jan. 1 18 21 31 31

Accounts Payable Explanation Ref. Balance  J1 J1 P1 CP1

Date Jan. 31

Interest Payable Explanation Ref. Adjusting entry J2

Date Jan. 1

Mortgage Payable Explanation Ref.  Balance

Solutions Manual .

Ref.  J1

C-52

Debit

No. 158 Credit 125

Balance 1,500 1,625

Credit 15,000

No. 200 Balance 15,000

Credit

500 15,000 55,800 49,400

Debit

No. 157 Balance 6,450

Credit 45

Credit

No. 201 Balance 36,000 35,500 20,500 76,300 26,900 No. 230 Balance 45 No. 275 Balance 125,000

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued)

Date Jan. 31 31 31

Income Summary Explanation Ref. Closing entry J2 Closing entry J2 Closing entry J2

Date Jan. 1 31 31

A. Winters, Capital Explanation Ref.  Balance Closing entry J2 Closing entry J2

Date Jan. 31 31

A. Winters, Drawings Explanation Ref. CP1 J2 Closing entry

Debit

Credit 73,720

39,122 34,598

Debit

Credit 34,598

2,000

Debit 2,000

Credit 2,000

Sales Date Jan. 31 31 31

Date Jan. 9 31

Solutions Manual .

No. 300 Balance 73,720 34,598 0 No. 301 Balance 80,000 114,598 112,598 No. 310 Balance 2,000 0

Credit 19,800 53,920

73,720

No. 401 Balance 19,800 73,720 0

Sales Returns and Allowances Explanation Ref. Debit 400 J1 Closing entry J2

Credit

No. 410 Balance 400 0

Explanation

Closing entry

Ref. S1 CR1 J2

C-53

Debit

400

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued)

Date Jan. 9 31 31 31 31

Cost of Goods Sold Explanation Ref. J1 S1 CR1 Adjusting entry J2 J2 Closing entry

Date Jan. 31 31

Depreciation Expense Explanation Ref. Adjusting entry J1 Closing entry J2

Date Jan. 31 31

Interest Expense Explanation Ref. Adjusting entry J2 Closing entry J2

Debit

Credit 160

7,920 21,568 102 29,430

Debit 625

Credit 625

Debit 45

Credit 45

Insurance Expense Date Jan. 31 31

Explanation Adjusting entry Closing entry

Date Jan. 31 31

Salaries Expense Explanation Ref. CP1 Closing entry J2

Date Jan. 31 31

Supplies Expense Explanation Ref. Adjusting entry J1 Closing entry J2

Solutions Manual .

Ref. J1 J2

C-54

No. 505 Balance (160) 7,760 29,328 29,430 0 No. 711 Balance 625 0 No. 718 Balance 45 0 No. 722

Debit 222

Credit 222

Debit 6,900

Credit 6,900

Debit 1,500

Credit 1,500

Balance 222 0 No. 725 Balance 6,900 0 No. 728 Balance 1,500 0

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Accounts Receivable Subsidiary Ledger R. Draves Date Jan. 1 11 22

Explanation Balance

Ref.  S1 S1

Debit

Ref. S1 J1 S1 CR1

Debit 1,800

B. Jacovetti Date Explanation Jan. 1 Balance 7 25

Ref.  CR1 S1

Debit

S. Tang Date Jan. 1 7 11 21

Ref.  CR1 S1 CR1

Debit

Ref. S1 S1 CR1

Debit 3,100 1,700

Credit

Balance 1,500 3,400 4,200

Credit

Balance 1,800 1,400 7,500 0

1,900 800

J. Ebel Date Jan. 3 9 25 31

B. Soto Date Jan. 3 22 31

Solutions Manual .

