Accounting Principles Fifth Canadian Edition Jerry J Weygandt Solution Manual by Ace Test Banks

Accounting Principles Fifth Canadian Edition By Jerry J. Weygandt

Email: Richard@qwconsultancy.com

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

APPENDIX B Sales Taxes SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE B-1 Merchandise Inventory ................................. GST Recoverable ($4,500 × 5%) ................... Accounts Payable ...................................

4,500 225 4,725

BRIEF EXERCISE B-2 Accounts Payable .......................................... GST Recoverable ($1,000 × 5%) ............ Merchandise Inventory ..........................

1,050 50 1,000

BRIEF EXERCISE B-3 Merchandise Inventory ................................. HST Recoverable ($4,500 × 13%) ................. Accounts Payable ...................................

4,500 585 5,085

BRIEF EXERCISE B-4 Accounts Payable .......................................... HST Recoverable ($1,000 × 13%) .......... Merchandise Inventory ..........................

1,130 130 1,000

BRIEF EXERCISE B-5 Office Supplies ($600 × 1.05) ........................ GST Recoverable ($600 × 5%) ...................... Cash .........................................................

630 30 660

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE B-6 Office Supplies............................................... HST Recoverable ($600 × 12%) .................... Cash .........................................................

600 72 672

BRIEF EXERCISE B-7 Delivery Truck ................................................ HST Recoverable ($25,000 × 13%) ............... Accounts Payable ...................................

25,000 3,250 28,250

BRIEF EXERCISE B-8 Delivery Truck ($25,000 × 1.05) .................... GST Recoverable ($25,000 × 5%) ................. Accounts Payable ...................................

26,250 1,250 27,500

BRIEF EXERCISE B-9 Merchandise Inventory ................................. Office Supplies ($200 × 7%).......................... GST Recoverable ($4,200 × 5%) ................... Accounts Payable ...................................

4,000 214 210 4,424

BRIEF EXERCISE B-10 Accounts Receivable .................................... 2,050.65 Sales......................................................... GST Payable ($1,800 × 5%) .................... PST Payable [($1,800 + $90) × 8.5%] ....

1,800.00 90.00 160.65

Cost of Goods Sold ....................................... 1,100.00 Merchandise Inventory ..........................

1,100.00

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE B-11 Sales Returns and Allowances .................... GST Payable ($900 × 5%) .............................. PST Payable [($900 + $45) × 8.5%]............... Accounts Receivable .............................

900.00 45.00 80.33

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

550.00

1,025.33

550.00

BRIEF EXERCISE B-12 Accounts Receivable .................................... 2,050.65 Sales......................................................... GST Payable ($1,800 × 5%) .................... PST Payable [($1,800 + $90) × 8.5%] ....

1,800.00 90.00 160.65

Sales Returns and Allowances .................... GST Payable ($900 × 5%) .............................. PST Payable [($900 + $45) × 8.5%]............... Accounts Receivable .............................

1,025.33

900.00 45.00 80.33

BRIEF EXERCISE B-13 Accounts Receivable .................................... Dental Fees Revenue .............................

250 250

BRIEF EXERCISE B-14 Accounts Receivable .................................... Accounting Fees Revenue .................... GST Payable ($400 × 5%) .......................

420 400 20

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE B-15 GST Payable ................................................... GST Recoverable .................................... Cash .........................................................

4,450

PST Payable ................................................... Cash .........................................................

4,870

900 3,550

4,870

BRIEF EXERCISE B-16 Cash ................................................................ HST Payable ................................................... HST Recoverable ....................................

1,690 2,920 4,610

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE B-1 (a) Province of Manitoba GENERAL JOURNAL Account Titles and Explanation Date March 1

Debit

Credit

Rent Expense ....................................................... 5,500 GST Recoverable ($5,500 × 5%) ......................... 275 Cash ................................................................

5,775

Accounts Receivable—Marvin .......................... 22,400 Sales ............................................................... GST Payable ($20,000 × 5%) ........................ PST Payable ($20,000 × 7%) ........................

20,000 1,000 1,400

Cost of Goods Sold ............................................. 10,600 Merchandise Inventory .................................

10,600

Sales Returns and Allowances .......................... 700 GST Payable ($700 × 5%) ....................................35 PST Payable ($700 × 7%) ....................................49 Accounts Receivable—Marvin ....................

784

Merchandise Inventory ....................................... 14,000 GST Recoverable ($14,000 × 5%)....................... 700 Accounts Payable—Xu ..................................

14,700

Furniture ($600 × 1.07) ........................................ 642 GST Recoverable ($600 × 5%) ............................30 Cash ................................................................

672

GST Payable......................................................... 5,280 GST Recoverable ............................................ Cash ................................................................

1,917 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-1 (Continued) (b)

Province of Alberta

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Credit

March 1 Rent Expense ............................................................... 5,500 GST Recoverable ($5,500 × 5%) ................................. 275 Cash .................................................................... 5,775 3 Accounts Receivable—Marvin ................................... 21,000 Sales ....................................................................20,000 GST Payable ($20,000 × 5%) ............................. 1,000 Cost of Goods Sold ..................................................... 10,600 Merchandise Inventory .....................................10,600 5 Sales Returns and Allowances .................................. 700 GST Payable ($700 × 5%) ............................................ 35 Accounts Receivable—Marvin .........................

735

7 Merchandise Inventory................................................ 14,000 GST Recoverable ($14,000 × 5%) ............................... 700 Accounts Payable—Xu ......................................14,700 12 Furniture ....................................................................... 600 GST Recoverable ($600 × 5%) .................................... 30 Cash .....................................................................

630

31 GST Payable ................................................................. 5,280 GST Recoverable ................................................ 1,917 Cash ..................................................................... 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-1 (Continued) (c)

Province of Prince Edward Island

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

March 1 Rent Expense .................................... GST Recoverable ($5,500 × 5%) ...... Cash .............................................

5,500.00 275.00

3 Accounts Receivable—Marvin ........ Sales ............................................. GST Payable ($20,000 × 5%) ...... PST Payable [($20,000 × 1.05) × 10%] ..............................................

23,100.00

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

10,600.00

5 Sales Returns and Allowances ....... GST Payable ($700 × 5%) ................. PST Payable [($700 × 1.05) × 10%] .. Accounts Receivable—Marvin ..

700.00 35.00 73.50

7 Merchandise Inventory..................... GST Recoverable ($14,000 × 5%) .... Accounts Payable—Xu ...............

14,000.00 700.00

12 Furniture [$600 + $63.00 (1)] ............ GST Recoverable ($600 × 5%) ......... Cash ............................................. (1) ($600 × 1.05) × 10% = $63.00

663.00 30.00

31 GST Payable ...................................... GST Recoverable ........................ Cash .............................................

5,280.00

Credit

5,775.00

20,000.00 1,000.00 2,100.00

10,600.00

808.50

14,700.00

693.00

1,917.00 3,363.00

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-1 (Continued) (d)

Province of Ontario

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

March 1 Rent Expense ..................................... HST Recoverable ($5,500 × 13%) ..... Cash ..............................................

5,500 715

3 Accounts Receivable—Marvin ........ Sales.............................................. HST Payable ($20,000 × 13%) .....

22,600

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

10,600

5 Sales Returns and Allowances ........ HST Payable ($700 × 13%) ................ Accounts Receivable—Marvin ...

700 91

7 Merchandise Inventory ..................... HST Recoverable ($14,000 × 13%) ... Accounts Payable—Xu ................

14,000 1,820

12 Furniture ............................................. HST Recoverable ($600 × 13%) ........ Cash ..............................................

600 78

31 HST Payable ....................................... HST Recoverable ......................... Cash ..............................................

5,280

Credit

6,215

20,000 2,600

10,600

791

15,820

678

1,917 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-2 (a)

Province of Manitoba

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

March 1 Rent Expense ........................................ GST Recoverable ($5,500 × 5%) .......... Cash .................................................

5,500 275

3 Accounts Receivable—Marvin ............ Sales................................................. GST Payable ($20,000 × 5%) .......... PST Payable ($20,000 × 7%) ..........

22,400

5 Sales Returns and Allowances ........... GST Payable ($700 × 5%) ..................... PST Payable ($700 × 7%) ..................... Accounts Receivable—Marvin .....

700 35 49

7 Purchases .............................................. GST Recoverable ($14,000 × 5%) ........ Accounts Payable—Xu ...................

14,000 700

12 Furniture ($600 × 1.07) ......................... GST Recoverable ($600 × 5%) ............. Cash .................................................

642 30

31 GST Payable .......................................... GST Recoverable ............................ Cash .................................................

5,280

Credit

5,725

20,000 1,000 1,400

784

14,700

672

1,917 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-2 (Continued) (b)

Province of Alberta GENERAL JOURNAL Account Titles and Explanation

Date Date March 1 Rent Expense ..................................... GST Recoverable ($5,500 × 5%) ....... Cash ..............................................

Debit

Credit

5,500 275 5,775

3 Accounts Receivable—Marvin ........ Sales.............................................. GST Payable ($20,000 × 5%) .......

21,000

5 Sales Returns and Allowances ........ GST Payable ($700 × 5%) .................. Accounts Receivable—Marvin ...

700 35

7 Purchases ........................................... GST Recoverable ($14,000 × 5%) ..... Accounts Payable—Xu ................

14,000 700

12 Furniture ............................................. GST Recoverable ($600 × 5%) .......... Cash ..............................................

600 30

31 GST Payable ....................................... GST Recoverable ......................... Cash ..............................................

5,280

20,000 1,000

735

14,700

630

1,917 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-2 (Continued) (c)

Province of Prince Edward Island

Date Date

GENERAL JOURNAL Account Titles and Explanation

March 1 Rent Expense ....................................... ............................................................... GST Recoverable ($5,500 × 5%) ......... Cash .................................................

Debit 5,500.00 275.00

5,775.00

3 Accounts Receivable—Marvin ........... 23,100.00 Sales ................................................. GST Payable ($20,000 × 5%) .......... PST Payable [($20,000 × 1.05) × 10%] ............................................. 5 Sales Returns and Allowances ........... GST Payable ($700 × 5%) .................... PST Payable [($700 × 1.05) × 10%] ..... Accounts Receivable—Marvin ....

Credit

20,000.00 1,000.00 2,100.00

700.00 35.00 73.50 808.50

7 Purchases ............................................. 14,000.00 GST Recoverable ($14,000 × 5%) ....... 700.00 Accounts Payable—Xu ................... 12 Furniture ($600 + $63.00 (1)) ............... GST Recoverable ($600 × 5%) ............ Cash ................................................ (1) ($600 × 1.05) × 10% = $63.00

663.00 30.00

31 GST Payable ......................................... GST Recoverable ........................... Cash ................................................

5,280.00

14,700.00

693.00

1,917.00 3,363.00

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-2 (Continued) (d)

Province of Ontario

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

March 1 Rent Expense ..................................... HST Recoverable ($5,500 × 13%) ..... Cash ..............................................

5,500 715

3 Accounts Receivable—Marvin ........ Sales.............................................. HST Payable ($20,000 × 13%) .....

22,600

5 Sales Returns and Allowances ........ HST Payable ($700 × 13%) ................ Accounts Receivable—Marvin ...

700 91

7 Purchases ........................................... HST Recoverable ($14,000 × 13%) ... Accounts Payable—Xu ...............

14,000 1,820

12 Furniture ............................................. HST Recoverable ($600 × 13%) ........ Cash ..............................................

600 78

31 HST Payable ....................................... HST Recoverable ......................... Cash ..............................................

5,280

Credit

6,215

20,000 2,600

791

15,820

678

1,917 3,363

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-3

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

June 8 Office Equipment ($1,500 × 1.07) ............ GST Recoverable ($1,500 × 5%) .............. Accounts Payable ..............................

1,605.00 75.00

10 Office Supplies ($50 × 1.07)..................... GST Recoverable ($50 × 5%) ................... Cash......................................................

53.50 2.50

12 Accounts Receivable ............................... Accounting Fees Revenue ................. GST Payable ($950 × 5%) ................... PST Payable ($950 × 7%) ....................

1,064.00

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

112.00

30 GST Payable .............................................. GST Recoverable ................................ Cash......................................................

1,520.60

30 PST Payable .............................................. Cash......................................................

2,128.84

Credit

1,680.00

56.00

950.00 47.50 66.50

112.00

820.45 700.15

2,128.84

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE B-4

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

June 8 Office Equipment ...................................... HST Recoverable ($1,500 × 13%) ............ Accounts Payable ..............................

1,500.00 195.00

10 Office Supplies ......................................... HST Recoverable ($50 × 13%) ................. Cash......................................................

50.00 6.50

12 Accounts Receivable ............................... Legal Fees Revenue ........................... HST Payable ($950 × 13%) .................

1,073.50

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

113.00

30 HST Payable .............................................. HST Recoverable ................................ Cash......................................................

1,520.60

Credit

1,695.00

56.50

950.00 123.50

113.00

820.45 700.15

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM B-1 (a)

Province of Ontario

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov 2 Merchandise Inventory .............................. HST Recoverable ($1,400 × 13%) ............. Accounts Payable—Fender Supply ...

1,400 182

4 Cash............................................................. Sales ...................................................... HST Payable ($2,200 × 13%) ...............

2,486

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

1,900

5 Accounts Payable—Western Acoustic .... HST Recoverable ($400 × 13%) ........... Merchandise Inventory .........................

452

7 Sales Returns and Allowances ................. HST Payable ($1,100 × 13%) ..................... Cash.......................................................

1,100 143

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

950

8 Store Supplies ............................................ HST Recoverable ($100 × 13%)................. Cash.......................................................

100 13

Credit

1,582

2,200 286

1,900

52 400

1,243

950

113

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-1 (Continued) (a) (Continued)

Date

GENERAL JOURNAL Account Titles and Explanation

Nov. 10 Accounts Receivable—Toronto Reg. Band Sales ...................................................... HST Payable ($2,700 × 13%) ...............

Debit

Credit

3,051 2,700 351

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

1,420

13 Merchandise Inventory .............................. HST Recoverable ($4,200 × 13%) ............. Accounts Payable—Yamaha Canada .

4,200 546

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

3,990

16 Accounts Payable—Yamaha Canada ...... HST Recoverable ($2,100 × 13%) ........ Merchandise Inventory .........................

2,373

20 Accounts Payable—Fender Supply ......... Cash ......................................................

1,582

1,420

4,746

3,990

273 2,100

1,582

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-1 (Continued) (b)

Province of Manitoba

Date Nov

GENERAL JOURNAL Account Titles and Explanation

Debit

2 Merchandise Inventory .............................. GST Recoverable ($1,400 × 5%) ............... Accounts Payable—Fender Supply ...

1,400 70

4 Cash ............................................................. Sales ...................................................... GST Payable ($2,200 × 5%) ................. PST Payable ($2,200 × 7%) ..................

2,464

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

1,900

5 Accounts Payable—Western Acoustic .... GST Recoverable ($400 × 5%) ............. Merchandise Inventory .........................

420

7 Sales Returns and Allowances ................. GST Payable ($1,100 × 5%) ....................... PST Payable ($1,100 × 7%) ........................ Cash .......................................................

1,100 55 77

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

950

8 Store Supplies ($100 × 1.07) ..................... GST Recoverable ($100 × 5%) .................. Cash .......................................................

107 5

Credit

1,470

2,200 110 154

1,900

20 400

1,232

950

112

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-1 (Continued) (b) (Continued)

Date Nov. 10

GENERAL JOURNAL Account Titles and Explanation

Debit

Accounts Receivable—Toronto Reg. Band Sales ...................................................... GST Payable ($2,700 × 5%) ................. PST Payable ($2,700 × 7%) .................

3,024

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

1,420

13 Merchandise Inventory .............................. GST Recoverable ($4,200 × 5%) ............... Accounts Payable—Yamaha Canada .

4,200 210

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

3,990

16 Accounts Payable—Yamaha Canada ...... GST Recoverable ($2,100 × 5%) .......... Merchandise Inventory .........................

2,205

20 Accounts Payable—Fender Supply ......... Cash ......................................................

1,470

Credit

2,700 135 189

1,420

4,410

3,990

105 2,100

1,470

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-2 (a)

Province of Ontario

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. Purchases ................................................... 2 HST Recoverable ($1,400 × 13%) .............. Accounts Payable—Fender Supply ....

1,400 182

4 Cash ............................................................. Sales ...................................................... HST Payable ($2,200 × 13%) ...............

2,486

5 Accounts Payable—Western Acoustic .... HST Recoverable ($400 × 13%) ............ ...................................................................... Purchase Returns and Allowances .....

452

7 Sales Returns and Allowances ................. HST Payable ($1,100 × 13%)...................... Cash .......................................................

1,100 143

8 Store Supplies ............................................ HST Recoverable ($100 × 13%) ................. Cash .......................................................

100 13

10 Accounts Receivable—Toronto Reg. Band Sales ...................................................... HST Payable ($2,700 × 13%) ...............

3,051

13 Purchases ................................................... HST Recoverable ($4,200 × 13%) .............. Accounts Payable—Yamaha Canada .

4,200 546

Credit

1,582

2,200 286

52 400

1,243

113

2,700 351

4,746

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-2 (Continued) (a) (Continued)

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. 14 Cash ............................................................ Accounts Receivable ...........................

3,990

16 Accounts Payable—Yahama Canada ...... HST Recoverable ($2,100 × 13%) ........ Purchase Returns and Allowances.....

2,373

20 Accounts Payable—Fender Supply ......... Cash ......................................................

1,582

Credit

3,990

273 2,100

1,582

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-2 (Continued) (b) Province of Manitoba

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. Purchases ................................................... 2 GST Recoverable ($1,400 × 5%) ............... Accounts Payable—Fender Supply ....

1,400 70

2,464

5 Accounts Payable—Western Acoustic .... GST Recoverable ($400 × 5%) ............. ...................................................................... Purchase Returns and Allowances .....

420

1,100 55 77

8 Store Supplies ($100 × 1.07) ..................... GST Recoverable ($100 × 5%) .................. Cash .......................................................

107 5

10 Accounts Receivable—Toronto Reg. Band Sales ...................................................... GST Payable ($2,700 × 5%) ................. PST Payable ($2,700 × 7%) ..................

3,024

13 Purchases ................................................... GST Recoverable ($4,200 × 5%) ............... Accounts Payable—Yamaha Canada .

4,200 210

Credit

1,470

2,200 110 154

20 400

1,232

112

2,700 135 189

4,410

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-2 (Continued) (b) (Continued)

Date

GENERAL JOURNAL Account Titles and Explanation

Debit

Nov. 14 Cash ............................................................ Accounts Receivable ...........................

3,990

16 Accounts Payable—Yahama Canada ...... GST Recoverable ($2,100 × 5%) .......... Purchase Returns and Allowances.....

2,205

20 Accounts Payable—Fender Supply ......... Cash ......................................................

1,470

Credit

3,990

105 2,100

1,470

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-3 (a)

Nunavut

Date May 1

GENERAL JOURNAL Account Titles and Explanation

Debit

Rent Expense ....................................... Prepaid Rent ......................................... GST Recoverable ($3,600 × 5%) ......... Cash ................................................

1,800 1,800 180

Office Furniture ................................... GST Recoverable ($3,100 × 5%) ......... Accounts Payable—George’s ......

3,100 155

Accounts Payable—George’s ............ GST Recoverable ($400 × 5%) ....... Office Furniture ...............................

420

Cash ...................................................... Legal Fees Revenue ...................... GST Payable ($1,000 × 5%) ...........

1,050

Office Supplies ..................................... GST Recoverable ($300 × 5%) ............ Cash ................................................

300 15

Accounts Receivable—Manson ......... Legal Fees Revenue ...................... GST Payable ($900 × 5%) ..............

945

Accounts Payable—George’s ............ Cash ($3,255 − $420) .....................

2,835

Office Expense ..................................... Cash ................................................

Credit

3,780

3,255

20 400

1,000 50

315

900 45

2,835

15 15

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-3 (Continued) (a) (Continued)

Date May 21

GENERAL JOURNAL Account Titles and Explanation Utilities Expense .............................. Accounts Payable ....................

100

Cash .................................................. Accounts Receivable—Manson

945

Accounts Receivable—Edwards ... Legal Fees Revenue .................. GST Payable ($1,200 × 5%).......

1,260

(b) Transaction Date

GST Recoverable

May 1

$180

May 4

155

May 5

(20)

May 6 May 10

Credit

100

945

1,200 60

GST Payable

$50 15

May 13 May 27

Debit

45 ____

$330

$155

A refund from the Receiver General would be received and Solutions Manual B-24 Appendix B © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

recorded as follows: Cash .................................................. GST Payable ..................................... GST Recoverable .......................

175 155 330

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-3 (Continued) (c)

Province of Ontario

Date May 1

GENERAL JOURNAL Account Titles and Explanation

Debit

Rent Expense ....................................... Prepaid Rent ......................................... HST Recoverable ($3,600 × 13%) ...... Cash ................................................

1,800 1,800 468

Office Furniture ................................... HST Recoverable ($3,100 × 13%) ....... Accounts Payable—George’s ......

3,100 403

Accounts Payable—George’s ............ HST Recoverable ($400 × 13%) ..... Office Furniture ...............................

452

Cash ...................................................... Legal Fees Revenue ...................... HST Payable ($1,000 × 13%) .........

1,130

Office Supplies ..................................... HST Recoverable ($300 × 13%) .......... Cash ................................................

300 39

Accounts Receivable—Manson ......... Legal Fees Revenue ...................... HST Payable ($900 × 13%) ............

1,017

Accounts Payable—George’s ............ Cash ($3,503 − $452) .....................

3,051

Office Expense ..................................... Cash ................................................

Credit

4,068

3,503

52 400

1,000 130

339

900 117

3,051

15 15

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM B-3 (Continued) (c) (Continued)

Date May 21

GENERAL JOURNAL Account Titles and Explanation Utilities Expense .............................. Accounts Payable ....................

100

Cash .................................................. Accounts Receivable—Manson

1,017

Accounts Receivable—Edwards ... Legal Fees Revenue .................. HST Payable ($1,200 × 13%) .....

1,356

(d) Transaction Date

HST Recoverable

May 1

$468

May 4

403

May 5

(52)

May 6 May 10

Credit

100

1,017

1,200 156

HST Payable

$130 39

May 13 May 27

Debit

117 ____

156

$858

$403

A refund from the Receiver General would be received and recorded as follows: Solutions Manual B-27 Appendix B © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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Cash .................................................. HST Payable ..................................... HST Recoverable .......................

455 403 858

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Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

Copyright © 2010 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved. The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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Accounting Principles, Fifth Canadian Edition

APPENDIX C Subsidiary Ledgers and Special Journals SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE C-1 (a)

(b)

Date

Accounts Receivable Subsidiary Ledger

General Ledger

McNeil Co.

Accounts Receivable

Ref.

Jan. 7 17

Debit

Credit Balance

800

Date

Ref.

800 Jan.31 100 31

700

Debit

Credit Balance

16,3001 2

15,200

16,300 1,100

Hanson Inc. Date

Ref.

Jan.15 24

Debit Credit

Balance

6,000

6,000 1,000

5,000 Lewis Co.

Date Jan.23 29 1 2

Ref.

Debit Credit Balance 9,500

9,500 0,000

9,500

$800 + $6,000 + $9,500 = $16,300 $700 + $5,000 + $9,500 = $15,200

BRIEF EXERCISE C-2 1. 2. 3. 4.

General ledger Subsidiary ledger General ledger General ledger

5. 6. 7. 8.

General ledger Subsidiary ledger General ledger General ledger

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE C-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Cash Payments Journal Purchases Journal Cash Payments Journal Sales Journal Cash Payments Journal General Journal Cash Receipts Journal Cash Payments Journal Cash Receipts Journal General 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 (Office 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 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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BRIEF EXERCISE C-5 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 Payments

Other Accounts (Dr.) (Purchases), Cash (Cr.)

Purchases

Purchases (Dr.), Accounts Payable (Cr.)

Cash Payments

Other Accounts (Dr.) (Freight In), Cash (Cr.)

Cash Receipts

Cash (Dr.), Other Accounts (Cr.) (Purchase Returns)

Cash Payments

Other Accounts (Dr.), (Freight Out), Cash (Cr.)

* There are no column titles in the general journal, but these are the account titles that would be used in journalizing.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE C-6 General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Sept. 30 Service Revenue .......................................... Income Summary ..................................

53,800

30 Income Summary. ......................................... Salaries Expense ................................... Rent Expense ......................................... Supplies Expense ..................................

30,900

30 Income Summary .......................................... B. Willis, Capital ....................................

22,900

30 B. Willis, Capital ............................................ B. Willis, Drawings ................................

22,000

Credit 53,800

15,400 12,000 3,500

22,900

22,000

BRIEF EXERCISE C-7 General Journal

Date

Account Titles and Explanations

Ref.

Oct

31 Depreciation Expense ............................... Accumulated Depreciation—Furniture

Debit

Credit

2,500 2,500

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE C-1 1. 2. 3. 4. 5. 6. 7.

General Journal Cash Payments Journal General Journal General Journal Cash Payments Journal Purchases Journal Cash Payments Journal

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

Cash Payments Journal General Journal Cash Receipts Journal Cash Receipts Journal Sales Journal Cash Receipts Journal

EXERCISE C-2 (a) and (b)

SING TAO COMPANY Sales Journal S1 Account Invoice Accounts Receivable Cost of Goods Sold Dr. Date Debited No. Ref. Dr. Merchandise Inventory Sales Cr. Cr. Sept. 2 T. Lu 101  1,520 960 26 M. Christie 102  890 520 (a) and (c) SING TAO COMPANY Purchases Journal Date Account Credited Sept. 10 Lavigne Co.

Terms n/30

Ref. 

P1 Merchandise Inventory Dr. Accounts Payable Cr. 800

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-3 (a) and (b)

SING TAO COMPANY Cash Receipts Journal

Account Credited

Date

Sept. 16 L. Maille 25 T.Lu

Ref.

Accounts Cash Receivable Dr. Cr.

 

800 1,520

(a) and (c)

Ch. No.

Date Sept. 10 18 24 26 30 30 30

Payee

800

Cost of Goods Sold Dr. Other Merchandise Accounts Inventory Cr. Cr. 480

1,520

SING TAO COMPANY Cash Payments Journal Merch. Accounts Cash Inventory Payable Account Cr. Dr. Dr. Debited

Apex Shippers 50 Lavigne Co. 450 Lavigne Co. 600 Freight Co. 75 Employees names 2,800 Sing Tao Berko Co.

Sales Cr.

CR1

800 350

CP1 Other Accounts Ref. Dr.

50 450 600 Freight Out Salaries Expense S. Tao, Drawings

75 2,800 800

350

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-3 (Continued) (a) and (d) SING TAO COMPANY General Journal

Date

Account Titles and Explanations

Ref.

Debit

Sept.

3 Office Supplies ............................................ Accounts Payable—Berko Co. ............

350

11 Accounts Payable—Lavigne Co. ................. Merchandise Inventory .........................

200

12 Office Equipment .......................................... Accounts Payable—Wells Co. ............

8,000

*20 Sales Returns and Allowances ................... Cash ......................................................

800

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

480

Credit 350

200

8,000

800

480

*Note to instructor: Normally a cash payment would be recorded in the cash payments journal. However, the format of the cash payments journal used in this chapter does not have a column to record the credit to Cost of Goods Sold.

EXERCISE C-4 (a) Mar.

2 Equipment ................................................... Accounts Payable—Lifetime Inc. .......

7,400

5 Accounts Payable—Lyden Company ........ Merchandise Inventory .......................

300

7 Sales Returns and Allowances .................. Accounts Receivable—Marco Presti .

400

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

275

7,400 300 400 275

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-4 (Continued) (b) To:

President, Narang Company

From:

Student

Subject:

Posting of Control and Subsidiary Accounts

The posting of 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.

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-5 (a) Debit balance of $340,400. Beginning balance of $320,000 plus $161,400 debit from sales journal less $141,000 credit from cash receipts journal. (b) Credit balance of $95,900. Beginning balance of $87,000 plus $56,400 credit from purchases journal less $47,500 debit from cash payments journal. (c) The column total of $161,400 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 $112,800 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 $141,000 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger.

EXERCISE C-6 (a) and (b) Account Date Debited Sept. 2 T. Lu 26 M. Christie

SING TAO COMPANY Sales Journal S1 Invoice Accounts Receivable Dr. No. Ref. Sales Cr. 101 1,520  102 890 

(a) and (c) SING TAO COMPANY Purchases Journal Date Sept. 10

Account Credited Lavigne Co.

Terms n/30

Ref. 

P1 Purchases Dr. Accounts Payable Cr. 800

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-7 (a) and (b) General Ledger Accounts Receivable Date Sept.

1 30 30 30

Explanation

Ref.

Balance

✓ S1 CR1 J1

Debit

Credit

Balance

7,030 0,190

10,960 15,150 08,120 07,930

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 03,820 04,620 02,320 2,130

Cavanaugh Date Sept.

1 30 30

Explanation

Ref.

Balance

✓ S1 CR1

Debit

Credit

1,100 1,310

Balance 02,060 00,3,160 1,850

Iman Date Sept. 30 30

Explanation

Ref.

Debit

S1 CR1

0,1,030

Credit 3800,

Balance 1,030 650

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-7 (Continued) (a) and (b) (continued) Accounts Receivable Subsidiary Ledger Jana Date Sept.

1 30 30

Explanation

Ref.

Balance

✓ S1 CR1

Debit

Credit

Balance

0,1,240

02,440 00,3,700 2,460

Credit

Balance

1,260

Kingston Date

Explanation

Ref.

Sept. 1 30

Balance

✓ CR1

Debit

1,800

02,640 0840

(c) PIRIE COMPANY Schedule of Customers September 30, 2011 Zhang ................................................................................. Cavanaugh ........................................................................ Iman ................................................................................... Jana ................................................................................... Kingston ............................................................................ Total ...........................................................................

$2,130 1,850 650 2,460 0 840 $7,930

Accounts Receivable (per general ledger account) .......

$7,930

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-8 (a) and (b)

Date Sept. 16 25

Account Credited L. Maille T. Lu

SING TAO COMPANY Cash Receipts Journal Accounts Cash Receivable Ref. Dr. Cr. 800  1,520 1,520 

Sales Cr. 800

CR1 Other Accounts Cr.

(a) and (c) SING TAO COMPANY Cash Payments Journal CP1 Accounts Other Ch. Cash Payable Account Accounts Date No. Payee Cr. Dr. Debited Ref. Dr. Sept. 10 Apex Shippers 50 Freight In 50 18 Lavigne Co. 450 Purchases 450 20 Maille 800 Sales Returns 800 24 Lavigne Co. 600 600 26 Freight Co. 75 Freight Out 75 30 Employees Salaries names 2,800 Expense 2,800 S. Tao, 30 Sing Tao 800 Drawings 800 30 Berko Co. 350 350

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Accounting Principles, Fifth Canadian Edition

EXERCISE C-8 (Continued) (a) and (d) SING TAO COMPANY General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Sept. 3 Office Supplies ............................................. Accounts Payable—Berko Co. .............

350

11 Accounts Payable—Lavigne Co. ................. Purchase Returns and Allowances ......

200

12 Office Equipment .......................................... Accounts Payable—Wells Co. ..............

8,000

Credit 350

200

8,000

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM C-1 (a), (b), and (c) Sales Journal

Date

Account Debited

Jan. 4 Hu 9 Mays Corp. 17 AMB Co. 31 Hu

Invoice No. Ref. 371 372 373 374

Accounts Receivable Dr. Sales Cr.

S1 Cost of Goods Sold Dr. Merchandise Inventory Cr.

06,500 05,600 01,500 09,330 22,930 (112)/(401)

033,900 03,360 900 05,598 13,758 (505)/(120)

✓ ✓ ✓ ✓

Purchases Journal

Date

Account Credited

Jan. 3 Sun Distributors 8 Irvine Co. 11 Chaparal Co. 23 Sun Distributors 24 Levine Corp.

Terms

Ref. ✓ ✓ ✓ ✓ ✓

P1 Merchandise Inventory Dr. Accounts Payable Cr. 9,800 05,400 04,300 07,800 04,690 31,990 (120)/(201)

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-1 (Continued) (a), (b) and (c) (Continued) General Journal Date

Account Titles and Explanations

Jan.

Ref.

Debit

5 Accounts Payable—Sun Distributors.........201/✓ Merchandise Inventory ............................................ 120 19 Equipment .................................................... 157 Accounts Payable—Johnson Corp. ....201/✓

0, 450

Date

Account Credited

Jan. 6 13 15 Mays Corp. 17 Hu 20 27 30 AMB Co.

Ref.

✓ ✓ ✓

Cash Dr. 4,650 5,290 5,600 6,500 3,400 3,370 1,500 30,310 (101)

4,800 CR1

CGS Dr. Merch. Other Inventory Accounts Cr. Cr.

4,650 5,290

2,790 3,174

5,600 6,500

1,500 13,600 (112)

3,400 2,040 3,370 2,022 _ _ 16,710 10,026 (401) (505)/(120)

Cash Payments Journal

Date Jan. 4 13 15 20 31

Ch. No.

Payee

Merch. Accounts Cash Inv. Payable Cr. Dr. Dr.

280 Sun Dist. 9,350 14,300 Irvine Co. 5,400 13,200 42,530 (101)

0, 450

4,800

Cash Receipts Journal Accounts Receivable Sales Cr. Cr.

Credit

Account Debited

CP1 Other Accounts Ref. Dr.

Supplies 126 ✓ 9,350 Sun Dist. Salaries Exp. 726 ✓ 5,400 Irvine Co. Salaries Exp. 726 14,750 (201)

280 14,300 13,200 27,780 (X)

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-2 (a), (b), and (c) Sales Journal Account Debited

Date Oct.

4 Petro Corp. 17 Martin Co. 25 Golden Corp. 30 Martin Co.

Invoice No. Ref. 204 205 206 207

✓ ✓ ✓ ✓

S1 Cost of Goods Accounts Sold Dr. Receivable Dr. Merchandise Sales Cr. Inventory Cr. 08,600 05,530 05,520 0 5,200 24,850 (112)/(401)

05,590 03,595 03,588 0 3,380 16,153 (505)/(120)

Purchases Journal

Date Oct.

Account Credited 2 10 27 30

Madison Co. Quinn Corp. Schmid Co. Madison Co.

Terms

Merchandise Inventory Dr. Ref. Accounts Payable Cr. ✓ ✓ ✓ ✓

5,800 04,900 09,000 16,200 35,900 (120)/(201)

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Accounting Principles, Fifth 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 Martin Co. 28

Date

Payee

Ref. ✓ 140 ✓

Cash Dr.

A/R Cr.

CR1

Sales Cr.

9,610 8,600 8,600 8,810 45,000 8,640 5,530 5,530 9,320 95,510 14,130 (101) (112)

CGS Dr. Other Merch. Inventory Accounts Cr. Cr.

9,610

6,247

8,810

5,727 45,000

8,640

5,616

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. Ref Dr.

Oct. 5 315 9 Madison Co. 5,800 18 2,215 23 Quinn Corp. 4,640 26 45,000 26 30 The Gazette 600 58,570 (101)

Account Debited

Supplies 126 5,800 Madison Co. ✓

315

2,215

✓ 4,640 Quinn Corp. 140 Land 145 Buildings Advertising 610 2,215 10,440 (120) (201)

26,000 19,000 600 45,915 (X)

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-2 (Continued) (a), (b), and (c) (Continued)

General Journal Date

Account Titles and Explanations

J1 Ref.

Debit

Credit

0, Oct. 13 Accounts Payable—Quinn Corp. ................ 201/✓ 260 Merchandise Inventory ............................................ 120

0, 260

25 Supplies ....................................................... 126 Accounts Payable—Frey Co ............... 201/✓

260

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (b) Sales Journal

Date

Account Debited

Jan. 3 24

B. Rohl B. Zerrs

Cost of Goods Sold Dr. Accounts Invoice Receivable Dr. Merchandise No. Ref. Sales Cr. Inventory Cr. ✓ ✓

1,000 7,800 8,800 (112)/(401)

550 3,300 3,850 (505)/(120)

Purchases Journal

Date

Account Credited

Terms

Ref. ✓ ✓

Jan. 5 Warren Parts 17 Lapeska Co.

P1 Merchandise Inventory Dr. Accounts Payable Cr. 2,400 1,900 4,300 (120)/(201)

Cash Receipts Journal

Date

Account Credited

Accounts Cash Receivable Sales Ref. Dr. Cr. Cr.

Jan. 7 S. Armstrong ✓ 3,000 ✓ 13 B. Rohl 1,000 23 8,200 115 35,000 29 Notes Rec. 47,200 (101)

CR1 CGS Dr. Merch. Inv. Cr.

Other Accounts Cr.

3,000 1,000 8,200 4,000 (112)

3,840

8,200 3,840 (401) (505)/(120)

35,000 35,000 (X)

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (b) (Continued) Cash Payments Journal

Date Jan. 11 15 18 27 31

Payee

Cash Cr.

Harms Dist. Employees Warren Parts

350 16,000 3,700 950

M.Gibbs

1,800 22,800 (101)

Merc. Inv. Dr.

Accts. Payable Dr.

CP1 Account Debited

Other Accts. Ref Dr.

350 16,000 Harms Dist. Salaries Exp. 950 Warren Parts M. Gibbs, Drawings 350 16,950 (120) (201)

✓ 725 ✓ 310

General Journal Date

Account Titles and Explanations

1,800 5,500 (X) J1

Ref.

Jan. 14 Sales Returns and Allowances.................... 410 Accounts Receivable—R. Goge........... ✓/112 Loss—Damaged Inventory ........................... Cost of Goods Sold ...............................

3,700

Debit 00, 600

920 505

250

20 Accounts Payable—Watson & Co. .............. ✓/201 Notes Payable ....................................... 200

17,000

30 Accounts Payable—Lapeska Co. ................ ✓/201 Merchandise Inventory ......................... 120

00,600

Credit 00, 600

250

17,000

00,600

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Accounting Principles, Fifth 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

22,800

49,500 96,700 73,900

47,200

Accounts Receivable Date Jan.

1 14 31 31

Explanation

Ref.

Balance

✓ J1 S1 CR1

No. 112 Debit

8,800

Credit

Balance

00,600 0 94,000

15,000 14,400 23,200 19,200

Notes Receivable Date Jan.

1 31

Explanation

Ref.

Balance

✓ CR1

No. 115 Debit

Credit

Balance

35,000

45,000 010,000

Merchandise Inventory Date Jan.

1 30 31 31 31 31

Explanation

Ref.

Balance

✓ J1 S1 P1 CR1 CP1

No. 120 Debit

Credit 600 3,850

4,300 3,840 350

Balance 22,000 21,400 17,550 21,850 18,010 18,360

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued)

Land Date Jan.

No. 140

Explanation

Ref.

Balance

✓

Debit

Credit

025,000

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

Jan. 20

Explanation

Balance 01,500

Notes Payable Date

Balance 06,450

Accumulated Depreciation—Equipment Date

Balance 018,000

Equipment Date

Balance 075,000

Accumulated Depreciation—Building Date

Balance

No. 200 Ref. J1

Debit

Credit

Balance

17,000

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Accounting Principles, Fifth 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

17,000 00,600 04,300 16,950

Mortgage Payable Date Jan.

Date Jan.

Date

No. 275

Ref.

Debit

Balance

✓

82,000

M. Gibbs, Capital

No. 301

Ref.

Balance

✓

94,450

M. Gibbs, Drawings

No. 310

Ref.

Debit

CP1

1,800

Credit

Explanation

Jan. 31 31

Credit

Balance

No. 401 Ref.

Debit

S1 CR1

Explanation

Balance

1,800

Credit

Balance

8,800 8,200

8,800 17,000

Sales Returns and Allowances Jan. 14

Balance

Explanation

Debit

Credit

Sales

Date

42,000 25,000 24,400 28,700 11,750

Explanation

Jan. 31

Date

Balance

Ref.

Debit

0,600

No. 410 Credit

Balance 00,600

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Cost of Goods Sold Date

Explanation

Jan. 14 31 31

Ref. J1 S1 CR1

No. 505 Debit

Credit 250

3,850 3,840

Salaries Expense Date

Explanation

Jan. 31

Jan. 14

Explanation

( (250) 5 3,600 7,440

No. 725

Ref.

Debit

CP1

3,700

Credit

Balance 033,700

Loss—Damaged Inventory Date

Balance

No. 920

Ref.

Debit

Credit

Balance

250

00,250

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Accounting Principles, Fifth 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

3,000

04,500 01,500

Credit

Balance

0,600

03,000 02,400

Credit

Balance

R. Goge Date Jan.

1 14

Explanation

Ref.

Balance

✓ J1

Debit

B. Zerrs Date Jan.

1 24

Explanation

Ref.

Debit

Balance

✓ S1

7,800

Ref.

Debit

S1 CR1

01,000

07,500 15,300

B. Rohl Date Jan.

Explanation 3 13

Credit

Balance

1,000

01,000 00,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (a) and (c) (Continued) Accounts Payable Subsidiary Ledger Fieldstone Corp. Date Jan.

Explanation

Ref.

Balance

✓

Debit

Credit

Balance 9,000

Harms Distributors Date Jan.

1 15

Explanation

Ref.

Debit

Balance

✓ CP1

16,000

Ref.

Debit

Credit

Balance 16,000 00,000

Lapeska Co. Date

Explanation

Jan. 17 30

P1 J1

00,600

Ref.

Debit

Credit

Balance

1,900

01,900 01,300

Credit

Balance

2,400

2,400 1,450

Credit

Balance

Warren Parts Date Jan.

Explanation 5 27

P1 CP1

950

Explanation

Ref.

Debit

Balance

✓ J1

Watson & Co. Date Jan.

1 20

17,000

17,000 00,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (d) GIBBS MUSIC CO. Trial Balance January 31, 2011 Debit Cash ..................................................................... Accounts receivable ........................................... Notes receivable .................................................. Merchandise inventory ....................................... Land ..................................................................... Building ................................................................ Accumulated depreciation—building ................ Equipment............................................................ Accumulated depreciation—equipment ............ Notes payable ...................................................... Accounts payable................................................ Mortgage payable ................................................ M. Gibbs, capital .................................................. M. Gibbs, drawings ............................................. Sales..................................................................... Sales returns and allowances ............................ Cost of goods sold .............................................. Salaries expense ................................................. Loss–damaged inventory ...................................

Credit

$ 73,900 19,200 10,000 18,360 25,000 75,000 $ 18,000 6,450 1,500 17,000 11,750 82,000 94,450 1,800 17,000 600 7,440 3,700 250 $241,700

$241,700

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-3 (Continued) (e) Accounts Receivable Subsidiary Ledger R. Goge ............................................................................. $02,400 B. Zerrs ............................................................................. 15,300 S. Armstrong .................................................................... 0 1,500 $19,200 Accounts Receivable control account balance .....................

Accounts Payable Subsidiary Ledger Lapeska Co. ...................................................................... Fieldstone Corp. ............................................................... Warren Parts. ....................................................................

Accounts Payable control account balance ..........................

$19,200

$01,300 9,000 1,450 $11,750 $11,750

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-4 (b) Sales Journal

Date

Account Debited

May 3

B. Simone

Invoice Ref. No.

Accounts Receivable Dr. Sales Cr.

CGS Dr. Merch. Inv. Cr

2,400 (112)/(401)

1,050 (505)/(120)

✓

Purchases Journal Date

Account Credited

Terms

Merch. Inv. Dr. Ref. Accounts Payable Cr. ✓ ✓

May 5 WN Widgit 17 Lancio Co.

2,600 2,100 4,700 (120)/(201)

General Journal Date

Account Titles and Explanations

J1 Ref.

May 14 Sales Returns and Allowances ................... 410 Accounts Receivable—W. Karasch .... ✓/112 Merchandise Inventory ................................ Cost of Goods Sold .............................

Debit 00, 750

120 505

325

20 Accounts Payable—Cobalt Sports. ............ ✓/201 Notes Payable ...................................... 200

15,500

20 Accounts Payable—Lancio Co. .................. ✓/201 Merchandise Inventory ........................ 120

00,510

Credit 00, 750

325

15,500

00,510

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 CGS 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 Widgit

318 1,500 17,400 4,700 1,000

31 C. Lee

1,000 25,918 (101)

Merch. Accts. Payable Inv. Dr. Dr.

40,000 40,000 (X)

CP1 Account Debited

Other Accts. Ref. Dr.

318

318 (120)

Rent Expense 730 ✓ 17,400 Buttercup Salaries Exp. 725 ✓ 1,000 WN Widgit C. Lee, 310 Drawings 18,400 (201)

1,500 4,700

1,000 7,200 (X)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 00,750 05,200

2,400

Explanation

Ref.

Balance

✓ CR1

May

1 14 20 31 31 31 31

Explanation

Ref.

Balance

✓ J1 J1 P1 S1 CR1 CP1

Balance 15,400 14,650 09,450 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 08,000

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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Equipment Date May

No. 157

Explanation

Ref.

Balance

✓

Debit

Credit

08,200

Accumulated Depreciation—Equipment Date May

Explanation

Ref.

Balance

✓

Debit

No. 158 Credit

Explanation

No. 200 Ref.

May 20

Debit

Credit 15,500

Accounts Payable Date May

1 20 20 31 31

May

Date May 31

Balance 15,500

No. 201

Explanation

Ref.

Balance

✓ J1 J1 P1 CP1

Debit

Credit

15,500 00,510 04,700 18,400

C. Lee, Capital Date

Balance 01,800

Notes Payable Date

Balance

Balance 43,400 27,900 27,390 32,090 13,690

No. 301

Explanation

Ref.

Balance

✓

85,100

C. Lee, Drawings

No. 310

Explanation

Ref. CP1

Debit

Debit 1,000

Credit

Balance

Balance 1,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-4 (Continued) (a) and (c) (Continued) Sales Date

Explanation

May 31 31

No. 401 Ref.

Debit

CR1 S1

Credit 9,500 2,400

Sales Returns and Allowances Date

Explanation

May 14

Ref. J1

Explanation

May 14 31 31

Debit

Credit

0,750

No. 505 Ref. J1 S1 CR1

Explanation

May 31

Debit

Credit 325

1,050 4,450

Ref. CP1

May 31

Explanation

Balance (325) 725 5,175 No. 725

Debit

Credit

4,700

Balance 04,700

Rent Expense Date

Balance 00,750

Salaries Expense Date

09,500 11,900 No. 410

Cost of Goods Sold Date

Balance

No. 730 Ref. CP1

Debit 1,500

Credit

Balance 01,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 07,400

W. Karasch Date May

1 14

Debit

Credit 0,750

Balance 03,250 02,500

G. Parrish Date May

1 7

Explanation

Ref.

Balance

✓ CR1

Debit

Credit 2,800

Balance 04,750 01,950

B. Simone Date May

Explanation 3 13

Ref.

Debit

S1 CR1

02,400

Credit 2,400

Balance 02,400 00,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 00,000

Cobalt Sports Date May

1 20

Credit

Balance 15,500 0 0

Lancio Co. Date

Explanation

May 17 20

P1 J1

00,510

Ref.

Debit

Credit 2,100

Balance 02,100 01,590

WN Widgit Date May

Explanation 5 27

P1 CP1

Credit 2,600

1,000

Balance 2,600 1,600

Winterware Corp. Date May

Explanation

Ref.

Balance

✓

Debit

Credit

Balance 10,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-4 (Continued) (d) LEE CO. Trial Balance May 31, 2011 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 8,200 $ 1,800 15,500 13,690 85,100 1,000 11,900 750 5,175 4,700 1,500 $127,990

Accounts Receivable control account balance ..............