Explanation

Explanation Balance

Explanation

C-55

400 6,100 7,500

Credit 2,000

3,500

Credit 5,000

900 900

Credit

4,800

Balance 7,500 5,500 9,000

Balance 5,000 0 900 0

Balance 3,100 4,800 0

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Accounts Payable Subsidiary Ledger Laux Supplies Date Jan. 5 17 27 28

Explanation

Ref. P1 P1 P1 P1

Debit

Credit 2,700 400 1,200 800

Balance 2,700 3,100 4,300 5,100

Explanation Balance

Ref.  CP1 P1 J1 CP1

Debit

Credit

Balance 10,000 0 13,900 13,400 0

Liazuk Co. Date Jan. 1 9 16 18 23

Mikush Bros. Date Explanation Balance Jan. 1 21

Ref.  J1

Nguyen & Son Date Explanation Jan. 1 Balance 9 16 23 27

Ref.  CP1 P1 CP1 P1

10,000 13,900 500 13,400

Debit

Credit

Balance 15,000 0

Credit

14,500

Balance 11,000 0 15,000 0 14,500

Credit 3,000 1,500 2,800

Balance 3,000 4,500 7,300

15,000

Debit 11,000

15,000 15,000

Welz Wares Date Jan. 5 16 27

Solutions Manual .

Explanation

Ref. P1 P1 P1

C-56

Debit

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (c) and (d)

WINTERS COMPANY Trial Balance January 31, 2014 Unadjusted Debit Credit $ 50,690 13,200 39,000 44,952 2,200 2,000 50,000 100,000

Cash ........................................ Accounts receivable............... Notes receivable ..................... Merchandise inventory........... Supplies .................................. Prepaid insurance .................. Land......................................... Building ................................... Accumulated depreciation— building............................... Equipment ............................... 6,450 Accumulated depreciation— equipment........................... Notes payable ......................... Accounts payable ................... Interest payable ...................... Mortgage payable ................... A. Winters, capital .................. A. Winters, drawings .............. 2,000 Sales ........................................ Sales returns & allowances 400 Cost of goods sold ................. 29,328 Depreciation expense............. Interest expense ..................... Salaries expense .................... 6,900 Insurance expense ................. Supplies expense ................... Totals .................................. $347,120

Solutions Manual .

C-57

Adjusted Debit Credit $ 50,690 13,200 39,000 44,850 700 1,778 50,000 100,000

$ 25,000

$ 25,500 6,450

1,500 15,000 26,900

1,625 15,000 26,900 45 125,000 80,000

125,000 80,000 2,000 73,720

73,720

400 29,430 625 45 6,900 222 1,500 $347,120 $347,790 $347,790

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued)

(c) (Continued) Accounts Receivable control account balance Subsidiary ledger account balances R. Draves .................................................. B. Jacovetti ...............................................

$13,200 $4,200 9,000 $13,200

Accounts Payable control account balance .. Subsidiary ledger account balances Laux Supplies........................................... Nguyen & Son........................................... Welz Wares ...............................................

$25,700 $ 5,100 14,500 7,300 $26,900

Solutions Manual .

C-58

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (e) WINTERS COMPANY Income Statement Month Ended January 31, 2014 Sales revenues Sales ................................................................. Less: Sales returns and allowances.............. Net sales ....................................................

$73,720 400 $73,320

Cost of goods sold ................................................ Gross profit ............................................................ Operating expenses Salaries expense.............................................. Supplies expense ............................................ Insurance expense .......................................... Depreciation expense...................................... Total operating expenses.......................... Profit from operations ...........................................

29,430 43,890 $6,900 1,500 222 625

Other expenses Interest expense .............................................. Profit .......................................................................

9,247 34,643 45 $34,598

WINTERS COMPANY Statement of Owner’s Equity Month Ended January 31, 2014 A. Winters, capital, January 1 ................................................ Add: Profit ............................................................................. Less: Drawings ...................................................................... A. Winters, capital, January 31 ..............................................

Solutions Manual .

C-59

$ 80,000 34,598 114,598 2,000 $112,598

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (e) (Continued) WINTERS COMPANY Balance Sheet January 31, 2014 Assets Current assets Cash ............................................................ Notes receivable......................................... Accounts receivable .................................. Merchandise inventory .............................. Supplies ...................................................... Prepaid insurance ...................................... Total current assets............................ Property, plant, and equipment Land ................................................. Building .......................................... $100,000 Less: Accumulated depreciation ... 25,500 Equipment ....................................... 6,450 Less: Accumulated depreciation .. 1,625 Total assets..............................

$ 50,690 39,000 13,200 44,850 700 1,778 150,218

$50,000 74,500 4,825

129,325 $279,543

Liabilities and Owner’s Equity Current liabilities Notes payable............................................. Accounts payable ...................................... Interest payable.......................................... Total current liabilities .......................

$ 15,000 26,900 45 41,945

Long-term liabilities Mortgage payable....................................... Total liabilities.....................................

125,000 166,945

Owner’s equity A. Winters, capital ...................................... Total liabilities and owner’s equity....

112,598 $279,543

Solutions Manual .

C-60

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

CUMULATIVE COVERAGE (Continued) (g) WINTERS COMPANY Post-Closing Trial Balance January 31, 2014 Cash ................................................................ Accounts receivable ...................................... Notes receivable ............................................ Merchandise inventory .................................. Supplies.......................................................... Prepaid insurance.......................................... Land ................................................................ Building .......................................................... Accumulated depreciation—building ........... Equipment ...................................................... Accumulated depreciation—equipment ....... Notes payable................................................. Accounts payable .......................................... Interest payable.............................................. Mortgage payable .......................................... A. Winters, capital .......................................... Totals .........................................................

Solutions Manual .

C-61

Debit $ 50,690 13,200 39,000 44,850 700 1,778 50,000 100,000

Credit

$ 25,500 6,450

$306,668

1,625 15,000 26,900 45 125,000 112,598 $306,668

Appendix C

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

Present Value Concepts Solutions to Brief Exercises BEPV–1 (a)

$50.00

($1,000 × 5%)

(b)

$40.00

($500 × 4% × 2 periods)

(c)

$40.80

($500 × 4%) + ($520 × 4%)

BEPV–2 Using tables: Discount rate from Table PV-1 is 0.82193 (5 periods at 4%). The present value of $600,000 to be received in 5 years discounted at 4% is therefore $493,158 ($600,000 × 0.82193). Wong Ltd. should therefore invest $493,158 to have $600,000 in five years.

Using a financial calculator: Enter:

600000

Press:

I/Y

PMT

CPT

Result: PV = $ (493,156.26)

Solutions Manual .

PV-1

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–2 (Continued) Using Excel: =PV(rate,nper,pmt,fv,type) RATE

.04

NPER

PMT

FV Type

$600,000 0

Result: PV = $(493,156.26)

Solutions Manual .

PV-2

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–3 Using tables: Discount rate from Table PV-1 is 0.67556 (10 periods at 4%). The future value of $8,000 invested today (present value) for a period of 10 years discounted at 4% is $11,842.03 ($8,000 ÷ 0.67556). Mohammed should receive $11,842.03 when the GIC matures in 10 years. After the first 5 years, using the discount rate from Table PV-1 of 0.82193 (5 periods at 4%), the value of $8,000 invested today (present value) is $9,733.19 ($8,000 ÷ 0.82193). The interest earned in the first 5 years is: $1,733.19 = $9,733.19 – $8,000.00 The interest earned in the second 5 years is: $2,108.84 = $11,842.03 – $9,733.19 The interest earned in the first 5 years of $1,733.19 is based on an initial investment of $8,000. The interest earned in the second 5 years of $2,108.84 is higher because it is based on the initial investment of $8,000 plus the $1,733.19 interest earned over the first five year period.

Solutions Manual .

PV-3

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–3 (Continued) Using a financial calculator: Value of the investment after 10 years: Enter: 4 10 –8000 Press:

I/Y

0 PMT

CPT

Result: FV = $11,841.95 Value of the investment after 5 years: Enter: 4 5 –8000 Press:

I/Y

0 PMT

Result: FV = $9,733.22 The interest earned in the first 5 years is: $1,733.22 = $9,733.22 – $8,000.00 The interest earned in the second 5 years is: $2,108.73 = $11,841.95 – $9,733.22 The interest earned in the first 5 years of $1,733.22 is based on an initial investment of $8,000. The interest earned in the second 5 years of $2,108.73 is higher because it is based on the initial investment of $8,000 plus the $1,733.22 interest earned over the first five year period.

Solutions Manual .

PV-4

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–3 (Continued) Using Excel functions: =FV(rate,nper,pmt,pv,type) Option 1

Option 2

Rate

.04

Rate

.04

nper

PMT

$ (8,000)

Type

Result FV = $11,841.95

PV Type

$ (8,000) 0

Result FV = $9,733.22

The interest earned in the first 5 years is: $1,733.22 = $9,733.22 – $8,000.00 The interest earned in the second 5 years is: $2,108.73 = $11,841.95 – $9,733.22 The interest earned in the first 5 years of $1,733.22 is based on an initial investment of $8,000. The interest earned in the second 5 years of $2,108.73 is higher because it is based on the initial investment of $8,000 plus the $1,733.22 interest earned over the first five year period.