$127,990 $11,850

Accounts Receivable Subsidiary Ledger account balances: L. Cellars .................................................................... $ 7,400 W. Karasch ................................................................ 2,500 G. Parrish ................................................................... 00 1,950 $11,850 Accounts Payable control account balance ................... Accounts Payable Subsidiary Ledger account balances: Lancio Co. .................................................................. WN Widgit .................................................................. Winterware Corp. ......................................................

$13,690

$ 1,590 1,600 10,500 $13,690

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM C-5 (a), (b) and (c) Sales Journal Date

Account Debited

Feb. 4 9 17 28

Gilles Co. Mawani Corp. Lumber Co. Gilles Co.

Invoice No.

Ref.

371 372 373 374

✓ ✓ ✓ ✓

Accounts Receivable Dr. Sales Cr. 07,220 07,050 01,600 9,810 25,680 (112)/(401)

Purchases Journal Date

Account Credited

Feb. 3 8 11 23 24

Zears Co. Fell Electronics Thomas Co. Zears Co. Lewis Co.

Terms

Purchases Dr. Ref. Accounts Payable Cr. ✓ ✓ ✓ ✓ ✓

9,200 05,200 03,100 8,800 5,130 31,430 (510)/(201)

GENERAL JOURNAL Date Feb.

Account Titles and Explanations

J1 Ref.

Debit

Credit

5 Accounts Payable—Zears Co ..................... 201/✓ 450 Purchase Returns and Allowances ......................... 512

450

19 Equipment .................................................... 157 Accounts Payable—Brown Corp. ....... 201/✓

6,400 6,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 Mawani Corp. 17 Gilles Co. 20 27 28 Lumber Co.

Ch. Date No.

Payee

Feb. 4 13 Zears Co. 15 20 Fell Elect. 28 28

CR1

✓ ✓ ✓

3,950 4,850 7,050 7,220 4,900 3,560 1,600 33,130 (101)

3,950 4,850 7,050 7,220 4,900 3,560 1,600 15,870 17,260 (112) (401)

Cash Payments Journal

CP1

Accounts Payable Dr.

Other Accounts Dr.

Cash Cr. 290 8,750 14,700 5,200 14,900 43,840 (101)

Account Debited

Supplies 8,750 Zears Co. Salaries 5,200 Fell Elect. Salaries 13,950 (201)

Ref. 126 ✓ 726 ✓ 726

290 14,700 14,900 29,890 (X)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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. Kysely B. Soto R. Draves B. Jacovetti J. Ebel

Invoice No. Ref. 510 ✓ 511 ✓ 512 ✓ 513 ✓ 514 ✓ 515 ✓ 516 ✓ 517 ✓

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)

Purchases Journal Date Jan. 5 5 16 16 16 27 27 27

Account Credited Terms Ref. Welz Wares ✓ Laux Supplies ✓ Nguyen & Son ✓ Liazuk Co. ✓ Welz Wares ✓ Nguyen & Son ✓ Laux Supplies ✓ Welz Wares ✓

P1 Merchandise Inv Dr. Accounts Payable Cr. 3,000 2,700 15,000 13,900 1,500 14,500 1,200 2,800 54,600 (120)/(201)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a) (Continued) Cash Receipts Journal CR1 Accounts CGS Dr. Other Account Cash Receivable Sales Merch. Inv. Accounts Date Credited Ref. Dr. Cr. Cr. Cr. Dr. Jan. 7 S. Kysely ✓ 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. Kysely ✓ 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 17 23 23 28 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. LeBrun 2,000 400 Nguyen & Son 15,000 Liazuk Co. 13,400 800 6,900 59,680 (101)

Account Debited

CP1 Other Accts. Ref. Dr.

180

180 (120)

✓ 10,000 Liazuk Co. 11,000 Nguyen & Son ✓ A. LeBrun, 310 Drawings Office Supplies 125 15,000 Nguyen & Son ✓ ✓ 13,400 Liazuk Co. Office Supplies 125 725 Salaries Exp. 49,400 (201)

2,000 400

800 6,900 10,100 (X)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (d), and (f)

Date Jan.9

General Journal Account Titles and Explanations

Ref.

Debit

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

Office Supplies Expense ................ Office Supplies ........................ ($1,000 + $400 + $800 − $700)

728 125

1,500

Insurance Expense (1/9 x $2,000) Prepaid Insurance ...................

722 130

222

Depreciation Expense .................... Accumulated Depreciation— Building (1/12 x $6,000).... Accumulated Depreciation— Equipment (1/12 x $1,500)

711

625

J1 Credit

400 160

500

15,000

Adjusting Journal Entries 31

1,500

222

146

500

158

125

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 ...................... Office Supplies Expense ..........

300 410 505 711 718 722 725 728

39,122

Income Summary ............................ A. LeBrun, Capital ...................

300 301

34,598

A. LeBrun, Capital........................... A. LeBrun, 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

73,720 400 29,430 625 45 222 6,900 1,500 34,598 2,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 Adjusting entry J2

Debit

Credit

74,120 59,680

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 49,490 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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Office Supplies Date Jan. 1 31 31 31

Explanation Balance Adjusting entry

Ref. ✓ CP1 CP1 J1

No. 125 Debit

Credit

400 800 1,500

Prepaid Insurance Date Jan. 1 31

Explanation Balance Adjusting entry

Ref. ✓ J1

No. 130 Debit

Credit 222

Land Date Jan. 1

Explanation Balance

Ref. ✓

Balance 1,000 1,400 2,200 700

Debit

Credit

Building

Balance 2,000 1,778 No. 140 Balance 50,000 No. 145

Date Jan. 1

Explanation Balance

Ref. ✓

Debit

Date Jan. 1 31

Accumulated Depreciation—Building Explanation Ref. Debit Balance ✓ Adjusting entry J1

Credit

Credit 500

Balance 100,000 No. 146 Balance 25,000 25,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Equipment Date Jan. 1

Explanation Balance

No. 157 Ref. ✓

Debit

Credit

Accumulated Depreciation—Equipment Date Jan. 1 31

Explanation Balance Adjusting entry

Ref. ✓ J1

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 ✓

Debit

No. 158 Credit 125

Balance 1,500 1,625

Credit 15,000

No. 200 Balance 15,000

Credit

500 15,000 54,600 49,400

Debit

Balance 6,450

Credit 45

Credit

No. 201 Balance 36,000 35,500 20,500 75,100 25,700 No. 230 Balance 45 No. 275 Balance 125,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Income Summary Date Jan. 31 31 31

Explanation Closing entry Closing entry Closing entry

Ref. J2 J2 J2

Date Jan. 1 31 31

A. LeBrun, Capital Explanation Ref. Balance ✓ Closing entry J2 Closing entry J2

Date Jan. 31 31

A. LeBrun, Drawings Explanation Ref. CP1 Closing entry J2

No. 300 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

Explanation

Closing entry

Ref. S1 CR1 J2

Debit

Credit 19,800 53,920

73,720

Sales Returns and Allowances Date Jan. 9 31

Explanation Closing entry

Ref. J1 J2

Debit 400

Balance 73,720 34,598 0 No. 301 Balance 80,000 114,598 112,598 No. 310 Balance 2,000 0 No. 401 Balance 19,800 73,720 0 No. 410

Credit 400

Balance 400 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 Closing entry J2

Debit

Credit 160

7,920 21,568 102 29,430

Depreciation Expense Date Jan. 31 31

Explanation Adjusting entry Closing entry

Ref. J1 J2

Date Jan. 31 31

Interest Expense Explanation Ref. Adjusting entry J2 Closing entry J2

Date Jan. 31 31

Insurance Expense Explanation Ref. Adjusting entry J1 Closing entry J2

No. 711 Debit 625

Credit 625

Debit 45

Credit 45

Debit 222

Credit 222

Salaries Expense Date Jan. 31 31

Date Jan. 31 31

Explanation Closing entry

Ref. CP1 J2

No. 505 Balance (160) 7,760 29,328 29,430 0

Balance 625 0 No. 718 Balance 45 0 No. 722 Balance 222 0 No. 725

Debit 6,900

Office Supplies Expense Explanation Ref. Debit Adjusting entry J1 1,500 Closing entry J2

Credit 6,900

Credit 1,500

Balance 6,900 0 No. 728 Balance 1,500 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Accounts Receivable Subsidiary Ledger R. Draves Date Jan. 1 11 22

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. Kysely Date Explanation Jan. 1 Balance 7 11 21

Ref. ✓ CR1 S1 CR1

Debit

Ref. S1 S1 CR1

Debit 3,100 1,700

J. Ebel Date Jan. 3 9 25 31

Explanation Balance

Explanation

Credit

Balance 1,500 3,400 4,200

Credit

Balance 1,800 1,400 7,500 0

1,900 800

400 6,100 7,500

Credit 2,000

3,500

Credit 5,000

900 900

Balance 7,500 5,500 9,000

Balance 5,000 0 900 0

B. Soto Date Jan. 3 22 31

Explanation

Credit

4,800

Balance 3,100 4,800 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) and (f) (Continued) Accounts Payable Subsidiary Ledger Laux Supplies Date Jan. 5 27

Explanation

Ref. P1 P1

Debit

Credit 2,700 1,200

Balance 2,700 3,900

Liazuk Co. Date Explanation Jan. 1 Balance 9 16 18 23

Ref. ✓ CP1 P1 J1 CP1

Debit

Credit

Balance 10,000 0 13,900 13,400 0

Mikush Bros. Date Explanation Jan. 1 Balance 21

Ref. ✓ J1

Nguyen & Son Date Explanation Jan. 1 Balance 9 16 23 27

Ref. ✓ CP1 P1 CP1 P1

Welz Wares Date Explanation Jan. 5 16 27

Ref. P1 P1 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

Debit

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (c) and (d)

LEBRUN COMPANY Trial Balance January 31, 2011

Unadjusted Adjusted Debit Credit Debit Credit Cash ................................................................ $ 49,490 $ 49,490 Accounts receivable ....................................... 13,200 13,200 Notes receivable ............................................. 39,000 39,000 Merchandise inventory................................... 44,952 44,850 Office supplies ................................................ 2,200 700 Prepaid insurance .......................................... 2,000 1,778 Land................................................................. 50,000 50,000 Building ........................................................... 100,000 100,000 Accumulated depreciation— building ....................................................... $ 25,000 $ 25,500 Equipment ....................................................... 6,450 6,450 Accumulated depreciation— equipment................................................... 1,500 1,625 Notes payable ................................................. 15,000 15,000 Accounts payable ........................................... 25,700 25,700 Interest payable .............................................. 45 Mortgage payable ........................................... 125,000 125,000 A. LeBrun, capital ........................................... 80,000 80,000 A. LeBrun, drawings ....................................... 2,000 2,000 Sales ................................................................ 73,720 73,720 Sales returns & allowances 400 400 Cost of goods sold ......................................... 29,328 29,430 Depreciation expense..................................... 625 Interest expense ............................................. 45 Salaries expense ............................................ 6,900 6,900 Insurance expense ......................................... 222 Office supplies expense................................. 1,500 Totals .......................................................... $345,920 $345,920 $346,590 $346,590

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 $ 3,900 14,500 7,300 $25,700

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (e) LEBRUN COMPANY Statement of Earnings Month Ended January 31, 2011 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.............................................. Office 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

LEBRUN COMPANY Statement of Owner’s Equity Month Ended January 31, 2011 A. LeBrun, capital, January 1 ................................................. Add: Profit ............................................................................. Less: Drawings ...................................................................... A. LeBrun, capital, January 31 ...............................................

$ 80,000 34,598 114,598 2,000 $112,598

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CUMULATIVE COVERAGE (Continued) (e) (Continued) LEBRUN COMPANY Balance Sheet January 31, 2011 Assets Current assets Cash ............................................................ Notes receivable......................................... Accounts receivable .................................. Merchandise inventory .............................. Office 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 ..............................

$ 49,490 39,000 13,200 44,850 700 1,778 149,018 $50,000 74,500 4,825

129,325 $278,343

Liabilities and Owner’s Equity Current liabilities Notes payable ............................................. Accounts payable ...................................... Interest payable .......................................... Total current liabilities .......................

$ 15,000 25,700 45 40,745

Long-term liabilities Mortgage payable ....................................... Total liabilities.....................................

125,000 165,745

Owner’s equity A. LeBrun, capital ....................................... Total liabilities and owner’s equity....

112,598 $278,343

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CUMULATIVE COVERAGE (Continued) (g) LEBRUN COMPANY Post-Closing Trial Balance January 31, 2011 Cash ................................................................ Accounts receivable ...................................... Notes receivable ............................................ Merchandise inventory .................................. Office supplies ............................................... Prepaid insurance .......................................... Land ................................................................ Building .......................................................... Accumulated depreciation—building ........... Equipment ...................................................... Accumulated depreciation—equipment ....... Notes payable................................................. Accounts payable .......................................... Interest payable.............................................. Mortgage payable .......................................... A. LeBrun, capital .......................................... Totals .........................................................

Debit $ 49,490 13,200 39,000 44,850 700 1,778 50,000 100,000

Credit

$ 25,500 6,450

0 $305,468

1,625 15,000 25,700 45 125,000 112,598 $305,468

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Present Value Concepts Solutions to Brief Exercises BEPV–1 (a) $ 5.00

($100 × 5%)

(b) $60.00

($500 × 6% × 2 periods)

($500 × 6%) + ($530 × 6%)

BEPV–2

Discount rate from Table PV-1 is 0.82193 (5 periods at 4%). The present value of $500,000 to be received in 5 years discounted at 4% is therefore $410,965 ($500,000 × 0.82193). Smolinski Company should therefore invest $410,965 to have $500,000 in five years.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–3

Discount rate from Table PV-1 is 0.82193 (5 periods at 4%). The future value of $8,000 invested today (present value) for a period of 5 years discounted at 4% is $9,733.19 ($8,000 ÷ 0.82193). Liam should receive $9,733.19 when the GIC matures in 5 years.

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). Liam should receive $11,842.03 when the GIC matures in 10 years. The interest earned in the first 5 years ($1,733.19) is based on an initial investment of $8,000. The interest earned in the second 5 years ($2,108.84) is based on an initial investment of $9,733.19 calculated earlier.

BEPV–4

Present value = Future amount × Present value of 1 Factor $44,401 = $100,000 × 0.44401

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

The 0.44401 at 7% is found in the 12 years column. Janet Bryden therefore must wait 12 years to receive $100,000.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–5

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 Kerry Dahl will earn an 8% return.

BEPV–6

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). Kilarny Company should pay $242,806.25 for this annuity contract.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–7 Annual Number Interest of Frequency Rate Years of Payment 1. 8% 3 Quarterly Semi2. 5% 4 annually 3. 7% 5 Annually 4. 4% 3 Quarterly Semi5. 6% 6 annually 6. 6% 15 Monthly

(n) Number of (i) Discount Periods Rate 3 × 4 = 12 8% ÷ 4 = 2% 4×2=8 5 3 × 4 = 12

5% ÷ 2 = 2.5% 7% 4% ÷ 4 = 1%

6 × 2 = 12 15 × 12 = 180

6% ÷ 2 = 3% 6% ÷ 12 = .5%

BEPV–8

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BEPV–9 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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–10

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

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BEPV–11

Present value of principal to be received at maturity: $50,000 × 0.66634 (PV of $1 due in 6 periods at 7% from Table PV-1) ..................................................... $ 33,317.00 Present value of interest to be received periodically over the term of the note: $4,000 × 4.76654 (PV of $1 due each period for 6 periods at 7% from Table PV-2) .......................................................................

19,066.16

Present value of note received .......................................

$52,383.16

BEPV–12

Discount rate from Table PV-2 is 9.38507. The present value of 12 payments of $112,825 each discounted at 4% is therefore $1,058,871 ($112,825 × 9.38507). Hung-Chao Yu Company should receive $1,058,871 from the issue of the note.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–13

The principal component of the total payments of $20,000 ($4,000 × 5) is the present value of the annuity, discounted at a rate of 4%. Present value of payments (From Table PV-2): $4,000 × 4.45182

$17,807.28

The total payment of $20,000 is allocated as follows: Principal Interest ($20,000 - $17,807.28) Total

$17,807.28 2,192.72 $20,000.00

BEPV–14 From Table PV-2, n = 5, i = 8%, the present value for a $1 payment annually is $3.99271. In this problem, we want to determine the payment that would result in a present value of $30,000. The required payment would be $7,513.69 ($30,000 ÷ 3.99271).

BEPV–15 From Table PV-2, the present value of an annuity stream of $6,000 per year, for 5 years at 8% is: $6,000 × 3.99271 = $23,956.26 If the price of the car you would like to purchase is $30,000, then you need to receive a $6,043.74 trade in value for your existing vehicle. Solutions Manual PV-9 Appendix PV © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–16

The best option for repayment of this piece of equipment is the single payment of $46,000 in 2 years.

BEPV–17

The same option would not be chosen; the best 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.

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BEPV–18

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). Barney Googal 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.

BEPV–19

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

$110,330.45

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition

BEPV–20 The present value of an annuity collected of $18,000 for 15 years at 9% is calculated as follows: $18,000 × 8.06069 = $145,092.42 Discount rate from Table PV-2

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The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 1 Accounting in Action ASSIGNMENT CLASSIFICATION TABLE Study Objectives 1. Identify the use and users of accounting.

Questions 1, 2, 3, 4, 5

Brief Exercises 1, 2, 3

Exercises 1, 3, 4

Problems Set A 1, 2

Problems Set B 1, 2

2. Explain Canadian accounting standards and apply basic accounting concepts.

6, 7, 8, 9, 10

4, 5

2, 3, 5

3, 11

3. Use the accounting equation and explain the meaning of assets, liabilities, and owner’s equity.

11, 12, 13, 14

6, 7, 8, 9, 12, 13

3, 4, 5, 6, 7, 12

4, 5, 6, 11

4, 5, 6

4. Analyze the effects of business transactions on the accounting equation.

15, 16, 17, 18

10, 11

5, 8, 9, 10, 11

4, 5, 7, 8

5. Prepare financial statements.

19, 20, 21, 22

12, 13, 14, 15, 16, 17, 18

5, 12, 13, 14, 15, 16

6, 7, 8, 9, 10, 11

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Identify financial statements for decision-making.

Simple

15-20

Determine forms of business organization.

Simple

15-20

Assess accounting treatment.

Moderate

20-25

Determine missing items.

Moderate

25-35

Analyze transactions and calculate owner’s equity.

Simple

35-45

Classify accounts and prepare accounting equation. Analyze transactions and prepare balance sheet.

Simple

20-30

Simple

40-50

Moderate

40-50

Analyze transactions and prepare financial statements. Prepare financial statements.

Simple

35-45

10A

Determine missing amounts and comment.

Moderate

35-45

11A

Discuss errors and prepare corrected balance sheet.

Moderate

45-55

Identify financial statements for decision-making.

Simple

15-20

Determine forms of business organization.

Simple

15-20

Assess accounting treatment.

Moderate

20-25

Determine missing items.

Moderate

25-35

Analyze transactions and calculate owner’s equity.

Simple

35-45

Classify accounts and prepare accounting equation. Analyze transactions and prepare balance sheet.

Simple

20-30

Simple

40-50

Moderate

40-50

Analyze transactions and prepare financial statements. Prepare financial statements.

Simple

35-45

10B

Determine missing amounts and comment.

Moderate

35-45

11B

Discuss errors and prepare corrected balance sheet.

Moderate

45-55

7A 8A

7B 8B

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objective 1. Identify the use and users of accounting.

Knowledge BE1-1 E1-3

2. Explain Canadian accounting standards and apply basic accounting concepts.

Q1-9 E1-3

3. Use the accounting equation and explain the meaning of assets, liabilities, and owner’s equity.

Q1-11 Q1-12 Q1-13 Q1-14 E1-3

4. Analyze the effects of business transactions on the accounting equation.

Comprehension Q1-1 Q1-2 Q1-3 Q1-4 Q1-5 BE1-3 E1-1 E1-4 Q1-6 Q1-7 Q1-8 Q1-10 BE1-4 BE1-5 E1-2 P1-3A P1-3B BE1-12 E1-4 E1-12

Q1-15 Q1-16 E1-8

Application P1-2A P1-2B

Analysis BE1-2

Synthesis P1-1A P1-1B

Evaluation

E1-5 P1-11A P1-11B

BE1-6 BE1-7 BE1-8 BE1-9 BE1-13 E1-5 E1-6 E1-7 P1-4A P1-5A P1-6A P1-11A P1-4B P1-5B P1-6B Q1-17 Q1-18 BE1-10 BE1-11 E1-5 E1-9 E1-10 E1-11 P1-4A P1-5A P1-7A P1-8A P1-4B P1-5B P1-7B P1-8B

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Study Objective 5. Prepare financial statements.

Knowledge

Comprehension Q1-19 Q1-20 Q1-21 Q1-22 BE1-12 BE1-14 E1-12

Broadening Your Perspective

BYP1-1

Continuing Cookie Chronicle

Application BE1-13 BE1-15 BE1-16 BE1-17 BE1-18 E1-5 E1-13 E1-14 E1-15 E1-16 P1-6A P1-7A P1-8A P1-9A P1-11A P1-6B P1-7B P1-8B P1-9B P1-11B BYP1-3

Analysis P1-10A P1-10B

Synthesis

BYP1-4

BYP1-2 BYP1-5 BYP1-6

Evaluation

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ANSWERS TO QUESTIONS 1.

Yes. Accounting is the financial information system that provides useful financial information to every person who owns and uses economic resources or otherwise engages in economic activity.

Understanding the basics of accounting is helpful for everyone. Studying accounting allows you to learn how the world of business actually works. Learning how to read and interpret financial information will provide you with a valuable set of skills.

(a)

Internal users are those who plan, organize, and run businesses and include managers, supervisors, directors, and company officers. External users work for other organizations but have reasons to be interested in the company’s financial position and performance, and include investors (owners), and creditors.

(b)

To assist internal users, accounting provides internal reports. Examples include financial comparisons of operating alternatives, projections of revenues and expenses from new sales campaigns, and forecasts of cash needs for the next year. Investors use the financial accounting information to evaluate a company’s performance. They would look for answers to questions such as “Is the company earning satisfactory profit?” They want to monitor return on investment. Creditors use financial accounting information to evaluate a company’s credit risk. They would look for answers to questions such as “Can the company pay its debts as they come due?”

Ethics is a fundamental business concept. If accountants do not have a high ethical standard the information they produce will not have any credibility. Ethics are important to statement users because they provide them comfort that the financial information they are using is truthful, or else it will have no value to them.

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QUESTIONS (Continued) 5.

A proprietorship is a private business with one owner who has unlimited liability for the business. The proprietorship has a limited life tied to the life of the owner. Proprietorships do not pay tax, the owners do.

A partnership has essentially the same characteristics as a proprietorship except that in a partnership, there is more than one owner. A partnership need not be a private business, although it usually is.

For corporations, the owners are one or more shareholders who enjoy limited liability. The corporation pays income taxes and can have an indefinite live since its ownership units, in the form of shares, are easily transferred to other owners. Public corporations issue publicly traded shares. That is, their shares are listed on Canadian or other stock exchanges.

Private corporations have essentially the same characteristics as public corporations except that they do not issue publicly traded shares.

The users of financial information on public companies have different needs than the users of financial information on private companies. Public corporations need the opportunity to present financial information using accounting rules that are consistent with those used globally. To do this, public companies need to follow International Financial Reporting Standards (IFRS). Doing so helps Canadian companies compete in a global market. But following this set of policies and standards is often not essential or cost effective for privately owned businesses. The users of private company financial statements often do not require the extensive measurements and disclosures required by IFRS. Companies are required to disclose which Generally Accepted Accounting Principles (GAAP) they are following in the notes to their financial statements. Thus users should read the notes in order to determine which generally accepted accounting principles a business has followed.

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QUESTIONS (Continued) 7.

The going concern assumption assumes that a business will remain in operation long enough to realize the value of its assets. Although it need not be explicitly stated, the business is assumed to be a going concern when financial statements are issued. If, on the other hand, a business is not regarded as a going concern or if there are significant doubts about the business’ ability to continue as a going concern, then this must be stated in the notes to the financial statements along with the reason why the business is not regarded as a going concern.

The going concern assumption supports recording assets at their cost because the intent is to use the assets for their intended purpose and to complete the company’s commitments. If the assets will be used, as opposed to being sold, the fair values of the assets are not particularly relevant.

The economic entity assumption states that economic events can be identified with a particular unit of accountability. This assumption requires that the activities of the entity be kept separate and distinct from the activities of its owners and all other economic entities.

10.

The monetary unit assumption requires that only transaction data capable of being expressed in terms of money can be included in the accounting records of the economic entity. As a result, information that cannot be objectively measured in dollars cannot be included. For example, a skilled manager may add value to a company, but since that skill cannot be objectively measured in dollars, it is not included as an asset of the company. Another important part of the monetary unit assumption is that the unit of measure remains sufficiently constant over time. In other words, inflation is ignored.

11.

The basic accounting equation is Assets = Liabilities + Owner's Equity. The expanded accounting equation is Assets = Liabilities + Owner's Capital − Owner’s Drawings + Revenue − Expenses.

12.

(a)

(b)

Assets are economic resources, owned by a business, that are capable of providing future services or benefits. Liabilities are current obligations, arising from past events, to make future payments of assets or services. Put more simply, liabilities are existing debts and obligations. Owner's equity is the ownership claim on the assets. Revenues and investments by the owner increase owner's equity. Drawings and expenses decrease owner’s equity.

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QUESTIONS (Continued) 13.

Accounts Receivable represent amounts owed to the business by its customers for services performed, but for which collection has not yet been received. Accounts Payable represent amounts owed by the business for services or goods received, but for which payment has not yet been made. In contrast to Accounts Payable, Notes Payable are written promises to pay specific amounts, at specific due dates, and generally involve the payment of interest to compensate for a delay in payment.

14.

A proprietorship’s equity is termed “owner’s equity”. The owner’s capital account is increased by an owner’s investments and the profit generated by the business. Owner’s capital account is decreased by an owner’s drawings and losses incurred by the business. Withdrawals by the owner are called drawings.

A partnership is accounted for essentially the same way as a proprietorship except that in a partnership, there is more than one owner and therefore any profit is divided among the owners to increase their individual capital accounts. Similarly, each owner has his own drawings account. The sum of all of the partners’ capital accounts equals the total “partners’ equity” in the business.

In the corporate form of business organization, the owners are the shareholders and the equity is termed “shareholders’ equity.” Shareholders’ equity is separated into two components: share capital and retained earnings. The investments by the shareholders (owners) are added to the share capital account. Profits are added to the retained earnings account, which represents the accumulated earnings (net profits) of the company that have not been distributed to shareholders. Withdrawals by the shareholders decrease retained earnings and are called “dividends”.

15.

Business transactions are the economic events of the enterprise and are recorded if they affect the elements (assets, liabilities, and/or owners’ equity) in the basic accounting equation. (a) (b) (c) (d)

The death of the owner of the company is not a business transaction, as it does not affect the elements in the basic accounting equation. Supplies purchased on account is a business transaction, because it affects elements in the basic accounting equation (+A; +L). A terminated employee is not a business transaction, as it does not affect the elements in the basic accounting equation. Winning the award is not a business transaction, as it does not affect the elements in the basic accounting equation.

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QUESTIONS (Continued) 16.

Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset, such as when equipment is purchased for cash (resulting in an increase in the equipment account which is offset by a decrease in the cash account).

17.

(a) (b) (c) (d) (e)

Decrease assets (cash) and decrease owner's equity (due to the expense incurred). Increase assets (equipment) and increase liabilities (note payable). Decrease assets (cash) and decrease owner's equity (from the owner’s withdrawal). Increased assets (account receivable) and increase owner’s equity (revenue). Increase assets (cash) and decrease assets (account receivable).

18.

No, this treatment is not proper. While the transaction does involve a disbursement of cash, it does not represent an expense. Expenses are decreases in owner's equity resulting from business activities entered into for the purpose of earning profit. This transaction is a withdrawal of capital from the business by the owner and should be recorded as a decrease in both cash and owner’s equity.

19.

Yes. Profit does appear on the income statement—it is the result of subtracting expenses from revenues. In addition, profit appears in the statement of owner's equity—it is shown as an addition to the beginningof-period capital. Indirectly, the profit of a company is also included in the balance sheet, as it is included in the capital account, which appears in the owner's equity section of the balance sheet.

20.

(a) The income statement reports profit for the period. The profit figure from the income statement is shown on the statement of owner’s equity as an addition to beginning capital. If there is a loss it is deducted from the opening capital account balance. (b) The statement of owner’s equity explains the change in the owner’s capital account balance from one period to the next. The ending capital account balance is reported on the balance sheet. (c) The cash flow statement explains the change in the cash balance from one period to the next. The ending balance of cash is reported on the balance sheet.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 21.

It is likely that the use of rounded figures would not change the decisions made by the users of the financial statements. As well, presenting the information in this manner make the statements easier to read and analyze thereby increasing their usefulness to the users.

22.

Financial statement users often compare the current year’s results with prior years to see if there is improvement. For example, they may compare sales this year with sales last year. If the year-end is not a fixed date the results could be affected because one period may be slightly longer than the other.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 User Owner Marketing manager Creditor Chief financial officer Labour union

(a) Kind of Decision 4 3 2 5 1

(b) Internal or External User Internal Internal External Internal External

BRIEF EXERCISE 1-2 1. 2.

3. 4. 5.

The student is provided with the opportunity to cheat on an exam. A production supervisor might become aware of a defect in a company’s product that is ready to ship but his/her bonus is based on volume of shipments. A salesperson might be provided with the opportunity to not report cash sales and pocket the cash instead. A banker is able to approve a loan for unqualified family member. The prime minister of Canada interferes in a political inquiry of a political ally.

BRIEF EXERCISE 1-3 (a) (b) (c)

P C PP

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BRIEF EXERCISE 1-4 (a) (b) (c) (d) (e) (f)

T F F F T T

BRIEF EXERCISE 1-5 (a) (b) (c) (d) (e)

5. 4. 3. 1. 2.

Monetary unit assumption Cost principle Economic entity assumption Generally accepted accounting principles Going concern assumption

BRIEF EXERCISE 1-6 (a)

$95,000 − $54,000 = $41,000 (Owner's Equity)

(b) $120,000 + $71,000 = $191,000 (Assets) (c)

$49,000 − $22,000 = $27,000 (Liabilities)

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BRIEF EXERCISE 1-7 (a)

$220,000 + $100,000 − $40,000 + $440,000 − $330,000 = $390,000 (Total assets)

(b) $80,000 − ($30,000 − $7,000 + $55,000 − $45,000) = $47,000 (Total liabilities) (c)

$800,000 − ($800,000 × ¼) = $600,000 (Owner's equity)

BRIEF EXERCISE 1-8 Assets = Liabilities + Owner’s Equity $750,000 = $500,000 + X Owner’s Equity = Assets − Liabilities $250,000 = $750,000 − $500,000 (a)

($750,000 + $120,000) − ($500,000 − $90,000) = $460,000 (Owner's equity)

(b) ($500,000 − $85,000) + ($250,000 − $50,000 + $100,000) = $715,000 (Assets) (c)

($750,000 + $90,000) − ($250,000 + $175,000 − $60,000) = $475,000 (Liabilities)

(d) ($750,000 + $25,000) − ($500,000 − $50,000) = $325,000 ending balance Owner’s equity + $40,000 − $250,000 = $115,000 Profit

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BRIEF EXERCISE 1-9 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

A L OE A A A OE L OE OE OE L

Cash Accounts Payable Drawings Accounts Receivable Supplies Equipment E. Johnston, drawings Salaries payable Service revenue E. Johnston, capital Rent expense Note payable

BRIEF EXERCISE 1-10 Transaction Assets 1. +$250 2. +500 3. -300 4. -250 5. +1,000 6. -400 7. NE +500 / 8. -500

Liabilities +$250 NE NE -250 NE NE NE

Capital NE NE NE NE +$1,000 NE NE

Owner's Equity Drawings Revenues NE NE NE +$500 NE NE NE NE NE NE -$400 NE NE NE NE

Expenses NE NE -$300 NE NE NE NE NE

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BRIEF EXERCISE 1-11 E R I E NE R R E D NE

(a) Cost incurred for advertising (b) Commission earnings (c) Equipment received from company owner (d) Amounts paid to employees (e) Cash paid to purchase equipment (f) Services performed on account (g) Rent received (h) Utilities incurred (i) Cash distributed to company owner (j) Collection of an account receivable

BRIEF EXERCISE 1-12 1. Accounts receivable 2. Wages payable 3. Wage expense 4. Office supplies 5. Supplies expense 6. K. Sen, capital (opening balance) 7. K. Sen, capital (ending balance) 8. Service revenue 9. Equipment 10. Note payable 11. Cash 12. K. Sen, drawings

(a) A L OE A OE OE OE OE A L A OE

(b) BS BS IS BS IS OE OE/BS IS BS BS BS OE

BRIEF EXERCISE 1-13 (a) (b) (c) (d)

$63,000 − $25,000 − $50,000 = drawings $12,000 $53,000 + $25,000 − $63,000 = profit $15,000 $53,000 Ending balance 2011 $53,000 + $20,000 + 17,000 − $12,000 = $78,000

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BRIEF EXERCISE 1-14 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)

BS BS IS BS BS IS IS BS BS IS IS

Accounts receivable Inventory Interest expense Share capital Equipment Stampede revenue Agricultural activities revenue Accounts payable and accrued liabilities Cash and short-term deposits Administration, marketing, and park services expenses Food and beverage revenue

BRIEF EXERCISE 1-15 Beginning capital + Investments + Profit (or − Loss) − Drawings = Ending capital (a)

Ending capital balance Beginning capital balance Profit

(b) Ending capital balance Beginning capital balance Increase in capital Deduct: Portion of increase arising from investment Profit (c)

Ending capital balance Beginning capital balance Increase in capital Deduct: Portion of increase arising from investment Add: Portion of decrease arising from withdrawal Profit

$150,000 125,000 $ 25,000 $150,000 125,000 25,000 0

(5,000) $ 20,000 $150,000 125,000 25,000 (10,000) 7,000 $ 22,000

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BRIEF EXERCISE 1-16 PORTAGE COMPANY Income Statement Month Ended August 31, 2011 Revenues Service revenue ............................................... Expenses Advertising expense ........................................ $1,200 Rent expense ................................................... 1,300 Total expenses ............................................ Profit......................................................................

$11,000

2,500 $8,500

BRIEF EXERCISE 1-17 PORTAGE COMPANY Statement of Owner's Equity Month Ended August 31, 2011 N. Hudson, Capital, August 1 .............................. Add: Profit ......................................................... Less: Drawings .................................................... N. Hudson, Capital, August 31 ............................

$26,000 8,500 34,500 3,000 $31,500

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BRIEF EXERCISE 1-18 PORTAGE COMPANY Balance Sheet August 31, 2011 Assets Cash .................................................................................. $ 49,000 Accounts receivable ........................................................ 72,500 Total assets ............................................................... $121,500 Liabilities and Owner's Equity Liabilities Accounts payable ..................................................... $ 90,000 Owner's equity N. Hudson, capital .................................................... 31,500 Total liabilities and owner's equity .................. $121,500

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SOLUTIONS TO EXERCISES EXERCISE 1-1 (a)

Chief Financial Officer − Does Roots Canada Ltd. generate enough cash to expand its product line? Human Resource Manager – What is Roots Canada Ltd.’s annual salary expense?

(b) Creditor – Does Roots Canada have enough cash available to make its monthly debt payments? Investor – How much did Roots Canada pay in dividends last year?

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EXERCISE 1-2 (a) and (b) (a)

This accounting treatment is incorrect, as it violates the cost principle. Land was reported at its market value, when it should have been recorded and reported at cost.

(b) This accounting treatment is correct. Although a commitment for future payments is put into place when the lease is signed, an exchange has not yet taken place and so there are no transactions that need to be recorded. At this time, all that is required concerning this lease is to disclose the details of the commitment in the notes to the financial statements. (c)

This accounting treatment is incorrect, as it violates the economic entity assumption. An owner’s personal transactions should be kept separate from those of the business. Instead of being charged as an expense to the business, the transaction should be recorded as drawings taken by the owner.

(d) This accounting treatment is incorrect, as it violates the monetary unit assumption. An important part of the monetary unit assumption is the stability of the monetary unit (the dollar) over time. Inflation is considered a nonissue for accounting purposes in Canada and is ignored. (e)

This accounting treatment is partially correct. It is assumed that a company is a going concern, unless the notes state otherwise. Consequently, the statement in the notes that the company is a going concern need not be added. On the other hand, the company is required to make the disclosure that it is following GAAP for Private Enterprises.

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EXERCISE 1-3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

7 8 1 9 10 3 6 4 5 2

Corporation Generally accepted accounting principles (GAAP) Accounts payable Accounts receivable Owner’s equity Creditor Assets International Financial Reporting Standards (IFRS) Profit Expenses

EXERCISE 1-4

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

Proprietorship

Partnership

Corporation

F T F F F F F T F

F T T F F F T T F

T F F T T T F F T

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-5 (a)

($ in U.S. millions) L A A A A A L A L SE SE

Accounts payable Accounts receivable Cash Inventories Investments Land, buildings, and equipment Notes payable Other assets Other liabilities Retained earnings Share capital

$ 1,031.9 2,883.9 2,291.1 2,357.0 1,164.0 1,957.7 812.1 2,595.9 2,712.5 5,451.4 3,241.7

(b) Assets = Liabilities + Shareholders’ Equity $2,883.9 + $2,291.1 + $2,357.0 + $1,164.0 + $1,957.7 + $2,595.9 = ($1,031.9 + $812.1 + $2,712.5) + ($5,451.4 + $3,241.7) $13,249.6 = $4,556.5 + $8,693.1

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EXERCISE 1-6 (a)

Total assets (beginning of year)............................. Total liabilities (beginning of year) ......................... Total owner's equity (beginning of year) ...............

$85,000 62,000 $23,000

(b) Total assets (end of year) ....................................... $110,000 Total owner's equity (end of year).......................... 60,000 Total liabilities (end of year) ................................... $ 50,000 (c)

Total owner's equity (end of year).......................... Total owner's equity (beginning of year) ............... Increase in owner's equity ......................................

$60,000 23,000 $37,000

Total revenues ......................................................... $175,000 Total expenses ......................................................... 140,000 Profit ......................................................................... $ 35,000 Increase in owner's equity ...................................... Less: Profit .............................................. ................ Add: Drawings ......................................................... Investments by owner .............................................

$37,000 (35,000) 18,000 $20,000

(d) Total assets (beginning of year)............................ Total owner's equity (beginning of year) .............. Total liabilities (beginning of year) ........................

$134,000 52,000 $ 82,000

(e)

$61,000 44,000 $105,000

Total liabilities (end of year) ................................. Total owner's equity (end of year) ........................ Total assets (end of year)......................................

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EXERCISE 1-6 (Continued) (f)

Total owner's equity (end of year).......................... Total owner's equity (beginning of year) ............... Decrease in owner's equity ....................................

$44,000 52,000 $(8,000)

Total revenues ......................................................... $99,000 Total expenses ........................................................ 48,000 Profit......................................................................... $ 51,000 Decrease in owner's equity .................................... Add: Profit............................................................... Investments ................................................... Drawings ..................................................................

$ 8,000 51,000 0 $59,000

(g) Total liabilities (beginning of year) ....................... Total owner's equity (beginning of year) .............. Total assets (beginning of year)............................

$ 30,000 33,000 $63,000

(h) Total assets (end of year) ...................................... Total liabilities (end of year) .................................. Total owner's equity (end of year).........................

$79,000 42,000 $37,000

(i)

Total owner's equity (end of year)......................... Total owner's equity (beginning of year) .............. Increase in owner's equity .....................................

$37,000 33,000 $ 4,000

Increase in owner's equity ..................................... Less: Investments .................................. $(5,000) Plus: Drawings....................................... 25,000 Profit........................................................................

$4,000 20,000 $24,000

Profit........................................................................ Less: Total revenues.............................................. Total expenses .......................................................

$24,000 85,000 $61,000

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EXERCISE 1-7 (a)

Owner's equity—12/31/09 ($350,000 − $200,000) .. $150,000 Owner's equity—1/1/09 ........................................... 0 0 Increase in owner's equity ...................................... 150,000 Less: Owner’s investment ...................................... 100,000 50,000 Add: Drawings ........................................................ 60,000 Profit for 2009 .......................................................... $110,000

(b) Owner's equity—12/31/10 ($420,000 − $265,000) .. $155,000 Owner's equity—12/31/09—see (a)......................... 150,000 Increase in owner’s equity..................................... 5,000 Less: Owner’s investment ...................................... 50,000 Loss for 2010 ........................................................... $(45,000) (c)

Owner's equity—12/31/11 ($510,000 − $330,000) .. $180,000 Owner's equity—12/31/10—see (b) ........................ 0 155,000 Increase in owner's equity ...................................... 25,000 Less: Owner’s investment ...................................... (10,000) Add: Drawings ......................................................... 40,000 Profit for 2011 .......................................................... $ 55,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-8 1.

Purchase inventory on credit. Increases an asset (inventory) and increases a liability (accounts payable).

Investment made by owner. Increases an asset (cash) and increases owner’s equity (owner’s capital).

Payment of accounts payable. Decreases an asset (cash) and decreases a liability (accounts payable).

Withdrawal of cash by the owner. Decreases an asset (cash) and decreases owner’s equity (drawings).

Record wages due to employees. Increases a liability (wages payable) and decreases owner’s equity (expense).

Collect an accounts receivable. Increases one asset (cash) and decreases another asset (accounts receivable).

Note: These are examples. There are other correct responses.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-9 Assets

Trans. Cash 1 +$15,000 2 -600 3 -1,000 4 -500 5 6 -1,000 7 +1,500 8 9 +1,000 10 -300 Total

$14,100

+ Accounts Rec.

= + Supplies

+ Equipment

+ Accounts Payable

+$5,000

+ Notes Payable

Owner's Equity

+ + R.Holland R. Holland Revenues Expe Capital Drawings +$15,000

+$4,000

+$500 +$2,500

+$2,500 -$1,000

-1,500 +500 +1,000 -300 +$1,000 +$500 +$5,000 $20,600 =

Solutions Manual

Liabilities

+$200

+$4,000

+$15,000

-$1,000

$20,600

Chapter 1

+$3,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-10 Assets

+ + Accounts EquipTrans. Cash Rec. ment Bal. $8,000 $20,000 1 -2,000 +19,000 2 +5,000 -5,000 3 -4,000 4 -2,000 5 +3,000 6 -1,000 7 +10,000 8 -1,100 9 10 Total $15,900 + $15,000 +$19,000 $49,900 =

Solutions Manual

Liabilities + Accounts Payable $3,000

+ Note Payable

Owner's Equity + + B.Paterson B.Paterson Revenues Expenses Capital Drawings $25,000

+17,000 -4,000 -2,000 +3,000 -1,000 +10,000 -1,000

-100

+2,000 +$3,000 +$16,000

-2,000 -$7,100

+ $35,000

+$3,000

$ 49,900

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EXERCISE 1-11 (a)

Owner invested $10,000 cash and office equipment with the fair value of $5,000 in the business. 2. Purchased office equipment for $5,000, paying $2,000 in cash with the balance of $3,000 on account. 3. Purchased supplies $750 on account. 4. Earned $6,100 in fees, receiving $2,700 cash with the remaining $3,400 on account. 5. Paid $1,500 cash on accounts payable. 6. B. Bnita withdrew $2,200 cash for personal use. 7. Paid $750 cash for rent. 8. Collected $1,450 cash from customers on account. 9. Paid salaries of $2,900. 10. Incurred $550 of utilities expense on account.

(b) Investment ................................................................. $15,000 Fees earned................................................................ 6,100 Drawings .................................................................... (2,200) Rent expense ............................................................. (750) Salaries expense........................................................ (2,900) Utilities expense ........................................................ (550) Increase in owner’s equity ........................................ $ 14,700 (c)

Fees earned ............................................................... Rent expense ............................................................. Salaries expense........................................................ Utilities expense ........................................................ Profit...........................................................................

$6,100 (750) (2,900) (550) $1,900

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

Accounts payable Accounts receivable Cash Dental equipment Furniture and fixtures Interest payable Interest revenue Interest expense Investment by the owner Orthodontist fees earned P. Zizler, capital (opening balance) P. Zizler, drawings Salaries expense Supplies Supplies expense

(a) L A A A A L OE OE OE OE

(b) BS BS BS BS BS BS IS IS OE IS

OE OE OE A OE

OE OE IS BS IS

EXERCISE 1-13 BNITA & CO. Income Statement Month Ended August 31, 2011 Revenues Fees earned...................................................... Expenses Salaries expense.............................................. $2,900 Rent expense ................................................... 750 Utilities expense .............................................. 550 Total expenses ............................................ Profit......................................................................

$6,100

4,200 $1,900

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EXERCISE 1-13 (Continued) BNITA & CO. Statement of Owner's Equity Month Ended August 31, 2011 B. Bnita, Capital, August 1................................... Add: Investments .............................................. $15,000 Profit .......................................................... 1,900 Less: Drawings .................................................... B. Bnita, Capital, August 31 .................................

$00,000 16,900 16,900 2,200 $14,700

BNITA & CO. Balance Sheet August 31, 2011 Assets Cash .................................................................................. Accounts receivable ........................................................ Supplies ............................................................................ Office equipment .............................................................. Total assets ...............................................................

$ 4,800 1,950 750 10,000 $17,500

Liabilities and Owner's Equity Liabilities Accounts payable ..................................................... Owner's equity B. Bnita, Capital ........................................................ Total liabilities and owner's equity ..................

$02,800 14,700 $17,500

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EXERCISE 1-14 ATLANTIC CRUISE CO. Income Statement Year Ended July 31, 2011 Revenues Ticket revenue ............................................ $355,000 Expenses Salaries expense......................................... $128,000 Maintenance expense ................................. 83,000 Food, fuel and other operating expenses . 65,500 Interest expense ......................................... 20,000 Advertising expense ................................... 3,500 Total expenses ....................................... 300,000 Profit................................................................. $ 55,000

ATLANTIC CRUISE CO. Statement of Owner's Equity Year Ended July 31, 2011 I. Sail, Capital, August 1 .................................. Add: Investments .......................................... Profit ..................................................... Less: Drawings ............................................... I. Sail, Capital, July 31 .....................................

$279,000 $5,000 55,000

60,000 339,000 35,000 $304,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-15 ATLANTIC CRUISE CO. Balance Sheet July 31, 2011 Assets Cash ....................................................................... Accounts receivable ............................................. Supplies ................................................................. Equipment.............................................................. Ships ...................................................................... Total assets .......................................................

$ 27,000 42,000 15,000 120,000 550,000 $754,000

Liabilities and Owner's Equity Liabilities Notes payable ................................................... Accounts payable ............................................. Total liabilities .............................................. Owner's equity I. Sail, Capital .................................................... Total liabilities and owner's equity .............

$400,000 50,000 450,000 304,000 $754,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 1-16 (a)

Revenues − camping fees........................................ $160,000 Revenues − general store ........................................ 40,000 Total revenue ..................................................... 200,000 Operating expenses ................................................. 150,000 Profit .......................................................................... $ 50,000

(b) J. Cumby, Capital, January 1 ................................... Add: Profit .............................................................. Less: J. Cumby, Drawings ...................................... J. Cumby, Capital, December 31 .............................