Solutions Manual .

PV-5

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–4

Using tables: Present value = Future amount × Present value of 1 Factor OR Present value of 1 Factor = Present value ÷ Future amount 0.44401= $44,401 ÷ $100,000 The 0.44401 at 7% is found in the 12 years column. Janet Bryden therefore must wait 12 years to receive $100,000. Using a financial calculator: Enter:

–44401

100000

Press:

I/Y

PMT

CPT

Result: N = 12

Solutions Manual .

PV-6

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–4 (Continued) Using Excel functions: the formula is: =NPER(rate,pmt,pv,fv,type) RATE

.07

PMT

$ (44,401.00)

$ 100,000.00

Type

Result: NPER = 12

Solutions Manual .

PV-7

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–8

Using tables: Present value = Future amount × Present value of 1 Factor $3,152 = $10,000 × Present value of 1 Factor Present value of 1 Factor = $3,152 ÷ $10,000 Present value of 1 Factor = 0.31520 The closest PV factor for 15 periods is 0.31524, which is found in the 8% column. As this factor is almost exactly equal to 0.31520, this means Jin Fei will earn an 8% return. Using a financial calculator: Enter:

–3152

10000

Press:

PMT

CPT

I/Y

Result: I/Y = 8.001% Using Excel functions: the formula is: =RATE(nper,pmt,pv,fv,type) NPER

PMT

$ (3,152.00)

$ 100,000.00

Type

Result: Rate = 8.001% Solutions Manual .

PV-8

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–9

Using tables: Discount rate from Table PV-2 is 9.71225. The present value of 15 payments of $25,000 each discounted at 6% is therefore $242,806.25 ($25,000 × 9.71225). Tarzwell Ltd. should pay $242,806.25 for this annuity contract. Using a financial calculator: Enter:

25000

Press:

I/Y

PMT

CPT

Result: PV = $(242,806.22)

Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.06

NPER

PMT

$ 25,000.00

Type

Result: PV = $ (242,806.22)

Solutions Manual .

PV-9

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV– 10

Annual Number Interest of Frequency Rate Years of Payment 1. 6% 2 Quarterly Semi2. 5% 8 annually 3. 7% 5 Annually 4. 4% 3 Quarterly Semi5. 2% 6 annually 6. 6% 9 Monthly

(n) Number of (i) Discount Periods Rate 2×4=8 6% ÷ 4 = 1.5% 8 × 2 = 16 5 3 × 4 = 12

5% ÷ 2 = 2.5% 7% 4% ÷ 4 = 1%

6 × 2 = 12 9 × 12 = 108

2% ÷ 2 = 1% 6% ÷ 12 = 0.5%

BEPV–8 Using tables: Present value of principal to be received at maturity: $100,000 × 0.61027 (PV of $1 due in 20 periods at 2.5% from Table PV-1) .............................................

$61,027.00

Present value of interest to be received periodically over the term of the bonds: $2,750* × 15.58916 (PV of $1 due each period for 20 periods at 2.5% from Table PV-2) .............................................................

42,870.19

Present value of bonds................................................... $103,897.19 * $100,000 × 5.5% ÷ 2 = $2,750

Solutions Manual .

PV-10

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–8 (Continued) Using a financial calculator: Enter:

2.5

2750

100000

Press:

I/Y

PMT

CPT

Result: PV = $(103,897.29)

Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.025

NPER

PMT

$2,750

$100,000

Type

Result: PV = $(103,897.29)

Solutions Manual .

PV-11

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV– 12 Using tables: Present value of principal to be received at maturity: $100,000 × 0.55368 (PV of $1 due in 20 periods at 3% from Table PV-1) .....................................................

$55,368.00

Present value of interest to be received periodically over the term of the bonds: $2,750 × 14.87747 (PV of $1 due each period for 20 periods at 3% from Table PV-2) ...........................................................

40,913.04

Present value of bonds ................................................

$96,281.04

Using a financial calculator: Enter:

2750

100000

Press:

I/Y

PMT

CPT

Result: PV = $(96,280.63) Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.03

NPER

PMT

$2,750

$100,000

Type

Result: PV = $(96,280.63)

Solutions Manual .