$17,000 50,000 67,000 5,000 $62,000

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EXERCISE 1-16 (Continued) (c) DEER PARK Balance Sheet December 31, 2011 Assets Cash ........................................................................... $010,000 Accounts receivable ................................................. 21,000 Supplies ..................................................................... 2,500 Equipment.................................................................. 110,000 Total assets ........................................................... $143,500 Liabilities and Owner's Equity Liabilities Notes payable ....................................................... $070,000 Accounts payable ................................................. 11,500 Total liabilities .................................................. 81,500 Owner's equity J. Cumby, Capital .................................................. 62,000 Total liabilities and owner's equity ................. $143,500

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SOLUTIONS TO PROBLEMS PROBLEM 1-1A 1.

In deciding to extend credit to a new customer, South Face Co. would focus its attention on the balance sheet of its new customer. The terms of credit they are extending require collection in a short period of time. Funds used to pay South Face would come from cash on hand. The balance sheet will show if the new customer has enough cash to meet its obligations.

When purchasing a business, the information that will be most relevant to the investor will be on the income statement. The income statement reports the past performance of the business in terms of its revenue, expenses and profit. This is the best indicator of the company’s future potential and return on the investment.

In order to determine if Tech Toy Limited is generating enough cash to increase the amount of dividends paid to shareholders and still have enough cash to buy additional equipment, the president should examine the cash flow statement. The cash flow statement would indicate where cash is coming from and what it is being used for. This, in conjunction with other statements such as the balance sheet and income statement, would help the president predict future cash inflows and outflows.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-1A (Continued) 4.

In deciding whether to extend a loan, the Caisse d’Économie Base Montréal is interested in two things—the ability of the company to make interest payments on an annual basis for the next five years and the ability to repay the principal amount at the end of five years. In order to evaluate both of these factors, the focus should be on the cash flow statement. This statement provides information on the cash the company generates from its operations on an ongoing basis. This will be the most important factor in determining if the company will survive and be able to repay the loan.

Taking It Further: When making decisions based on the financial statements of a business, users need to rely on the accuracy of the financial statements. To ensure this reliability, the individual preparing the financial statements must adhere to the highest standards of ethical behaviour to ensure that the decision maker is not hurt by false or misleading financial information.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-2A 1.

Dawn will likely operate her vegetable stand as a proprietorship because she is planning on operating it for a short time period and a proprietorship is the simplest and least costly business organization to form and dissolve.

Joseph and Sabra should form a corporation when they combine their operations. This is the best form of business for them to choose because they plan to raise funds in the coming year. It is easier to raise funds in a corporation. A corporation may also receive more favourable income tax treatment.

The professors should incorporate their business because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to its owners.

Abdur would likely form a corporation because he needs to raise funds to invest in inventories and property, plant, and equipment. He has no savings or personal assets and it is normally easier to raise funds through a corporation than through a proprietorship or partnership.

A partnership would be the most likely form of business for Mary, Richard and Jigme to choose. A partnership is simpler to form than a corporation and less costly.

Taking It Further: The advantages of starting a business as a proprietorship and later incorporating the business include: the ease of formation, simplicity and reduced costs. As the business grows and the additional costs and administration that are required of corporations are justified, incorporating the business provides additional advantages.

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PROBLEM 1-3A 1. (a)

This accounting treatment is incorrect as people involved with the organization are not an asset of the business to be placed on the balance sheet. (b) The entries to record people as assets should be removed from the accounting records.

2. (a)

This accounting treatment is incorrect as it violates the cost principle. The equipment should be recorded at the amount paid on purchase of $75,000. (b) The entry to increase the carrying value of the equipment from $75,000 to $100,000 should be removed from the accounting records of Barton Co.

3. (a)

This accounting treatment is incorrect as it violates the economic entity assumption. The computer is a personal asset, and not an asset of the business. (b) The entry to record the purchase of the computer should be removed from the accounting records. Instead this should be recorded as a drawing by Steph Wolfson.

4. (a)

West Spirit Oil Corp. does not have a choice in adopting IFRS because it is a publicly traded corporation. (b) The 2011 financial statements must be prepared in accordance with the International Financial Reporting Standards. The accountant’s treatment is correct as the business can no longer be assumed to be a going concern. (b) No change required.

5. (a)

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-3A (Continued) Taking It Further: It is important for private and public companies to follow generally accepted accounting principles (GAAP) because a common set of standards, applied by all businesses and entities, provides financial statements which are reasonably comparable. Without a common set of standards, each enterprise could, develop its own theory structure and set of practices, resulting in noncomparability among enterprises, to the detriment of financial statement users.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4A (a)

Total assets (Jan. 1, 2010) ...................................... Total liabilities (Jan. 1, 2010) .................................. Total owner's equity (Jan. 1, 2010) .........................

$40,000 0 $40,000

(b) Total liabilities (Dec. 31, 2010) ................................ $45,000 Total owner's equity (Dec. 31, 2010) (c) below ...... 65,000 Total assets (Dec. 31, 2010) .................................... $110,000 (c)

Total owner's equity (Dec. 31, 2010) ...................... Equal to owner's equity (Jan. 1, 2011) given

$65,000

(d) Total owner's equity (Dec. 31, 2010) ...................... Total owner's equity (Jan. 1, 2010)......................... Increase in owner's equity ......................................

$65,000 40,000 $25,000

Increase in owner's equity ...................................... Less: Investments ................................................... Add: Drawings ......................................................... Profit .........................................................................

$25,000 (9,000) 12,000 $28,000

(e)

Total revenues ......................................................... $125,000 Less: Profit ............................................................... (28,000) Total expenses ......................................................... $ 97,000

(f)

Total liabilities (Jan. 1, 2011) .................................. $45,000 Total owner's equity (Jan. 1, 2011)......................... 65,000 Total assets (Jan. 1, 2011) ...................................... $110,000 Also same as (b) above

(g) Total assets (Dec. 31, 2011) ................................... Total owner's equity (Dec. 31, 2011)...................... Total liabilities (Dec. 31, 2011) ...............................

$140,000 75,000 $ 65,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4A (Continued) (h) Total owner's equity (Dec. 31, 2011) ...................... Total owner's equity (Jan. 1, 2011)......................... Increase in owner's equity ......................................

$75,000 65,000 $10,000

Increase in owner's equity ...................................... Less: Profit ............................................. $40,000 Investments ................................... 0 Drawings ..................................................................

$10,000 40,000 $30,000

(i)

Profit......................................................................... $40,000 Total expenses ........................................................ 105,000 Total revenues ......................................................... $145,000

(j)

Total assets (Jan. 1, 2012) ........................................ $140,000 Equal to total assets (Dec. 31, 2011) given

(k)

Total liabilities (Jan. 1, 2012) .................................... $65,000 Equal to total liabilities (Dec. 31, 2011) (g) above

(l)

Total owner's equity (Jan. 1, 2012)........................... $75,000 Equal to total owner's equity (Dec. 31, 2011) given

(m) Total assets (Dec. 31, 2012) ................................... Total liabilities (Dec. 31, 2012) ............................... Total owner's equity (Dec. 31, 2012) .....................

$155,000 85,000 $70,000

(n) Total owner's equity (Dec. 31, 2012) ..................... Total owner's equity (Jan. 1, 2012)........................ Decrease in owner's equity ...................................

$70,000 75,000 $ 5,000

Decrease in owner's equity ................................... Add: Profit (o) below .............................. . $29,000 Less: Drawings....................................... (36,000) Investments ............................................................

$5,000 (7,000) $2,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4A (Continued) (o) Total revenues ........................................................ Less: Total expenses ............................................. Profit........................................................................

$155,000 126,000 $29,000

Taking It Further: In order to decide if an owner is able to withdraw cash from the business, the owner needs to find out if his capital account is sufficiently high to cover the drawings charge. He also needs to know that there is cash available in business to make the withdrawal.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-5A (a)

LOKEN TRAVEL AGENCY

Account Accounts Office s Note A. Loken, A. Loken, Cash + Receivable + Supplies + Equipment = Payable + Payable + Capital - Drawings + Revenues - Expenses Apr 1 +$12,000 +$12,000 2 −1,100 −$1,100 2 −2,000 +$7,500 +$5,500 7 +$300 −300 8 −725 +$725 11 +1,000 +$8,000 +$9,000 17 −300 −300 25 −500 −$500 30 −3,500 −3,500 30 +400 −400 30 +5,000 −5,000 00 0 0 00 0 0 000 0 000000 00 0 00000 00000 $9,875 + $ 3,000 + $725 + $7,500 = $400 + $5,500 + $12,000 $500 + $9,000 $5,300

$21,100 = $21,100

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Chapter 1

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-5A (Continued) (b) Capital Investment .................................................... $12,000 Less: Drawings ......................................................... 500 11,500 Add: Revenue .......................................................... 9,000 Less: Expenses ........................................................ (5,300) A. Loken, Capital, April 30 ........................................ $15,200 Taking It Further: Cash received from customers for services to be performed in a future accounting period should be recorded as a liability (Unearned Revenue) not as revenue. The company has not earned the revenue when they receive the cash. Instead, they have an obligation to perform services in the future, which is a liability.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-6A

(a) and (b) ($ in thousands) 1. L 2. A 3. E 4. E 5. R 6. A 7. C 8. D 9. E 10. E 11. L 12. A 13. E 14. L 15. R 16. R 17. A 18. E 19. A

(c)

BS BS IS IS IS BS OE OE IS IS BS BS IS BS IS IS BS IS BS

Accounts payable Accounts receivable Aircraft fuel expense Airport fee expense Cargo revenues Cash C. Chung, capital, January 1 C. Chung, drawings Interest expense Maintenance expense Notes payable Other assets Other expenses Other liabilities Other revenue Passenger revenues Property and equipment Salaries expense Spare parts and supplies

$ 1,197 547 432 309 161 632 1,160 14 75 78 2,536 1,270 650 1,436 230 1,681 3,561 596 237

($ in thousands) Assets = Liabilities + Owner’s Equity ($547 + $632 + $1,270 + $3,561 + $237) = ($1,197 + $2,536 + $1,436) + ($1,160 − $14 − $432 − $309 + $161 − $75 − $78 − $650 + $230 + $1,681 − $596) $6,247 = $5,169 + $1,078

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-6A (Continued) Taking It Further: It is important for Capital Aviation to keep track of its different types of revenues to ensure that management is able to get the necessary information to make decisions concerning where improvements in performance can be made. As well, separate revenues can be compared with their related expenses to determine the amount of profit from the different sources of revenue activity for Capital Aviation.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 1-7A (a)

ANITA LETOURNEAU, LAWYER Assets

+ Transaction 1

Cash

Liabilities

+ Comp. Equip-

+ Office Furni-

Acc.

+ Office Sup-

Acc.

Note

Rec.

plies

ment

ture

Payable Payable

Owner's Equity

+ A. LeTourneau

A. LeTourneau

Capital

Drawings

+ Revenues

Expenses

2 3

+$40,000

4 5

-1,000

-$1,000

6 7

-8,000

+$8,000

8 9

+$500 -2,000

+$6,500

+$4,500

+$3,000

-500

-300

Total

+500 +$3,000 -500 -300

$28,200 $3,000

$500

$6,500

$8,000

$200

$4,500

$40,000

$3,000

$46,200 = $46,200

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-$1,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-7A (Continued) (a) (Continued) Notes: Items 1 (March 4), 2 (March 7), and 4 (March 14) are not relevant to the business entity. They are personal transactions. Item 6 (March 20) is not recorded, because the transaction has not yet been completed. There is no expense, nor liability, until he begins working. (b)

Profit = Revenues − Expenses = ($3,000 − $1,500) = $1,500 Owner’s Equity = Investment − Drawings + Profit = ($40,000 − $0 + $1,500) = $41,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-7A (Continued) (c) ANITA LETOURNEAU, LAWYER Balance Sheet March 31, 2011 Assets Cash .......................................................................... Accounts receivable ................................................ Office supplies ......................................................... Computer equipment ............................................... Office furniture .........................................................

$28,200 3,000 500 6,500 8,000

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

$46,200

Liabilities and Owner's Equity Note payable ............................................................. Accounts payable..................................................... Total liabilities ......................................................

$ 4,500 200 4,700

Owner’s Equity A. LeTourneau, Capital ........................................

41,500

Total liabilities and owner's equity .....................

$46,200

Taking It Further: A good rule of thumb to determine whether or not a transaction should be recorded, is to test if an exchange has taken place. Only when the event represents an exchange should a transaction be recorded. As well, personal transactions must be excluded, to comply with the economic entity assumption.

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PROBLEM 1-8A (a)

Bal Aug. 4 5 7 12 15 15 15 18 20 26 29 30

TONY TIBERIO, BARRISTER & SOLICITOR Accounts Office Notes Accounts T. Tiberio, T.Tiberio Cash + Receivable + Supplies + Equipment = Payable + Payable + Capital - Drawings + Revenues - Expenses $4,000 + $1,900 + $500 + $5,000 = $5,500 + $5,900 +1,200 −1,200 +3,000 +3,500 +$6,500 −2,100 −2,100 −400 +1,600 +1,200 -3,500 -$3,500 -1,100 -1,100 -275 -275 +700 -700 −500 -$500 +2,000 +2,000 +275 -275 00000 +1,000 0000 00000 00000 00000 000 00 0000 +1,000 00000 $3,025 + $4,500 + $500 + $6,600 = $2,000 +$4,875 + $5,900 $500 + $7,500 $5,150

$14,625 = $14,625 Note that the August 28 transaction is not recorded, because the work will not commence until September.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-8A (Continued) (b) TONY TIBERIO, BARRISTER & SOLICITOR Income Statement Month Ended August 31, 2011 Revenues Fees earned .............................................................. $7,500 Expenses Salaries expense.......................................... $3,500 Rent expense ............................................... 1,100 Advertising expense .................................... 275 Utilities expense .......................................... 275 Total expenses .................................................... 5,150 Profit.............................................................................. $2,350 TONY TIBERIO, BARRISTER & SOLICITOR Statement of Owner's Equity Month Ended August 31, 2011 T. Tiberio, Capital, August 1 ........................................ $5,900 Add: Profit .................................................................. 2,350 8,250 Less: Drawings ............................................................ 500 T. Tiberio, Capital, August 31 ...................................... $7,750

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-8A (Continued) (b) (Continued) TONY TIBERIO, BARRISTER & SOLICITOR Balance Sheet August 31, 2011 Assets Cash ........................................................................... Accounts receivable ................................................. Supplies on hand ...................................................... Office equipment .......................................................

$ 3,025 4,500 500 6,600

Total assets ........................................................... $14,625 Liabilities and Owner's Equity Liabilities Notes payable ....................................................... Accounts payable ................................................. Total liabilities ..................................................

$ 2,000 4,875 6,875

Owner's Equity T. Tiberio, Capital ..................................................

7,750

Total liabilities and owner's equity ................. $14,625 Taking It Further: When an item is purchased on account, payment usually must be made in 30 days. If a note payable is used, payment will be delayed until the maturity date of the note, which is typically longer than 30 days. Although this will likely mean that interest will also have to be paid, the cash remains in the business longer than if the item had been purchased on account.

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PROBLEM 1-9A BENNETT’S HOME RENOVATIONS Income Statement Year Ended December 31, 2011 Revenues Renovation fee revenue ............................................. $154,700 Expenses Interest expense .......................................... Insurance expense ...................................... Office supplies expense .............................. Salaries expense.......................................... Truck operating expense ............................ Total expenses ........................................

$ 1,190 3,375 2,975 87,430 19,545

Profit.................................................................................

114,515 $ 40,185

BENNETT’S HOME RENOVATIONS Statement of Owner's Equity Year Ended December 31, 2011 J. Bennett, Capital, January 1 .......................................... $54,350 Add: Profit ....................................................................... 40,185 94,535 Less: J. Bennett, Drawings .............................................. 44,800 J. Bennett, Capital, December 31 ..................................... $49,735

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-9A (Continued) BENNETT’S HOME RENOVATIONS Balance Sheet December 31, 2011

Assets Cash ................................................................................... Accounts receivable ......................................................... Office supplies .................................................................. Truck .................................................................................. Equipment..........................................................................

$ 7,700 10,080 595 42,000 29,400

Total assets ................................................................... $89,775 Liabilities and Owner's Equity Liabilities Notes payable ............................................................... $30,800 Accounts payable ......................................................... 9,240 Total liabilities .......................................................... 40,040 Owner's equity J. Bennett, Capital ........................................................

49,735

Total liabilities and owner's equity ......................... $89,775 Taking It Further: In order to prepare the statement of owner’s equity, you need to have the amount of the profit or loss for the year. This is why the income statement is prepared first. The statement of owner’s equity is prepared next in order to have the ending capital balance for the balance sheet.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-10A $85,000 (from ii) − $10,000 − $15,000 − $45,000 = $15,000 (ii) Total liabilities and owner’s equity = $85,000 (iii) $45,000 − $18,500 = $26,500 (iv) $85,000 − $45,000 = $40,000 (v) $64,000 − $30,000 − $28,000 = $6,000 (vi) $75,000 − $64,000 = $11,000 (vii) $40,000 − $14,000 − $11,000 (from viii) = $15,000 (viii) $11,000 from income statement (from vi) (ix) $40,000 − $40,000 (from x) = $0 (x) $40,000 from the balance sheet (from iv)

(a) (i)

(b) In preparing the financial statements, the first statement to be prepared is the income statement. The profit figure is used in the statement of owner’s equity to calculate the ending balance of capital. The balance sheet is then completed using the balance of capital as calculated in the statement of owner’s equity. Taking It Further: The balance sheet, which is sometimes referred to as the statement of financial position, reports balances at a point in time, at the end of a reporting period. The income statement on the other hand, reports the results of revenue and expense business transactions for a period of time, whether it is a month, a quarter or a fiscal year. The statement of owner’s equity also reports for the period of time, those items that have increased or decreased capital. Consequently, the income statement and the statement of owner’s equity are for the period of time ending at a specific date and the balance sheet is at that specific date.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-11A (a) 1. The land should be recorded at cost of $36,000 until it is sold. The increase in value is not recognized until the land is sold. (cost principle) 2.

The accounts receivable should be recorded in Canadian dollars not in yuan (monetary unit assumption). Accounts receivable are assets and not liabilities. The entry in the liabilities for accounts receivable of $37,000 must be removed and appear instead under assets at the corrected balance of $7,000 Canadian.

Equipment and furnishings are assets and not liabilities. The entry in the liabilities for equipment and furnishings of $58,000 must be removed and appear instead under assets. Supplies are also assets, not liabilities. This item will also have to be removed from the liabilities and added to assets.

Note payable is a liability and not an asset. The company has an obligation to pay the note in the future. The entry in the assets for notes payable must be removed from assets and instead should appear under liabilities.

C. Cai, capital is an equity account, and not an asset. His investment in the company is an asset to him, but for the company it is equity (economic entity assumption). The entry in the assets for C. Cai, capital should be removed and instead appear under owner’s equity section of the balance sheet.

The ‘plug’ figure needs to be removed. The accounting equation states that Assets = Liabilities + Owner’s Equity. Cai needs to make the corrections above in order to determine the Owner’s Equity balance.

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(b) CONFUCIUS BOOK SHOP Balance Sheet April 30, 2011 Assets Cash ................................................................................ $ 10,000 Accounts receivable ($5,000 + $2,000) .......................... 7,000 Supplies ........................................................................... 4,000 Land ................................................................................. 36,000 Equipment and furnishings ............................................ 58,000 Building ............................................................................ 110,000 Total assets ................................................................. $225,000 Liabilities and Owner's Equity Liabilities Notes payable ............................................................. $120,000 Accounts payable ....................................................... 15,000 Total liabilities ........................................................ 135,000 Owner's equity: C. Cai, capital ..............................................................

90,000

Total liabilities and owner's equity ....................... $225,000 Taking It Further: All transactions affect a minimum of two financial statement items because all transactions involve exchanges. For example, when cash is decreased the reason why the cash is decreased is also recorded. Thus an increase in another asset, or a decrease in a liability or owner’s equity, must also be recorded.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-1B 1.

In deciding to extend credit to a new customer, Backroads Company would focus its attention on the balance sheet of its new customer. The terms of credit they are extending require collection in a short period of time. Funds used to pay Backroads would come from cash on hand. The balance sheet will show if the new customer has enough cash to meet its obligations.

To determine if the Private Label Enterprises has enough cash to expand the business and at the same time increase the partners’ drawings, the senior partner would need to focus his attention on the cash flow statement. The cash flow statement would indicate where cash is coming from and what it is being used for. This, in conjunction with other statements such as the balance sheet and income statement, would help the senior partner predict future cash inflows and outflows.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-1B (Continued) 4.

In deciding whether to extend a loan, the Laurentian Bank is interested in two things—the ability of the company to make interest payments on an annual basis for the next three years and the ability to repay the principal amount at the end of three years. In order to evaluate both of these factors, the focus should be on the cash flow statement. This statement provides information on the cash the company generates from its operations on an ongoing basis. This will be the most important factor in determining if the company will survive and be able to repay the loan.

Taking It Further: When making decisions based on the financial statements of a business, users need to rely on the accuracy of the financial statements. To ensure this reliability, the individual preparing the financial statements must adhere to the highest standards of ethical behaviour so that the decision maker is not hurt by false or misleading financial information.

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PROBLEM 1-2B 1.

The professors should incorporate their business because of their concerns about legal liabilities. A corporation is the only form of business that provides limited liability to its owners.

Joseph should run his bait shop as a proprietorship because this is the simplest and least costly form of business organization to establish and eventually dissolve. He is the only person involved in the business and is planning to operate for a limited time.

Robert and Tom should form a corporation when they combine their operations. This is the best form of business for them to choose because they expect to raise funds in the coming year and it is easier to raise funds in a corporation. A corporation may also receive more favourable income tax treatment.

A partnership would be the most likely form of business for Darcy, Ellen and Meg to choose. It is simpler to form than a corporation and less costly.

Hervé is most likely to select to operate his business as a corporation. He wants to raise substantial funds to purchase equipment and DVDs. It is easier to raise funds through a corporation rather than a proprietorship or partnership.

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PROBLEM 1-2B (Continued) Taking It Further: The advantages of starting a business as a partnership and later incorporating the business include: ease of formation, simplicity, and reduced costs. As the business grows and the additional costs and administration that are required of corporations are justified, incorporating the business provides additional advantages.

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PROBLEM 1-3B 1. (a)

The accounting treatment is incorrect. The president is a person outside of the organization and not an asset of the business so the impact of his death should not be recorded. (b) The entry to record the impact of the death of the president should be removed from the accounting records. Users of the statements would be aware of the death and no mention need be made in the financial statements notes.

2. (a)

The accounting treatment is incorrect as it violates the economic entity assumption. The boat is a personal asset which is being used occasionally for business. (b) The entry to record the purchase of the boat should be removed from the accounting records or charged to Marc Paradis’ drawings account if the business is a proprietorship or partnership.

3. (a)

The accounting treatment is incorrect as it violates the cost principle. The equipment should be recorded at the amount paid to purchase it. (b) The entry to record the purchase of the equipment should be reduced by $100,000 in the accounting records of Montigny.

4. (a)

A note to the financial statements stating that Vertical Lines Company is a going concern is not necessary. The business is assumed to be a going concern, unless there is evidence to the contrary. (b) Any note stating that the business is a going concern should be removed.

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PROBLEM 1-3B (Continued) 5. (a)

Adopting IFRS is appropriate in this case, but the omitting a note to that effect is not appropriate. The readers of the financial statements are not aware of the basis under which the financial statements have been prepared and cannot interpret the information appropriately. (b) Add a note to the financial statements stating that Three Green Thumbs uses the International Financial Reporting Standards.

Taking It Further: It is important for private and public companies to follow generally accepted accounting principles (GAAP) because a common set of standards, applied by all businesses and entities, provides financial statements which are reasonably comparable. Without a common set of standards, each enterprise could, develop its own theory structure and set of practices, resulting in noncomparability among enterprises, to the detriment of financial statement users.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4B (a)

Total owner's equity (Jan. 1, 2010)......................... Total liabilities (Jan. 1, 2010) .................................. Total assets (Jan. 1, 2010).......................................

$50,000 0 $50,000

(b) Total assets (Dec. 31, 2010) .................................... Total owner's equity (Dec. 31, 2010) (c) below ...... Total liabilities (Dec. 31, 2010) ................................

$80,000 40,000 $40,000

(c)

Total owner's equity (Dec. 31, 2010) ...................... Total owner's equity (Jan. 1, 2010)......................... Decrease in owner's equity .....................................

$40,000 50,000 $10,000

Decrease in owner's equity .................................... Add: Investments..................................................... Less: Drawings ........................................................ Loss ..........................................................................

$10,000 5,000 0 $15,000

(d) Total expenses ........................................................ $110,000 Less: Loss ................................................................ (15,000) Total revenues ......................................................... $95,000 (e)

Total liabilities (Jan. 1, 2011) .................................... $40,000 Equal to total liabilities (Dec. 31, 2010) (b) above

(f)

Total owner's equity (Jan. 1, 2011)........................... $40,000 Equal to total owner's equity (Dec. 31, 2010) given

(g) Total assets (Dec. 31, 2011) ................................... Equal to total assets (Jan. 1, 2012) given

$135,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4B (Continued) (h) Total assets (Dec. 31, 2011) ................................... Total liabilities (Dec. 31, 2011) ............................... Total owner's equity (Dec. 31, 2011)......................

$135,000 75,000 $ 60,000

(i)

Total owner's equity (Dec. 31, 2011) ...................... Total owner's equity (Jan. 1, 2011)......................... Increase in owner's equity ......................................

$60,000 40,000 $20,000

Increase in owner's equity ...................................... Less: Profit ............................................. $(25,000) Add: Drawings ....................................... 10,000 Investments .............................................................

$20,000 (15,000) $5,000

(j)

Profit......................................................................... $25,000 Add: Total expenses ............................................... 105,000 Total revenues ......................................................... $130,000

(k)

Total liabilities (Jan. 1, 2012) .................................... $75,000 Equal to total liabilities (Dec. 31, 2011) given

(l)

Total owner's equity (Jan. 1, 2012)........................... $60,000 Equal to total owner's equity (Dec. 31, 2011) (h) above

(m) Total assets (Dec. 31, 2012) ................................... Total owner's equity (Dec. 31, 2012) ..................... Total liabilities (Dec. 31, 2012) ...............................

$170,000 80,000 $90,000

(n) Total owner's equity (Dec. 31, 2012) ..................... Total owner's equity (Jan. 1, 2012)........................ Increase in owner's equity .....................................

$80,000 60,000 $ 20,000

Increase in owner's equity ..................................... Less: Profit ............................................. $(60,000) Less: Investments .................................. .. 0 Drawings .................................................................

$20,000 (60,000) $40,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-4B (Continued) (o) Total revenues ........................................................ Less: Profit ............................................................. Total expenses .......................................................

$155,000 60,000 $95,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-5B (a) JAEGER’S REPAIR SHOP Cash

Accounts Accounts Note R.Jaeger, R.Jaeger, + Receivable + Supplies + Equipment = Payable + Payable + Capital - Drawings +Revenue - Expenses

May 1 +$15,000 2 −2,000 5 −940 7 9 +2,100 16 26 +500 27 −850 28 −220 30 −500 31 31 −1,000 31 000 0000 $12,090 +

+$15,000 +$8,000 +$850

+$6,000

−$940

+$850 +$2,100 +1,800

+$1,800 −500 −850

0−220 −500 +100 +350 $1,650 +

000 00000000 0000000 000000 0 0000 $850 + $8,000 = $100 + $6,000 + $15,000 −

0 00000 $500

+350 + $4,250 −

−100 −1,000 000000 $2,260

$22,590 = $22,590

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PROBLEM 1-5B (Continued) (b) Capital investment .................................................... $15,000 Less: Drawings ........................................................ 500 14,500 Add: Revenue .......................................................... 4,250 Less: Expenses ........................................................ (2,260) R. Jaeger, Capital, May 31 ......................................... $16,490

Taking It Further: Cash received from customers for services to be performed in a future accounting period should be recorded as a liability (Unearned Revenue) not as revenue because the company has not earned the revenue when they receive the cash. Instead, they have an obligation to perform services in the future, which is a liability.

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PROBLEM 1-6B (a) and (b) ($ in thousands) 1. L 2. A 3. A 4. A 5. E 6. A 7. A 8. L 9. E 10. A 11. L 12. R 13. R 14. L 15. C 16. D (c)

BS BS BS BS IS BS BS BS IS BS BS IS IS BS OE OE

Accounts payable Accounts receivable Cash Hotel real estate and equipment Interest expense Investments Non-hotel real estate Notes payable Operating expenses Other assets Other liabilities Other revenue Revenues from hotel operations Salaries payable T. Waye, capital, January 1 T. Waye, drawings

$159 90 100 1,435 33 150 100 802 661 512 256 37 841 35 966 15

Assets = Liabilities + Owner’s Equity ($90 + $100 + $1,435 + $150 + $100 + $512) = ($159 + $802 + $256 + $35) + ($966 + $37 + $841 − $33 − $661 − $15) $2,387 = $1,252 + $1,135

Taking It Further: It is important for Happy Valley Hotel and Resort to keep track of its different types of expenses to ensure that management is able to get the necessary information to make decisions concerning where improvements in performance can be made. As well, separate expenses can be compared with their related revenues to determine the amount of profit from the different sources of revenue activity for the business.

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PROBLEM 1-7B (a)

BARRY CONSULTING

Trans- Cash + Accounts + Office + Office action Rec. Supplies Equip. June 1 +$4,500 2 -750 3 +$475 5 -80 9 +2,175 12 -400 15 +$3,000 17 21 22 26 29 30

-1,500 +2,400 -475 +4,000 -1,650 -150

= Notes + Accounts + L. Barry, - L. Barry, + Revenue - Expenses Payable Payable Capital Drawings +$4,500 -$750 +$475 -80 +$2,175 -$400 +3,000 -1,500

-2,400 -475 +$4,000 +$1,650 -150

$8,070 +

$600 +

$475 +

$1,650 =

$4,000 +

0 +

$4,500 -

$400 +

$5,175 -

$10,795 = $10,795 Note:

The first June 1 transaction is not relevant to the business entity. It is a personal transaction. The June 25 transaction is not recorded because the transaction has not yet been completed. Revenue will not be earned until the services are performed in July.

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$2,480

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PROBLEM 1-7B (Continued) (b)

Profit = Revenues − Expenses = ($5,175 − $2,480) = $2,695 Owner’s Equity = Investment − Drawings + Profit = ($4,500 − $400 + $2,695) = $6,795

(c) BARRY CONSULTING Balance Sheet June 30, 2011 Assets Cash ........................................................................... $ 8,070 Accounts receivable ................................................. 600 Office supplies .......................................................... 475 Office equipment ....................................................... 1,650 Total assets ........................................................... $10,795 Liabilities and Owner's Equity Liabilities Note payable ......................................................... $ 4,000 Owner’s equity L. Barry, Capital (see part (b)) ..............................

6,795

Total liabilities and owner's equity ...................... $10,795 Taking It Further: A good rule of thumb is to test whether or not an exchange has taken place. Only when the event represents an exchange should a transaction be recorded. As well, personal transactions must be excluded to comply with the economic entity assumption.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-8B (a)

Bal Sept. 1 1 4 8 14 15 18 20 25 28 29 30 30

FRASER VETERINARY CLINIC Accounts Office Notes Accounts B. Fraser, B. Fraser, Cash + Receivable + Supplies + Equipment = Payable + Payable + Capital - Drawings + Revenue - Expenses $ 4,500 $1,800 $400 $6,500 $3,200 $10,000 -2,800 -2,800 -800 -$800 +1,450 -1,450 -1,000 +5,000 +$4,000 +500 +$500 0 -200 -200 +500 -500 -250 -$250 +7,500 +$7,500 +2,900 +1,400 +4,300 -675 0 -675 +175 -175 -750 0 000000 0 0000 000 000 000 00 000000 000000 -750 000000 0000 0 0 $10,375 + $1,750 + $400 + $11,500 = $11,500 + $575 + $10,000 - $1,000 + $4,800 - $1,850 $24,025 = $24,025

Note: The September 5 transaction and the September 26 transaction are not recorded because these transactions are not yet completed. The September 26 statement is not a transaction. In the September 5 transaction, the expense incurred for the office assistant will be recorded when the office assistant has worked for Fraser.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-8B (Continued) (b) FRASER VETERINARY CLINIC Income Statement Month Ended September 30, 2011 Revenues Fees earned .............................................................. $4,800 Expenses Rent expense ............................................... $800 Salaries expense.......................................... 675 Advertising expense .................................... 200 Telephone expense ..................................... 175 Total expenses ....................................................

1,850

Profit.............................................................................. $2,950 FRASER VETERINARY CLINIC Statement of Owner's Equity Month Ended September 30, 2011 B. Fraser, Capital, September 1................................ $10,000 Add: Profit .............................................................. 2,950 12,950 Less: Drawings ...................................................... 1,000 B. Fraser, Capital, September 30.............................. $11,950

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-8B (Continued) (b) (Continued) FRASER VETERINARY CLINIC Balance Sheet September 30, 2011 Assets Cash ............................................................................. $10,375 Accounts receivable ................................................... 1,750 Supplies on hand ........................................................ 400 Office equipment ......................................................... 11,500 Total assets ............................................................. $24,025 Liabilities and Owner's Equity Liabilities Notes payable ......................................................... $11,500 Accounts payable ................................................... 575 Total liabilities .................................................... 12,075 Owner's Equity B. Fraser, Capital .................................................. 0 11,950 Total liabilities and owner's equity ................... $24,025 Taking It Further: Although a payment was made from the business bank account, the payment was with respect to a personal transaction of the owner for his daughter. The amount must be recorded as a drawings transaction to the B. Fraser, Drawings account as it is not a business expense.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-9B JOHANSEN DESIGNS Income Statement Year Ended December 31, 2011 Revenues Design fee revenue ...................................................... $122,395 Expenses Salaries expense............................................... $66,360 Rent expense .................................................... 16,800 Telephone expense .......................................... 5,320 Office supplies expense ................................... 2,625 Interest expense ............................................... 315 Total expenses ......................................................... 91,420 Profit................................................................................... $30,975 JOHANSEN DESIGNS Statement of Owner's Equity Year Ended December 31, 2011 J. Johansen, Capital, January 1 ....................................... $30,575 Add: Profit ....................................................................... 30,975 61,550 Less: Drawings................................................................. 35,000 J. Johansen, Capital, December 31 .................................. $26,550

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-9B (Continued) JOHANSEN DESIGNS Balance Sheet December 31, 2011 Assets Cash ................................................................................... $ 10,390 Accounts receivable ......................................................... 7,645 Office supplies .................................................................. 525 Furniture ............................................................................ 11,730 Computer equipment ........................................................ 8,050 Total assets ................................................................... $38,340 Liabilities and Owner's Equity Liabilities Note payable ................................................................. Accounts payable ......................................................... Total liabilities ..........................................................

$ 5,950 5,840 11,790

Owner's equity J. Johansen, Capital .....................................................

26,550

Total liabilities and owner's equity ......................... $38,340 Taking It Further: In order to be able to determine the December 31, 2011, balance in the J. Johansen, Capital account, for the balance sheet, you need to have prepared the statement of owner’s equity first. The balance in the owner’s capital is not updated each time owner’s equity is increased or decreased. Instead, at the end of the accounting period, the impact of the revenues, expenses, and drawings on owner’s capital is determined in the income statement and then the statement of owner’s equity.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 1-10B (a)

(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x)

$110,000 − $5,000 − $10,000 − $45,000 = $50,000 $66,500 − $59,600 = $6,900 $110,000 − $66,500 = $43,500 Total assets = $110,000 $62,500 − $37,500 − $6,000 = $19,000 $80,000 − $62,500 = $17,500 $57,500 − $35,000 − $17,500 (from vi) = $5,000 $17,500 (from vi) $57,500 − $43,500 (from iii) = $14,000 $43,500 from the balance sheet (from iii)

(b) In preparing the financial statements the first statement to be prepared is the income statement. The profit figure is used in the statement of owner’s equity to calculate the ending balance of capital. The balance sheet is then completed using the balance of capital as calculated in the statement of owner’s equity. Taking It Further: The balance sheet, which is sometimes referred to as the statement of financial position, reports balances at a point in time, at the end of a reporting period. The income statement on the other hand, reports the results of the business transactions of revenues and expenses for a period of time, whether it is a month, a quarter or a fiscal year. The statement of owner’s equity also reports for the period of time, those items that have increased or decreased capital. Consequently, the income statement and the statement of owner’s equity are for the period of time ending at a specific date and the balance sheet is at that specific date.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 1-11B (a)

Only the assets that belong to the business and the liabilities that are owed by the business should be recorded in its financial statements. The boat and related debt should be removed from the balance sheet to conform to the economic entity assumption of GAAP.

The supplies should be recorded at cost of $15,000 until they are used. (cost principle)

The $5,000 should be returned to cash as this transaction has not yet occurred. (recognition criteria)

G. Gélinas’ Capital should be reported at its ending balance at December 31, 2011 on the balance sheet. He needs to update the balance to include the impact of all revenues, expense, and drawings during the period on owner’s equity.

Accounts and Notes Payable should be shown separately. (disclosure policy)

The profit should not appear on the balance sheet but included in the ending balance of the Capital account.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 1-11B (Continued) (b) GG Company Balance Sheet December 31, 2011 Assets Liabilities and Owner’s Equity Cash $20,000 Accounts payable $30,000 Accounts receivable 55,000 Notes payable 15,000 Supplies 15,000 G. Gélinas, Capital 45,000 Total assets $90,000 Total liabilities and owner’s equity $90,000 G. Gélinas, Capital = $25,000 + $5,000 (cash) − $5,000 (supplies) − $18,000 (boat) + $13,000 (boat loan payable) + $25,000 (profit) = $45,000 Taking It Further: If G. Gélinas did not make any withdrawals or further investments from GG Company during 2011, the change in his capital account will correspond to the profit for the year ending December 31, 2011. In this case the G. Gélinas, Capital account increased from $25,000 to $45,000 and so the profit was $20,000.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a)

Natalie has a choice between a sole proprietorship and a corporation. A partnership is not an option since she is the sole owner of the business. A proprietorship is the easiest to create and operate because there are no formal procedures involved in creating the proprietorship. However, if she operates the business as a proprietorship she will personally have unlimited liability for the debts of the business. Operating the business as a corporation would limit her liability to her investment in the business. Natalie will in all likelihood require the services of a lawyer to incorporate. Costs to incorporate as well as additional ongoing costs to administrate and operate the business as a corporation may be costly. The corporation would pay income taxes on its profits, instead of Natalie paying taxes on the income of the proprietorship. The amount of taxes that would be paid could be higher with the corporation. My recommendation is that Natalie choose the proprietorship form of business organization. This is a very small business where the cost of incorporating outweighs the benefits of incorporating at this point in time. Furthermore, it will be easier to stop operating the business if Natalie decides not to continue with it once she is finished college.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) Yes, Natalie will need accounting information to help her operate her business. She will need information on her cash balance on a daily or weekly basis to help her determine if she can pay her bills. She will need to know the cost of her services so she can establish her prices. She will need to know revenue and expenses so she can report her profit for personal income tax reporting purposes, on an annual basis. If she borrows money, she will need financial statements so lenders can assess the liquidity, solvency, and profitability of the business. Natalie would also find financial statements useful to better understand her business and identify any financial issues as early as possible. Monthly financial statements would be best because they are more timely but they are also more work to prepare. (c)

If Natalie needs to borrow money from a relative or from the bank or needs to establish credit with some suppliers, she will need to be able to present these creditors with some financial information to obtain credit and to demonstrate her ability to repay loans, plus any interest. The Canada Revenue Agency (CRA) is another user of the financial information Natalie will present in reporting the profit of her business on her personal income tax return. CRA will want to make sure that Natalie is reporting all of the profits properly and that the expenses of the business are in fact deductible.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (d) Natalie will have a choice of adopting IFRS or Canadian GAAP for Private Enterprises because Cookie Creations is a private company. Natalie will likely use Canadian GAAP for Private Enterprises as this set of standards will meet her company’s needs. As a very small private company it will not need the extra disclosure that is required by IFRS.

(e)

Assets: Cash, Accounts Receivable, Supplies, Equipment, Prepaid Insurance Liabilities: Accounts Payable, Unearned Revenue, Notes Payable Owner’s Equity: N. Koebel, Capital, N. Koebel, Drawings Revenue: Teaching Revenue Expenses: Advertising Expense, Supplies Expense, Travel Expense, Telephone Expense, Internet Expense, Insurance Expense

(d) Natalie should have a separate bank account. This will make it easier to prepare financial statements for her business. The business is a separate entity from Natalie and must be accounted for separately.

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Accounting Principles, Fifth Canadian Edition

BYP 1-1 FINANCIAL REPORTING PROBLEM

(a)

There are 23 notes to the financial statements, which occupy 23 pages. The financial statements themselves take up 4 pages.

(b) As per note 2 (j) the Company’s fiscal year is the 52 week period ended February 1, 2009. The previous fiscal year was the 53 week period ended February 3, 2008. The Company’s fiscal year follows the retail calendar. (c)

Total assets as at February 1, 2009: February 3, 2008:

$689,460,000 $754,964,000

(d) Net earnings for 2008 Net earnings for 2009 Net decline in profit

$47,451,000 29,325,000 $18,126,000

(e)

(f)

Cash on hand was February 1, 2009: February 3, 2008:

$19,266,000 $26,018,000

The Forzani Group will be required to change to IFRS effective January 1, 2011. The comparative prior year’s financial statements will be based on IFRS. The first fiscal year to show reporting under IFRS will be the 52 weeks ending January 30, 2011. The notes to the financial statements reveal continued efforts on the part of the company to compile and report at a later date the impact of IFRS on the types of policy changes and impacts on results that the company expects.

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Accounting Principles, Fifth Canadian Edition

BYP 1-2 INTERPRETING FINANCIAL STATEMENTS (a)

For a company such as RIM, the most important economic resources are the knowledge, skills, and creativity of its people. These human resources are not reflected in the balance sheet.

(b) The balance sheet reflects only the results of business transactions, based upon the cost principle. It does not attempt to show what the company's assets are currently worth. In the case of a company which has just recently been formed, the accounting (or book) values recorded on the balance sheet may be approximately the same as the economic (or market) values. For companies which have been in existence for some time, however, there may be a great difference between the historical amounts recorded in the accounting system and the current values of these items, in economic terms. In the case of RIM, this would be particularly the case for the intangible assets listed on the balance sheet. (c)

There are several reasons why RIM might prepare its financial statements in US dollars. It might be done for regulatory reasons, in order to be listed on US stock exchanges. It might also be done because the company does a great deal of business in the US and wants to be compared accurately with its US competitors. Another possible reason is that RIM competes in many countries worldwide, and the US dollar is a more recognized unit of currency on a global basis.

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Accounting Principles, Fifth Canadian Edition

BYP 1-3 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, Fifth Canadian Edition

BYP 1-4 COMMUNICATION ACTIVITY Date: To: Robert Joote From: Student Subject: Balance Sheet Correction The balance in your capital account should be the accumulation of all investments, either in cash or other assets, contributed by you to the company, less any drawings, in either cash or other assets, you have made for personal use, plus profit and less losses over time. The purpose of a balance sheet is to present the financial position of the company at a point in time. The balance sheet lists the company’s assets, liabilities and equities. I have received the balance sheet of Peak Company as of December 31, 2011. A number of items in this balance sheet are not properly reported. They are: 1.

The balance sheet should be dated as of a specific date, not for a period of time. It should be dated "December 31, 2011."

The bottom portion of the balance sheet should be headed "Liabilities and Owner's Equity", with sub-headings and sub-totals for the Liabilities section and the Owner's Equity section.

Assets should be reordered, in order of liquidity. Equipment should be reported below Supplies on the balance sheet.

Accounts Receivable should be shown as an asset and reported between Cash and Supplies.

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Accounting Principles, Fifth Canadian Edition

BYP 1-4 (Continued) 5.

Accounts Payable should be shown as a liability, not an asset.

The Note Payable should be reported in the liability section.

R. Joote, Capital and R. Joote, Drawings are not liabilities. They are part of owner's equity. The Drawings account is not reported on the balance sheet but is subtracted from R. Joote, Capital to arrive at owner's equity at the end of the period.

A correct balance sheet is as follows: PEAK COMPANY Balance Sheet December 31, 2011 Assets Cash ................................................................................... $10,500 Accounts receivable ......................................................... 3,000 Supplies ............................................................................. 2,000 Equipment.......................................................................... 20,500 Total assets ................................................................... $36,000 Liabilities and Owner's Equity Liabilities Notes payable ............................................................... $12,000 Accounts payable ......................................................... 5,000 Total liabilities .......................................................... 17,000 Owner's equity R. Joote, Capital............................................................ 19,000 Total liabilities and owner's equity ......................... $36,000 R. Joote, Capital = $21,000 − $2,000 = $19,000

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Accounting Principles, Fifth Canadian Edition

BYP 1-4 (Continued) In order to be able to prepare the statement of owner’s equity, you need to have the amount of the profit or loss for the year. This is why the income statement is prepared first, to have the amount of profit or loss. In order to have the ending balance in Capital, for the balance sheet, you need to have prepared the statement of owner’s equity second, before finishing with the balance sheet.

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Accounting Principles, Fifth Canadian Edition

BYP 1-5 ETHICS CASE (a)

The stakeholders in this situation are the new CEO and CFO, and the creditors and investors who rely on the financial statements to make business decisions.

(b)

The CEO and CFO should not sign the certification until they have taken steps to assure themselves that the most recent reports accurately reflect the activities of the business. However, as the current management of the company, they cannot refuse to sign the certification just because they are new. They are the management team now and must accept the responsibility that goes with these positions. When they were hired or appointed to their positions, they were aware of this requirement. Consequently they should have dedicated the necessary effort and time to become aware and familiar with the information to allow them to sign the certification.

(c)

The CEO and CFO have no alternative other than to take the steps necessary to assure themselves of the accuracy of the financial information, and, if accurate, sign the certification. If the information is not accurate, they need to make the required corrections to the financial information.

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Accounting Principles, Fifth Canadian Edition

BYP 1-6 ALL ABOUT YOU (a) 1. As a person with $5,000 to invest in Company A or B, I would want to be able to compare the two companies to determine which one is the better investment. For example, I will need financial information about these two companies to help me determine if either of these companies will be able to repay the loan and if either of the companies is earning enough to provide a return on my investment. And I would want to be able to determine which would provide the better return on my investment. As an external user of the financial information of Company A and Company B, I should be mindful of the source of the information I am using to make my investment decision. Assuming these are publicly traded companies, financial information is readily available from the individual company web sites. The financial statements of publicly owned companies must be audited. If the financial information has been audited, I will be able to place more reliance on the information and thus make a more informed decision. 2. When looking for an employer that is financially stable and has growth potential, it will be useful to have financial information. Once again, if the two are public companies, audited financial statements would be a good source of information about the companies’ financial stability and growth potential.

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Accounting Principles, Fifth Canadian Edition

BYP 1-6 (Continued) 3. Before I lend my brother’s company money, I will want to determine if his company will be able to repay me and if it will be able to pay interest on the loan. Since his business is a privately owned business, the financial information concerning the business is not publicly available. But since my brother owns the business, I can ask him for a copy of the financial statements of the landscaping business. Information concerning the plans in place for the purchase of the equipment and the amount of revenue that is expected to be earned from this additional asset would help in formulating my opinion on the ability of the business to repay the loan. (b)

By understanding the financial statements of a business, I will be in a better position to reduce the risk involved in making decisions. By studying accounting, I will learn how to evaluate a company’s financial stability, its growth potential, its ability to repay debt and its ability to earn sufficient profit to provide a return on my investments. Understanding the organization’s financial performance and financial position will provide a good basis for decisions involving investments, employment, or loans.