PV-12

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–13 Using tables: From Table PV-2, n = 6, i = 8%, the present value for a $1 payment annually is $4.62288. In this problem, we want to determine the payment that would result in a present value of $50,000. The required payment would be $10,815.77 ($50,000 ÷ 4.62288). Using a financial calculator: Enter:

–50000

Press:

I/Y

CPT

PMT

Result: PMT = $10,815.77

Using Excel functions: the formula is: =PMT(rate,nper,pv,fv,type) RATE

.08

NPER

$(50,000.00)

Type

Result: PMT = $10,815.77

Solutions Manual .

PV-13

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–14 Using tables: From Table PV-2, n = 6, i = 9%, the present value for a $1 payment annually is $4.48592. In this problem, we want to determine the payment that would result in a present value of $50,000. The required payment would be $11,145.99 ($50,000 ÷ 4.48592). Using a financial calculator: Enter:

–50000

Press:

I/Y

CPT

PMT

Result: PMT = $11,145.99

Using Excel functions: the formula is: =PMT(rate,nper,pv,fv,type) RATE

.09

NPER

$(50,000.00)

Type

Result: PMT = $11,145.99

Solutions Manual .

PV-14

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–15 Using tables: Using present value tables, for an annuity, find the rate for 12 periods that will give the factor arrived at by dividing the present value (PV) by the amount of the payment (PMT). $1,058,871 ÷ $112,825 = 9.38507 The factor will be found in the column for 4% interest*. Using a financial calculator: Enter: 12 –112825 Press:

1058871

PMT

CPT

I/Y

Result: I/Y = 4%* Using Excel functions: the formula is: =RATE(nper,pmt,pv,fv,type) NPER

PMT

$(112,825.00)

$1,058,871.00

Type

Result: Rate = 4%* *Semi-annual rate of 4% × 2 = annual rate of 8%

Solutions Manual .

PV-15

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–16 Using a financial calculator: Enter:

1.25*

12**

185000

Press:

I/Y

CPT

PMT

Result: PMT = $(16,697.79) * 5 ÷ 4 = 1.25 ** 3 × 4 = 12 Using Excel functions: the formula is: =PMT(rate,nper,pv,fv,type) RATE

.0125

NPER

$185,000

Type

Result: PMT = $(16,697.79)

Solutions Manual .

PV-16

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–17 Using tables: First divide the present value with the amount of the payment: $18,000 ÷ $1,702 = 10.57579 Look in the Present Value Table PV-2 for an annuity under the column for 2% and locate the number of periods which is close to the factor 10.57579. You will find the factor 10.57534 under 12 periods. **(within rounding) Using a financial calculator: Enter:

18000

–1702

Press:

I/Y

PMT

CPT

Result: N = 12 periods** *4 ÷ 2 = 2 Using Excel functions: the formula is: =NPER(rate,pmt,pv,fv,type) RATE

.02

PMT

$(1,702.00)

$18,000.00

Type

Result: NPER = 12 periods **12 periods semi-annual will equal 6 years

Solutions Manual .

PV-17

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–18 Using tables: From Table PV-2, n = 5, i = 3%, the present value for a $1 payment annually is $4.57971. In this problem, we want to determine the payment that would result in a present value of $32,000. The required payment would be $6,987.34 ($32,000 ÷ 4.57971). Using a financial calculator: Enter:

32000

Press:

I/Y

CPT

PMT

Result: PMT = $(6,987.35) Using Excel functions: the formula is: =PMT(rate,nper,pv,fv,type) RATE

.03

NPER

$32,000

Type

Result: PMT = $(6,987.35)

Solutions Manual .

PV-18

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–19 Using tables: From Table PV-2, the present value of an annuity stream of $6,500 per year, for 5 years at 3% is: $6,500 × 4.57971 = $29,768.12 If the price of the car you would like to purchase is $32,000, then you need to receive a $2,231.88 ($32,000.00 – $29,768.12) trade in value for your existing vehicle.

Using a financial calculator: Enter:

–6500

Press:

I/Y

PMT

CPT

Result: PV = $29,768.10 Trade-in value required: $32,000.00 – $29,768.10 = $2,231.90

Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.03

NPER

PMT

$(6,500)

Type

Result: PV = $29,768.10 Trade-in value required: $32,000.00 – $29,768.10 = $2,231.90

Solutions Manual .