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Accounting Principles, Fifth Canadian Edition

Legal Notice

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Accounting Principles, Fifth Canadian Edition

CHAPTER 2 The Recording Process ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

Problems Set A

Problems Set B

1. Define debits and credits and illustrate how they are used to record transactions.

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

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

1, 2, 3

1, 2

2. Describe the accounting cycle and the steps in the recording process.

9, 10, 11, 12, 19

1, 8

3. Explain what a journal is, and journalize transactions. 4. Explain what a ledger is, and post journal entries.

13, 14, 15, 19

9, 10,

1, 4, 5, 6, 9

2, 3, 4, 5, 6, 7, 9,

15, 16, 17, 19

11, 12

1, 7, 8, 10

4, 5, 6, 7, 9, 13

5. Explain the purpose of a trial balance, and prepare one.

18, 19, 20, 21

13, 14

1, 9, 10, 11, 12, 13

4, 5, 6, 7, 8, 9, 10, 11, 12, 13

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Difficulty Level

Time Allotted (min.)

Simple

15-20

Identify type of account, financial statement, normal balances and debits and credits Perform transaction analysis and journalize transactions.

Simple

15-20

Journalize transactions.

Simple

20-30

Journalize transactions, post and prepare trial balance.

Moderate

40-50

Journalize transactions, post and prepare trial balance

Moderate

40-50

Journalize transactions, post and prepare trial balance.

Moderate

55-65

Journalize transactions, post and prepare trial balance.

Moderate

55-65

Prepare financial statements.

Simple

25-35

Journalize transactions, post and prepare trial balance.

Moderate

65-75

10A

Prepare financial statements.

Simple

25-35

11A

Prepare trial balance and financial statements

Simple

35-45

12A

Analyze errors and effects on trial balance

Moderate

25-35

13A

Prepare correct trial balance

Complex

30-40

Simple

15-20

Identify type of account, financial statement, normal balances and debits and credits Perform transaction analysis and journalize transactions.

Simple

15-20

Journalize transactions.

Simple

20-30

Journalize transactions, post and prepare trial balance.

Moderate

40-50

Journalize transactions, post and prepare trial balance.

Moderate

40-50

Journalize transactions, post and prepare trial balance.

Moderate

55-65

Journalize transactions, post and prepare trial balance.

Moderate

55-65

Prepare financial statements.

Simple

25-35

Journalize transactions, post and prepare trial balance.

Moderate

65-75

10B

Prepare financial statements.

Simple

25-35

Description

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

11B

Prepare trial balance and financial statements

Simple

35-45

12B

Analyze errors and effects on trial balance

Moderate

25-35

13B

Prepare correct trial balance.

Complex

30-40

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objective 1. Define debits and credits and illustrate how they are used to record transactions.

Knowledge Q2-2 Q2-5 Q2-4 BE2-2 BE2-3 BE2-4 E2-1 E2-2 P2-1A P2-1B Q2-9 Q2-10 Q2-11 Q2-12 E2-1

Comprehension Q2-1 Q2-3 Q2-6 Q2-7 Q2-8 BE2-5 BE2-6 BE2-7 E2-3

3. Explain what a journal is, and journalize transactions

E2-1

Q2-13 Q2-14

4. Explain what a ledger is, and post journal entries.

E2-1 E2-8

5. Explain the purpose of a trial balance, and prepare one.

E2-1

2. Describe the accounting cycle and the steps in the recording process.

BYP2-1 Broadening Your Perspective

Application BE2-1 P2-2A P2-2B

Analysis

Synthesi s

Evaluation

BE2-8 P2-2A P2-2B

Q2-21

Q2-15 BE2-9 E2-4 E2-5 P2-2A P2-3A P2-4A P2-5A P2-6A P2-7A P2-9A Q2-15 Q2-17 BE2-11 E2-7 P2-4A P2-5A P2-6A P2-7A P2-9A Q2-18 BE2-13 E2-9 E2-10 P2-4A P2-5A P2-6A P2-7A P2-8A P2-9A P2-10A P2-11A BYP2-2 BYP2-3 BYP2-4 BYP2-6

Q2-19 BE2-10 E2-6 E2-9 P2-2B P2-3B P2-4B P2-5B P2-6B P2-7B P2-9B Q2-16 Q2-19 BE2-12 E2-10 P2-4B P2-5B P2-6B P2-7B P2-9B Q2-19 BE2-14 E2-12 E2-13 P2-4B P2-5B P2-6B P2-7B P2-8B P2-9B P2-10B P2-11B

P2-9B P2-9B

P2-13A P2-13B

Q2-20 E2-11 P2-12A P2-13A P2-12B P2-13B

BYP2-5

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Accounting Principles, Fifth Canadian Edition

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 1.

An account is an accounting record of increases and decreases in a specific asset, liability, or owner’s equity item. A company will need, at a minimum, two accounts to represent an asset and either a liability, or owner’s capital. Companies will, however, usually have many accounts since they will have different types of assets and liabilities and to track the various types of revenues and expenses.

Debiting an account refers to the practice of increasing the debit (or left) side of an account. Crediting an account signifies increasing the credit (or right) side of an account.

Jos is incorrect. The double-entry system merely records the effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once, with a dual effect on the equation.

Assets are on the left side of the basic accounting equation and liabilities and owner’s equity are on the right side of the basic accounting equation. Since debits are on the left side, and assets are also on the left side, the normal balance of an asset is a debit balance. Since credits are on the right side and liabilities are on the right side, the normal balance of a liability is a credit balance. The same is also true for owner’s equity. Revenues increase owner’s equity and therefore also have a credit balance. But expenses and drawings are decreases to owner’s equity and thus have a debit balance.

(a) Asset accounts are increased by debits and decreased by credits. The normal balance of an asset account is a debit balance. (b) Liability accounts are decreased by debits and increased by credits. The normal balance of a liability account is a credit balance. (c) Owner's equity accounts are increased by owner’s investment and revenues and decreased by owner’s drawings and expenses. (1) The owner’s capital account is increased by credits and decreased by debits. Its normal balance is a credit. (2) Revenue accounts are increased by credits and decreased by debits. The normal account balance of a revenue account is a credit. (3) The owner’s drawings account is increased by debits and decreased by credits. Its normal account balance is a debit. (4) Expense accounts are increased by debits and decreased by credits. The normal account balance of an expense account is a debit.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 6.

Kim is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Whether a debit or credit balance is favourable or unfavourable depends on the type of account being considered.

The normal balance of owner’s capital is a credit. The account is increased by credits and decreased by debits. Both drawings and expenses represent decreases to owner’s capital. Their normal balance is a debit and they are increased by debits.

(a) Accounts Payable—both debit and credit entries (b) Accounts Receivable—both debit and credit entries (c) Cash—both debit and credit entries (d) Drawings—debit entries only (e) Rent Expense—debit entries only (f) Service Revenue—credit entries only

The accounting cycle is a series of steps that are used in recording transaction information. The first three steps include (1) analyze each transaction; (2) journalize the transaction and (3) transfer the journal information to the correct accounts in the ledger. (1) Analyze each transaction. In this step, business documents are examined to determine the effects of the transaction on the accounts. This basic step must be done by people in both a computerized and manual system. (2) Enter each transaction in a journal. This step is called journalizing and it results in making a chronological record of the transactions. (3) Transfer journal information to ledger accounts. This step is called posting. Posting makes it possible to accumulate the effects of journalized transactions on individual accounts. In computerized accounting systems, posting usually occurs automatically right after each journal entry is prepared. The system finds obvious errors in the recording process.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 10.

Each transaction must be analyzed for its effect on the components of the accounting equation. A transaction is recorded only if it causes the company’s financial position to change. (That is, it is recorded if assets, liabilities, or owner’s equity items change.)

11.

Two examples of business documents that are analyzed when journal entries are being prepared are 1) Utility bill, 2) Sales slip (note that there are many other possible answers to this question).

12.

The steps in the recording process are the same whether they are performed manually or by a computerized system. The first two steps, the analysis and entering of each transaction, must be done by a person even when a computerized system is used. The first step involves determining what accounts are affected by the transaction and for what amount – this step does not change whether the system is manual or computerized. The second step, entering, or journalizing, the transaction must be done by a person. However, in some computerized systems, errors can be prevented by ensuring that both the debit and credit sides of the entry balance before the transaction is recorded. The third step, posting to ledger accounts, can be done automatically by a computerized system. This substantially reduces the possibility of making mistakes, since the accounts identified in the second step are adjusted automatically by the computerized system and for the same amount as recorded. When done manually, this step can lead to errors in posting the amount, posting the amount to the wrong side of the account, posting the amount to the wrong account, or not posting part of a transaction.

13.

A simple journal entry refers to an entry that affects only two accounts, a debit and a credit account. A compound entry refers to an entry that affects three or more accounts. To ensure the accounting equation remains balanced, the total of the debit and credit amounts must be equal.

14.

The accounts that could be credited are Revenue, Accounts Receivable and Unearned Revenue. Revenue would be credited for a cash sale. Accounts Receivable would be credited when a customer makes a payment on account. Unearned Revenue would be credited when a customer pays in advance.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 15.

Debits and credits could be recorded directly in the ledger; however, this is not the recommended practice. The advantages of using the journal are: 1. It discloses in one place the complete effect of a transaction. 2. It provides a chronological record of all transactions. 3. It helps to prevent or locate errors, because the debit and credit amounts for each entry can be readily compared. The advantage of the last step in the posting process is to indicate that the item has been posted, and to provide a cross-reference.

16.

The T account is often used in accounting textbooks for illustrative purposes. It shows the debit and credit side of a ledger account. It is faster to create and more efficient for analyzing the impact of specific transactions Businesses however usually use a “standard” form of account. This form shows a debit and credit column but also include additional information such as the balance of the account (to show the account balance after every transaction), the date, explanation and reference. This additional information is useful in preventing and detecting errors.

17.

The entire group of accounts maintained by a company, including all the asset, liability, and owners' equity accounts, is referred to collectively as the ledger. A chart of accounts lists the accounts and account numbers that identify their location in the ledger. The numbering system used to identify the accounts usually starts with the balance sheet accounts and follows with the income statement accounts. The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger.

18.

A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits, after all journalized transactions have been posted. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements.

19.

The proper sequence is as follows: 1. The business transaction occurs. (b) 2. Information is entered in the journal. (c) 3. Debits and credits are posted to the ledger. (a) 4. A trial balance is prepared. (e) 5. Financial statements are prepared. (d)

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QUESTIONS (Continued) 20.

(a) The trial balance would not balance, because there were two debits for $750 and no credits. The debits do not equal the credits. Accounts Payable should have been credited, not debited, for $750. (b) The trial balance would balance, because the debits ($1,000) and credits ($1,000) are equal. But both the Service Revenue and the Accounts Receivable balances would be incorrect as the credit should have been recorded as a credit to Accounts Receivable not Service Revenue. (c) The trial balance would not balance, because the debit to Rent Expense for $650 is not equal to the credit to Cash for $560. The debit side of the trial balance is overstated by $90, because either the Rent Expense is overstated by $90 (Rent Expense should have been debited for $560), or cash is overstated by $90 (the payment should have been credited for $650).

21.

The company should use “December 31” on its trial balance. The trial balance is prepared at a specific point in time.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 Accounts Receivable 8,000 5,210 6,340 2,750 2,390 Debit Bal. 3,990 Accounts Payable 220 560 175 355 Credit Bal.

390 710 850 640

BRIEF EXERCISE 2-2

2. 3. 4.

Account Accounts Receivable Accounts Payable Equipment Rent Expense

B. Damji, Drawings

6. 7. 8. 9.

Supplies Unearned Revenue Cash Service Revenue

10. Prepaid Insurance

(1) Type of Account Asset Liability Asset Owner’s Equity Owner’s Equity Asset Liability Asset Owner’s Equity Asset

(2) Financial Statement Balance Sheet

(3) Normal Balance Debit

Balance Sheet Balance Sheet Income Statement

Credit Debit Debit

Statement of Owner’s Equity Balance Sheet Balance Sheet Balance Sheet Income Statement

Debit

Balance Sheet

Debit

Debit Credit Debit Credit

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BRIEF EXERCISE 2-3

1. Accounts Payable 2. Accounts Receivable 3. Cash 4. Office Equipment 5. J. Takamoto, Capital 6. J. Takamoto, Drawings 7. Notes Payable 8. Prepaid Rent 9. Insurance Expense 10. Salaries Expense 11. Service Revenue 12. Unearned Revenue

(a) Debit Effect

(b) Credit Effect

Decrease Increase Increase Increase Decrease Increase Decrease Increase Increase Increase Decrease Decrease

Increase Decrease Decrease Decrease Increase Decrease Increase Decrease Decrease Decrease Increase Increase

BRIEF EXERCISE 2-4 1. 2. 3. 4. 5. 6. 7. 8.

Credit Debit Credit Debit Debit Credit Debit Credit

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BRIEF EXERCISE 2-5 Account Debited Type of Owner’s Equity Account

Account Credited Type of (a) (b) Owner’s Specific Basic Equity Account Type Account Accounts Liability Payable Unearned Liability Revenue

(a) Specific Account

(b) Basic Type

1. Equipment

Asset

2. Cash

Asset

Utility Expense Office 4. Supplies

Owner’s Expense Equity

Cash

Asset

Cash

Asset

5. Cash

Asset

Service Revenue Service Revenue

Owner’s Revenue Equity Owner’s Revenue Equity

Accounts Receivable J. Parker, 7. Drawings Wages 8. Expense 6.

Asset

Owner’s Drawings Cash Equity Owner’s Expense Cash Equity

Asset Asset

BRIEF EXERCISE 2-6 June 1 2 3 4 12 22 25 29

Account Debited Cash Equipment Rent Expense Prepaid Insurance Accounts Receivable Cash No entry required Accounts Payable

Account Credited D. Ing, Capital Accounts Payable Cash Cash Service Revenue Accounts Receivable Cash

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BRIEF EXERCISE 2-7 Account Debited (a) (b) Basic Specific Type Account Asset Cash

+ $17,000

4 5

Asset Asset

Prepaid rent Supplies

+ $3,600 + $440

Asset

Cash

Asset

Owner’s Equity Owner’s Equity

Accounts Receivable Salaries Expense J. Fischer, Drawings

Transaction Aug. 1

+ $750

Account Credited (a) (b) (c) Basic Specific Effect Type Account Owner’s J. Fischer, + $17,000 Equity Capital Asset Cash - $3,600 Liability Accounts + $440 Payable Owner’s Service + $950 Equity Revenue Owner’s Service + $1,500 Equity Revenue Asset Cash - $750

+ $500

Asset

+ $950 + $1,500

2-14

Cash

- $500

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BRIEF EXERCISE 2-8 (1) This transaction should be recorded. The asset account Accounts Receivable is increased and the revenue account Service Revenue is also increased. Revenue is recorded when the service is performed, regardless of when the cash is received. (2) This transaction should be recorded. The asset account Cash is increased and the asset account Accounts Receivable is decreased. This transaction represents an exchange of assets. Service Revenue is not recorded here again since it was recorded when the service was performed. (3) This transaction is not recorded. No asset, liability, owner’s equity, revenue or expense account is affected. The balance owing by the customer, Accounts Receivable, was recorded when the service was performed.

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BRIEF EXERCISE 2-9 June 1

Cash ..................................................... 5,500 D. Ing, Capital .................................

5,500

Equipment ........................................... 3,000 Accounts Payable...........................

3,000

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

500

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

800

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

350

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

350

500

800

350

No entry required—not a transaction

Accounts Payable ............................... 3,000 Cash ................................................

350

3,000

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BRIEF EXERCISE 2-10 Aug.

Cash .................................................. 17,000 J. Fischer, Capital ........................

17,000

Prepaid Rent ..................................... Cash .............................................

3,600 3,600

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

440

Cash .................................................. Service Revenue ..........................

950

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

1,500

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

750

J. Fischer, Drawings ........................ Cash .............................................

500

440

950

1,500

750

500

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 2-11 Aug. 1 6 Bal.

Cash 17,000 Aug. 4 950 27 29 13,100

J. Fischer, Capital Aug. 1 17,000

3,600 750 500

Bal.

Accounts Receivable Aug. 17 1,500

J. Fischer, Drawings Aug. 29 500

Bal.

1,500

Bal.

Aug. 4

Prepaid Rent 3,600

Bal.

3,600

Aug. 5

Supplies 440

Salaries Expense Aug. 27 750

Bal.

440

Bal.

500 Service Revenue Aug. 6 17 Bal.

Accounts Payable Aug. 5

440

Bal.

440

17,000

950 1,500 2,450

750

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 2-12 Cash Sep. 2 875 Sep. 15 28 300 30 Sep 30 Bal. 375

Sep. 4

Furniture 750

Sep 30 Bal.

750

250 550

Service Revenue Sep. 2 875 10 1,200 Sep 30 Bal. 2,075 Accounts Payable Sep. 30 550 Sep. 4 Sep 30 Bal.

Accounts Receivable Sep. 10 1,200 Sep. 28 Sep 30 Bal. 900

750 200

Salaries Expense 300 Sep. 15 250 Sep 30 Bal.

250

BRIEF EXERCISE 2-13 PETTIPAS COMPANY Trial Balance April 30, 2011 Debit

Credit

Cash ............................................................... $ 8,400 Accounts receivable ..................................... 3,000 Supplies ......................................................... 650 Prepaid insurance ......................................... 1,500 Equipment ..................................................... 14,600 Accounts payable.......................................... Unearned revenue ......................................... C. Pettipas, capital ........................................ C. Pettipas, drawings .................................... 1,200 Service revenue ............................................. Rent expense ................................................. 800 Salaries expense ........................................... 4,000 $34,150

$ 3,900 150 22,000 8,100 ______ $34,150

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BRIEF EXERCISE 2-14 1.

The Prepaid Insurance balance was in the wrong column. Assets have a normal debit balance. When this account is moved the new total in the debit column will be $46,200 ($42,700 + $3,500) and the new total in the credit column will be $47,100 ($50,600 - $3,500).

The trial balance is now out $900 ($46,200 - $47,100). The only account balance that could have caused a $900 transposition error is the $15,400 balance in L. Bourque, capital. If balance in that account is transposed to $14,500 this will reduce the total credits by $900 and the trial balance will now balance. See revised trial balance below: BOURQUE COMPANY Trial Balance December 31, 2010

Debit Cash ............................................................... $15,000 Accounts receivable ..................................... 1,800 Prepaid insurance ......................................... 3,500 Accounts payable.......................................... Unearned revenue ......................................... L. Bourque, capital ........................................ L. Bourque, drawings .................................... 4,900 Service revenue ............................................. Rent expense ................................................. 2,400 Salaries expense ........................................... 18,600 $46,200

Credit

$ 2,000 2,200 14,500 27,500 ______ $46,200

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SOLUTIONS TO EXERCISES EXERCISE 2-1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

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

Credit Analyzing transactions Posting Account Debit Journalizing Trial balance Credit Chart of accounts Journal

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-2

Account 1. Cash 2. M. Kobayashi, Capital 3. Accounts Payable 4. Building 5. Consulting Fee Revenue 6. Insurance Expense 7. Interest Earned 8. Notes Receivable 9. Prepaid Insurance 10. Rent Expense 11. Supplies

(1) Type of Account Asset Owner’s Capital Liability Asset Revenue

(2) Financial Statement Balance Sheet Balance Sheet and Statement of Owner’s Equity Balance Sheet Balance Sheet Income Statement

Expense Revenue Asset Asset Expense Asset

Income Statement Income Statement Balance Sheet Balance Sheet Income Statement Balance Sheet

(3) Normal Balance Debit Credit

Credit Debit Credit Debit Credit Debit Debit Debit Debit

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EXERCISE 2-3 Transaction Mar. 3

Account Debited (a) (b) (c) Basic Specific Type Account Effect Asset Cash + $10,000

Account Credited (a) (b) (c) Basic Specific Type Account Effect Owner’s L. Visser, + $10,000 Equity Capital Asset Cash - $6,500 Liability Accounts + $500 Payable Owner’s Service + $2,100 Equity Revenue Asset Cash - $225

6 7

Asset Asset

Vehicle Supplies

+ $6,500 + $500

Asset

+ $2,100

21 25

Owner’s Equity Asset

Accounts Receivable Advertising Expense Cash

+ $1,200

Asset

Liability

- $500

Asset

Accounts Payable Cash

+ $750

Liability

Owner’s Equity

L. Visser, Drawings

+ $600

Asset

+ $225

2-23

Accounts Receivable Cash

- $1,200

Unearned Revenue Cash

+ $750

- $500

- $600

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EXERCISE 2-4 GENERAL JOURNAL Date Mar.

Account Titles and Explanation

J1 Debit

Credit

3 Cash ........................................................ 10,000 L. Visser, Capital ................................

10,000

6 Vehicle .................................................... 6,500 Cash ....................................................

6,500

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

500 500

12 Accounts Receivable ............................. 2,100 Service Revenue ................................ 21 Advertising Expense .............................. Cash ....................................................

2,100

225 225

25 Cash ........................................................ 1,200 Accounts Receivable ......................... 28 Accounts Payable .................................. Cash ....................................................

500

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

750

31 L. Visser, Drawings ................................ Cash ....................................................

600

1,200

500

750

600

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-5 GENERAL JOURNAL Date Oct.

Account Titles and Explanation Ref.

Debit

Credit

1 Cash ........................................................ 14,000 Office Equipment.................................... 3,000 S. Gardiner, Capital............................ 17,000 2 No entry—not a transaction 3 Office Equipment.................................... Cash .................................................... Note Payable ......................................

4,450

10 Cash ........................................................ Service Revenue ................................

350

16 Accounts Receivable ............................. Service Revenue ................................

7,500

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

700

29 Telephone Expense ................................ Accounts Payable ..............................

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

2,000

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

7,500

850 3,600

350

7,500

700

2,000

7,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-6 GENERAL JOURNAL Trans. (a)

Account Titles and Explanation Ref.

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

1,600

Cash ........................................................ Service Revenue ................................

875

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

625

Telephone Expense ................................ Cash ....................................................

220

Debit

Credit

1,600

875

(b) 7.

14.

(c)

8, 9, 11. 10.

625

220

Investments by an owner are not revenues and are recorded as an investment in the owner’s capital account. The revenue was recorded in transaction 2 when the service was performed and must not be recorded again. Increase in the liability Notes Payable. This does not represent revenue and does not affect owner’s equity. Increase in the liability account Unearned Revenue because the service has not been provided yet. Assets are increased because the costs will benefit a future accounting period. The asset Office Equipment is increased to show that a benefit will be received in the future.

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EXERCISE 2-6 (Continued) 12.

13.

The liability is decreased (debited). The payment represents the repayment of a liability and does not affect owner’s equity. Drawings are not expenses. They represent a withdrawal of previous investments and profits and have the opposite effect of an owner’s investment.

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EXERCISE 2-7 Cash Oct. 1 14,000 Oct. 3 850 10 350 27 700 31 7,500 30 2,000 Oct.31Bal.18,300

S. Gardiner, Capital Oct. 1 17,000

Accounts Receivable Oct. 16 7,500 Oct. 31 7,500

Service Revenue Oct. 10 350 16 7,500 Oct. 31 Bal. 7,850

Oct. 31 Bal.

Office Equipment Oct. 1 3,000 3 4,450 Oct.31 Bal. 7,450

Note Payable Oct. 3

Oct. 31 Bal. 17,000

Salaries Expense Oct. 30 2,000 Oct.31Bal.2,000

Advertising Expense 3,600 Oct. 27 700

Oct.31 Bal.3,600 Oct. 31 Bal. 700

Accounts Payable Oct. 29 Oct.31 Bal.

Telephone Expense 95 Oct. 29 95 95 Oct. 31 Bal. 95

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-8 1.

The ledger contains the entire group of accounts, including asset and liability accounts, and owner’s equity accounts.