PV-19

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–17

The better option for repayment of this piece of equipment is the single payment of $46,000 in 2 years.

Solutions Manual .

PV-20

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–17 (Continued) Using a financial calculator: Option 1:

Enter:

–10000

Press:

I/Y

PMT

CPT

Result: PV = $39,927.10 Option 2:

Enter:

–46000

Press:

I/Y

PMT

Result: PV = $39,437.59 Using Excel functions the formula is: =PV(rate,nper,pmt,fv,type) Option 1

Option 2

RATE

.08

RATE

.08

NPER

PMT

$(10,000)

PMT

Type

Result PV = $39,927.10

Solutions Manual .

$(46,000) 0

Result PV = $39,437.59

PV-21

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–18 Using tables:

The same option would not be chosen; the better choice now is 5 payments of $10,000 each. As market (or discount) rates rise, the effect of the timing of repayments becomes more significant. Using a financial calculator: Option 1:

Enter:

–10000

Press:

I/Y

PMT

CPT

Result: PV = $37,907.87 Option 2:

Enter:

–46000

Press:

I/Y

PMT

Result: PV = $38,016.53

Solutions Manual .

PV-22

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–18 (Continued) Using Excel functions the formula is: =PV(rate,nper,pmt,fv,type) Option 1

Option 2

RATE

.10

RATE

.10

NPER

PMT

$(10,000)

PMT

Type

Result PV = $37,907.87

$(46,000) 0

Result PV = $38,016.53

BEPV–19

Using tables: Discount rate from Table PV-2 is 5.14612. The present value of 8 payments of $2,690 each discounted at 11% is therefore $13,843.06 ($2,690 × 5.14612). Sam Waterston should not purchase the tire retreading machine because the present value of the future cash flows is less than the purchase price of the retreading machine.

Solutions Manual .

PV-23

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–19 (Continued) Using a financial calculator: Enter:

2690

Press:

I/Y

PMT

CPT

Result: PV = $(13,843.07) PV is less than cost. Do not buy machine.

Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.11

NPER

PMT

$2,690

Type

Result: PV = $(13,843.07) PV is less than cost. Do not buy machine.

Solutions Manual .

PV-24

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–20

Using tables: To determine the present value of the future cash flows, discount the future cash flows at 10%, using Table PV-1. Year 1 ($35,000 × 0.90909) =

$ 31,818.15

Year 2 ($45,000 × 0.82645) =

37,190.25

Year 3 ($55,000 × 0.75131) =

41,322.05

Present value of future cash flows

Solutions Manual .

PV-25

$110,330.45

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–20 (Continued)

Using a financial calculator: Year 1:

Enter:

–35000

Press:

I/Y

PMT

CPT

Result: PV = $31,818.18 Year 2:

Enter:

–45000

Press:

I/Y

PMT

Result: PV = $37,190.08 Year 3:

Enter:

–55000

Press:

I/Y

PMT

Result: PV = $41,322.31 Value in use = $31,818.18 + $37,190.08 + $41,322.31 = $110,330.57

Solutions Manual .

PV-26

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–20 (Continued) Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) Year 1

Year 2

RATE

.10

RATE

.10

NPER

PMT

$(35,000)

Type

Result PV = $31,818.18

Type

$(45,000) 0

Result PV = $37,190.08

Year 3 RATE

.10

NPER

PMT

$(55,000)

Type

Result PV = $41,322.31 Value in use = $31,818.18 + $37,190.08 + $41,322.31 = $110,330.57

Solutions Manual .

PV-27

Appendix PV

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow

Accounting Principles, Sixth Canadian Edition

BEPV–21 The present value of an annuity collected of $21,000 for 12 years at 4% is calculated as follows: Using tables: $21,000 × 9.38507 = $197,086.47 (discount rate from Table PV-2)

Using a financial calculator: Enter:

21000

Press:

I/Y

PMT

CPT

Result: PV = $(197,086.55) The value in use is $197,086.55.

Using Excel functions: the formula is: =PV(rate,nper,pmt,fv,type) RATE

.04

NPER

PMT

$21,000

Type

Result: PV = $(197,086.55) The value in use is $197,086.55.

Solutions Manual .

PV-28

Appendix PV