The accounts are arranged in the same order as presented in the financial statements.

The accounts in a general ledger may be numbered for easier identification.

The Journal is the book of original entry.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-9 (a) Date Oct.

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

1 Cash .......................................................... 1,200 A. Fortin, Capital .................................. Invested cash in business.

1,200

3 Equipment................................................. 5,400 Cash ...................................................... Notes Payable ...................................... Purchased equipment and issued a note.

400 5,000

4 Supplies .................................................... Accounts Payable ................................ Purchased supplies on account.

800 800

6 Accounts Receivable ............................... 1,000 Service Revenue .................................. Performed services on credit. 10 Cash .......................................................... Service Revenue .................................. Performed services for cash.

650

12 Accounts Payable .................................... Cash ...................................................... Paid cash on account.

500

650

500

15 Cash .......................................................... 3,000 Service Revenue .................................. Performed services for cash. 20 Accounts Receivable ............................... Service Revenue .................................. Performed services for credit.

1,000

3,000

940 940

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EXERCISE 2-9 (Continued) (a) (Continued) GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

20 Cash .......................................................... Accounts Receivable ........................... Received cash on account.

Credit

800 800

25 Cash .......................................................... 2,000 A. Fortin, Capital .................................. Invested cash in business.

2,000

28 Advertising Expense ................................ 400 Accounts Payable ................................ Purchased advertising on account.

400

30 A. Fortin, Drawings .................................. Cash ...................................................... Withdrew cash for personal use.

600 600

31 Rent Expense ........................................... Cash ...................................................... Paid rent.

250

31 Store Wages Expense .............................. Cash ...................................................... Paid wages.

500

250

500

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EXERCISE 2-9 (Continued)

(b) FORTIN CO. Trial Balance October 31, 2011

Debit Cash ....................................................... $ 5,400 Accounts receivable ............................. 1,140 Supplies ................................................. 800 Equipment.............................................. 5,400 Notes payable ........................................ Accounts payable.................................. A. Fortin, capital .................................... A. Fortin, drawings ................................ 600 Service revenue ..................................... Advertising expense ............................. 400 Rent expense ......................................... 250 Store wages expense ............................ 500 $14,490

Credit

$ 5,000 700 3,200 5,590

______ $14,490

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EXERCISE 2-10 (a) and (b) Cash Aug. 1 8,800 Aug. 1 1,200 Aug. 30 12 2,400 10 420 31 5,910 25 2,250 30 540 31 4,770 Aug. 31 Bal. 7,930

Notes Payable 500 Aug. 1

Accounts Receivable Aug. 1 2,750 Aug. 12 2,400 31 2,550 Aug. 31 Bal. 2,900

L. Meche, Capital Aug. 1

Aug. 1

Supplies 585

Aug. 31

Bal. 585

Aug. 1

Equipment 15,550

Aug. 31Bal. 15,550

Aug. 31 Bal. 9,500

L. Meche, Drawings Aug. 1 5,125 31 4,770 Aug.31 Bal. 9,895 Medical Fee Revenue Aug. 1 10,410 31 8,460 Aug. 31 Bal. 18,870 Salaries Expense Aug. 1 2,250 25 2,250 Aug.31 Bal. 4,500

Interest Expense Aug. 30 40

Accounts Payable Aug.10 420 Aug. 1

Bal. 40

15,000

Aug. 31 Bal. 15,000

Rent Expense Aug. 1 1,200 1 1,200 Aug. 31 Bal. 2,400

Aug. 31

10,000

Aug. 31

850 Bal. 430

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-10 (Continued) (c) LEE MECHE, MD Trial Balance August 31, 2011

Cash ............................................................ Accounts receivable .................................. Supplies ...................................................... Equipment................................................... Notes payable ............................................. Accounts payable....................................... L. Meche, capital......................................... L. Meche, drawings .................................... Service revenue .......................................... Interest expense ......................................... Rent expense .............................................. Salaries expense ........................................

Debit $7,930 2,900 585 15,550

Credit

$9,500 430 15,000 9,895 18,870 40 2,400 4,500 $43,800

$43,800

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EXERCISE 2-11 Error 1.

(a) In Balance No

(b) Difference $400

Yes

None

Yes

None

$500

Credit

Yes

None

$18

Credit

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EXERCISE 2-12 ROYAL MOUNTAIN TOURS Trial Balance March 31, 2011

Debit Credit Cash ($12,800 + $400 – [$240 X 2]) ............ $12,720 Accounts receivable ($4,090 + $900 + $620)........................................... 5,610 Supplies ...................................................... 840 Equipment................................................... 7,350 Accounts payable ($2,500 + 400) .............. 2,900 T. Zelinski, capital ...................................... 24,000 T. Zelinski, drawings .................................. 3,650 Service revenue ($6,750 + $620) ................ 7,370 Advertising expense .................................. 3,700 Salaries expense ........................................ 400 _______ Totals $34,270 $34,270

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-13 O’CALLAGHAN’S COUNSELLING SERVICES Income Statement Year Ended July 31, 2011 Revenues Service revenue .................................................... $58,090 Expenses Insurance expense .................................. $ 1,020 Rent expense ........................................... 5,440 Salaries expense...................................... 22,770 Supplies expense .................................... 2,980 Total expenses ................................................. 032,210 Profit .......................................................................... $25,880

O’CALLAGHAN’S COUNSELLING SERVICES Statement of Owner's Equity Year Ended July 31, 2011 C. O’Callaghan, capital, July 31, 2010 ...................... $34,670 Plus: Profit .............................................................. 25,880 60,550 Less: Drawings......................................................... 28,990 C. O’Callaghan, capital, July 31, 2011 ...................... $31,560

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Accounting Principles, Fifth Canadian Edition

EXERCISE 2-13 (Continued) O’CALLAGHAN’S COUNSELLING SERVICES Balance Sheet July 31, 2011 Assets Cash ........................................................................... $ 2,895 Accounts receivable ................................................. 3,670 Supplies ..................................................................... 395 Prepaid insurance ..................................................... 044340 Equipment.................................................................. 29,450 Total assets ........................................................... $36,750 Liabilities and Owner's Equity Liabilities Accounts payable ................................................. $4,515 Unearned revenue ................................................ 675 Total liabilities .................................................. 5,190 Owner's Equity C. O’Callaghan, capital ......................................... 31,560 Total liabilities and owner's equity ................. $36,750

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SOLUTIONS TO PROBLEMS PROBLEM 2-1A (a) Account Accounts Payable Accounts Receivable Building Cash Equipment Insurance Expense Interest Earned Land Legal Fees Earned M. Brock, Capital

(1) Type of Account Liability Asset Asset Asset Asset Expense Revenue Asset Revenue Owner’s Capital

M. Brock, Drawings

Drawings

Notes Receivable Prepaid Insurance Rent Expense

Asset Asset Expense

(2) Financial Statement Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Income Statement Income Statement Balance Sheet Income Statement Balance Sheet and Statement of Owner’s Equity Statement of Owner’s Equity Balance Sheet Balance Sheet Income Statement

2-39

(3) Normal Balance Credit Debit Debit Debit Debit Debit Credit Debit Credit Credit

(4)

(5)

Increase Credit Debit Debit Debit Debit Debit Credit Debit Credit Credit

Decrease Debit Credit Credit Credit Credit Credit Debit Credit Debit Debit

Debit

Credit

Debit Debit Debit

Credit Credit Credit

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PROBLEM 2-1A (Continued) (a) (Continued)

Account Rent Revenue Salaries Expense Salaries Payable Supplies Supplies Expense Unearned Legal Fees

(1) Type of Account Revenue Expense Liability Asset Expense Liability

(2) Financial Statement Income Statement Income Statement Balance Sheet Balance Sheet Income Statement Balance Sheet

(3) Normal Balance Credit Debit Credit Debit Debit Credit

(4)

(5)

Increase Credit Debit Credit Debit Debit Credit

Decrease Debit Credit Debit Credit Credit Debit

Taking It Further The term debit indicates left and the term credit indicates right. The normal balance of the account represents its position in the accounting equation. Assets have a normal debit balance because they represent the left side of the accounting equation. Therefore transactions that increase assets are reflected by an increase (a debit) to an asset account. Conversely, liabilities and owner’s equity accounts have a normal credit balance because they represent the right side of the accounting equation. Revenues and expenses represent changes in the owner’s equity account. Revenues increase owner’s equity and therefore increase the right side of the accounting equation; revenues have a normal credit balance. Expenses reduce owner’s equity and increases in expenses reduce the right side of the accounting equation; expenses have a normal debit balance.

2-40

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PROBLEM 2-2A (a)

(1) Transaction Apr. 1

Basic Type Asset

Owner’s Equity Asset

Asset

Owner’s Equity Asset

8 10

Account Debited (2) Specific Account Cash Insurance Expense Painting Equipment Supplies

(3) Effect + $13,500 + $115

Account Credited (1) (2) (3) Specific Basic Type Account Effect Owner’s J. Butterfield, + $13,500 Equity Capital Asset Cash - $115

+ $3,000

Asset

Cash

- $3,000

+ $375

Liability

Accounts Payable Cash

+ $375

Painting Revenue

+ $750

Advertising + $870 Asset Expense Accounts + $750 Owner’s Receivable Equity No transaction at this point in time (see Apr. 25).

2-41

- $870

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PROBLEM 2-2A (Continued) (a) (Continued)

Basic Type Asset

Account Debited (2) Specific Account Cash

Effect + $1,500

Asset

Cash

+ $750

Owner’s Equity Liability

J. Butterfield, Drawings Accounts Payable

+ $870

(1) Transaction 25

(3)

- $375

2-42

Account Credited (1) (2) (3) Specific Basic Type Account Effect Owner’s Painting + $1,500 Equity Revenue Asset Accounts - $750 Receivable Asset Cash - $870 Asset

Cash

Chapter 2 Unauthorized copying, distribution, or transmission of this page is prohibited.

- $375

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-2A (Continued) (b) Date Apr.

GENERAL JOURNAL Account Titles and Explanation

Debit

1 Cash ....................................................... 13,500 J. Butterfield, Capital ........................ 2 Insurance Expense ................................ Cash ...................................................

115

2 Painting Equipment ............................... Cash ...................................................

3,000

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

375

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

870

8 Accounts Receivable ............................ Painting Revenue ..............................

750

Credit

13,500

115

3,000

375

870

750

10 No transaction at this time. 25 Cash ....................................................... Painting Revenue ..............................

1,500

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

750

28 J. Butterfield, Drawings ........................ Cash ...................................................

870

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

375

1,500

750

870

375

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-2A (Continued) Taking It Further The investment by the owner increases cash, an asset. Assets are on the left (or debit) side of the accounting equation. The same transaction also increases the right (or credit) side of the accounting equation and increases the owner’s capital. Since both the left and right side of the accounting equation must remain in balance, a transaction must have both a debit and a credit.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-3A (a) Date May

GENERAL JOURNAL Account Titles and Explanation

Debit

1 Cash ...................................................... 70,000 A. Mawani, Capital ...........................

Credit

70,000

3 Land ...................................................... 100,000 Building ................................................. 70,000 Equipment............................................. 40,000 Cash .................................................. 60,000 Notes Payable ($210,000 - $60,000) 150,000 4 Equipment............................................. Accounts Payable ............................

6,000

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

1,800

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

2,760

15 Cash ...................................................... Golf Fees Revenue ..........................

2,500

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

5,000

20 Accounts Receivable ........................... Golf Fees Revenue ..........................

500

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

2,445

6,000

1,800

2, 760

2,500

5,000

500

2,445

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-3A (Continued) (a) (Continued) Date

Account Titles and Explanation

Debit

May 30 Cash ...................................................... Accounts Receivable .......................

500

31 Cash ...................................................... Golf Fees Revenue ..........................

4,000

31 Interest Expense.................................. Cash ..................................................

750

31 A. Mawani, Drawings ............................ Cash ..................................................

1,750

Credit

500

4,000

750

1,750

Taking It Further The purpose of the journal entries is to show the debit and credit effects of each transaction on specific accounts. This helps to prevent and locate errors because the debit and credit amounts in the entry have to balance. The journal entries also provide a chronological record of transactions as well as give an explanation of the transaction and identify source documents. The next step in the recording process is to transfer the information to the ledger by posting the transactions to specific ledger accounts. Amin should find the information generated by this next step more useful since posting transactions to the ledger will update the ledger account balances. Once this step is completed, a trial balance can be prepared from the ledger accounts as well as financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4A (a)

GENERAL JOURNAL

Date

Account Titles and Explanation Ref.

Debit

Apr.

1 Cash ............................................ 101 Office Equipment........................ 151 F. Virmani, Capital ................. 301

15,000 6,000

Credit

21,000

2 No entry—not a transaction. 3 Rent Expense ............................. 726 Cash ........................................ 101

950

3 Supplies ...................................... 126 Accounts Payable .................. 201

1,750

10 Accounts Receivable ................. 112 Service Revenue .................... 400

975

20 Cash ............................................ 101 Service Revenue .................... 400

1,200

21 Cash ............................................ 101 Accounts Receivable ............. 112

800

23 Cash ............................................ 101 Unearned Revenue ................ 209

1,000

28 Accounts Payable ...................... 201 Cash ........................................ 101

900

29 Salaries Expense ........................ 729 Cash ........................................ 101

1,900

950

1,750

975

1,200

800

1,000

900

1,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4A (Continued) (a) (Continued) Date

Account Titles and Explanation Ref.

Debit

Apr. 29 F. Virmani, Drawings .................. 306 Cash ........................................ 101

1,500

30 Telephone Expense .................... 737 Accounts Payable .................. 201

155

Credit

1,500

155

(b) Cash Date Apr.

Explanation 1 3 20 21 23 28 29 29

Ref.

Debit

J1 J1 J1 J1 J1 J1 J1 J1

15,000 950 1,200 800 1,000 900 1,900 1,500

Accounts Receivable Explanation Ref. Debit

Date Apr. 10 21

J1 J1

Apr.

Explanation 3

15,000 14,050 15,250 16,050 17,050 16,150 14,250 12,750

No. 112 Credit Balance

975 800

Supplies Date

No. 101 Credit Balance

975 175

Ref.

Debit

No. 126 Credit Balance

1,750

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4A (Continued) (b) (Continued)

Date Apr.

3 28 30

6,000

Debit

No. 201 Credit Balance

J1 J1 J1 Unearned Revenue Explanation Ref.

Date Apr. 23

Date Apr. 29

Date Apr. 10 20

1,750 900 155

Debit

J1 F. Virmani, Capital Explanation Ref.

Date Apr.

Debit

No. 151 Credit Balance

Accounts Payable Explanation Ref.

Date Apr.

Office Equipment Explanation Ref.

Service Revenue Explanation Ref. J1 J1

1,000

No. 301 Credit Balance 21,000

F. Virmani, Drawings Explanation Ref. Debit J1

No. 209 Credit Balance 1,000

Debit

1,750 850 1,005

21,000

No. 306 Credit Balance

1,500

Debit

No. 400 Credit Balance 975 1,200

975 2,175

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4A (Continued) (b) (Continued)

Date Apr.

Date Apr. 29

Date Apr. 30

Rent Expense Explanation Ref.

Debit

No. 726 Credit Balance

950

Salaries Expense Explanation Ref.

Debit

No. 729 Credit Balance

1,900

Telephone Expense Explanation Ref.

Debit

No. 737 Credit Balance

155

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4A (Continued) (c) VIRMANI ARCHITECTS Trial Balance April 30, 2011 Debit Cash............................................................. $12,750 Accounts receivable ................................... 175 Supplies ...................................................... 1,750 Office equipment ........................................ 6,000 Accounts payable ....................................... Unearned revenue ...................................... F. Virmani, capital ....................................... F. Virmani, drawings................................... 1,500 Service revenue .......................................... Rent expense .............................................. 950 Salaries expense......................................... 1,900 Telephone expense .................................... 155 $25,180

Credit

$1,005 1,000 21,000 2,175

______ $25,180

Taking It Further A transaction should be recorded when it causes the company’s financial position (its assets, liabilities, and/or owner’s equity) to change. On May 2nd, an accounting transaction has not occurred. There is only an agreement between the employer, Virmani Architects, and the employee to enter into a business transaction beginning on May 2 nd. No asset, liability, revenue, expense or owner’s equity account has been affected. On May 30th, an accounting transaction has occurred; a liability and an expense have occurred since telephone services have been used by Virmani Architects. Therefore, an accounting transaction needs to be recorded.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5A (a) Date May

GENERAL JOURNAL Account Titles and Explanation 1 Cash .................................................... Office Equipment................................ J. Abramson, Capital .....................

Debit

Credit

40,000 10,000 50,000

1 No entry—not a transaction. 2 Prepaid Insurance .............................. Cash ................................................

3,300

5 Rent Expense ..................................... Prepaid Rent ....................................... Cash ................................................

2,400 2,400

8 Office Equipment................................ Cash ................................................ Notes Payable ................................

17,000

9 Supplies .............................................. Cash ................................................

500

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

750

17 Accounts Receivable ......................... Service Revenue ............................

3,000

22 Telephone Expense ............................ Cash ................................................

250

25 Cash .................................................... Service Revenue ............................

1,100

3,300

4,800

7,000 10,000

500

750

3,000

250

1,100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5A (Continued) (a) (Continued) Date

Account Titles and Explanation

Debit

May 26 J. Abramson, Drawings...................... Cash ................................................

1,600

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

2,500

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

750

30 Interest Expense................................. Cash ................................................

31 Cash .................................................... Unearned Service Revenue ...........

500

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

2,475

Credit

1,600

2,500

750

500

2,475

(b)

May 1 25 28 31

Bal.

Cash May 40,000 2 1,100 5 2,500 8 500 9 22 26 30 30 31 23,375

Office Equipment 3,300 4,800 7,000 500 250 1,600 750 50 2,475

May 1 8 Bal.

10,000 17,000 27,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5A (Continued) (b) (Continued) J. Abramson, Capital May 1 50,000 Bal. 50,000

May 5 Bal.

May 9 15 Bal.

Prepaid Insurance May 2 3,300 Bal. 3,300

Prepaid Rent 2,400 2,400

Rent Expense May 5 2,400 Bal. 2,400

Notes Payable May 8 10,000 Bal. 10,000

Accounts Payable May 30 750 May 15 Bal.

Supplies 500 750 1,250

Service Revenue May 17 3,000 25 1,100 Bal. 4,100

Accounts Receivable May 17 3,000 May 28 2,500 Bal. 500

Telephone Expense May 22 250 Bal. 250

J. Abramson, Drawings May 26 1,600 Bal. 1,600

Interest Expense May 30 50 Bal. 50

Unearned Service Revenue May 31 500 Bal. 500

750 0

Salaries Expense May 31 2,475 Bal. 2,475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5A (Continued) (c) ABRAMSON FINANCIAL SERVICES Trial Balance May 31, 2011 Debit Cash............................................................. $23,375 Accounts receivable ................................... 500 Supplies ...................................................... 1,250 Prepaid insurance....................................... 3,300 Prepaid rent................................................. 2,400 Office equipment ........................................ 27,000 Unearned service revenue ......................... Notes payable ............................................. J. Abramson, capital................................... J. Abramson, drawings .............................. 1,600 Service revenue .......................................... Interest expense ......................................... 50 Rent expense .............................................. 2,400 Salaries expense......................................... 2,475 Telephone expense .................................... 250 $64,600

Credit

$ 500 10,000 50,000 4,100

______ $64,600

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5A (Continued) Taking It Further This is not true. The cash account shows an increase of $23,375 during the month of May, whereas the company shows a loss of $1,075 for the month ($4,100 - $50 - $2,400 - $2,475 - $250). The change in the cash account does not reflect profit or loss because not all transactions represent increases in revenues or expenses. One of the major sources of cash during the month is an investment by the owner of $40,000. This increases owner’s equity, but is not a source of revenue for the company. The company received cash in advance of doing work (unearned service revenue of $500) and performed services in advance of payment ($500), as well as making non-expense payments for services in advance (prepaid rent and insurance), payments for office equipment and for owner drawings. The statement of cash flows reconciles the changes in the cash account to its various uses and sources.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6A (a) GENERAL JOURNAL Date

Account Titles and Explanation

June 2 Film Rental Expense ......................... Cash............................................... Accounts Payable .........................

Debit

Credit

22,000 10,000 12,000

2 No entry—not a transaction. 3 No entry—not a transaction. 9 Cash ................................................... Admission Revenue .....................

16,300

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

12,000

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

5,000

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

950

20 Cash ................................................... Admission Revenue .....................

16,600

21 Film Rental Expense ......................... Cash............................................... Accounts Payable .........................

9,000

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

4,200

16,300

12,000

5,000

950

16,600

4,500 4,500

4,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6A (Continued) (a) (Continued) Date

Account Titles and Explanation

Debit

June 30 Cash ................................................... Accounts Receivable ........................ Concession Revenue ...................

765 765

30 Cash ................................................... Admission Revenue .....................

18,400

30 Mortgage Payable ............................. Interest Expense ............................... Cash...............................................

1,250 475

Credit

1,530

18,400

1,725

(b) and (c) Cash Date Explanation June 1 Balance 2 9 10 10 11 20 21 29 30 30 30

Date June 30

Ref. ✓

Debit

Credit Balance 15,000 10,000 5,000 16,300 21,300 12,000 9,300 5,000 4,300 950 3,350 16,600 19,950 4,500 15,450 4,200 11,250 765 12,015 18,400 30,415 1,725 28,690

Accounts Receivable Explanation Ref. Debit

Credit Balance

765

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6A (Continued) (b) and (c) (Continued) Land Date

Explanation

Ref.

Debit

Credit Balance

✓

June 1 Balance

85,000

Buildings Date

Explanation

Ref.

Debit

Credit Balance

✓

June 1 Balance

70,000

Equipment Date

Explanation

June 1 Balance

Date

Credit Balance 20,000

Debit

Credit Balance

✓ 12,000 12,000 5,000 4,500

Mortgage Payable Explanation Ref.

5,000 17,000 5,000 0 4,500

Debit

Credit Balance

1,250

118,000 116,750

N. Fedkovych, Capital Explanation Ref. Debit

Credit Balance

June 1 Balance 30

Date

Debit

✓

Accounts Payable Explanation Ref.

June 1 Balance 2 10 10 21

Date

Ref.

June 1 Balance

✓

67,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6A (Continued) (b) and (c) (Continued)

Date

Admission Revenue Explanation Ref.

Debit

June 9 20 30

Date

16,300 16,600 18,400 Concession Revenue Explanation Ref. Debit

June 30

Date

Credit Balance

950

Debit

Credit Balance

22,000 9,000

22,000 31,000

Debit

Credit Balance

475

Debit

Credit Balance

4,200

Film Rental Expense Explanation Ref.

Interest Expense Explanation Ref.

June 30

Date June 29

1,530

Advertising Expense Explanation Ref. Debit

June 2 21

Date

16,300 32,900 51,300

Credit Balance 1,530

June 11

Date

Credit Balance

Salaries Expense Explanation Ref.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6A (Continued) (d) VISTA THEATRE Trial Balance June 30, 2011 Debit

Credit

Cash ............................................................ $28,690 Accounts receivable .................................. 765 Land ............................................................. 85,000 Buildings ..................................................... 70,000 Equipment ................................................... 20,000 Accounts payable ....................................... $ 4,500 Mortgage payable ....................................... 116,750 N. Fedkovych, capital ................................. 67,000 Admission revenue..................................... 51,300 Concession revenue................................... 1,530 Advertising expense ................................... 950 Film rental expense .................................... 31,000 Interest expense ......................................... 475 Salaries expense ........................................ 4,200 _______ $241,080 $241,080 Taking It Further The trial balance shows a net profit for the month of June of $16,205 ($51,300 + $1,530 - $950 - $31,000 - $475 - $4,200). Although a positive net profit is a good indication of the company’s profitability, it is not sufficient information to determine whether Vista Theatre is a sound company. One month’s transactions do not indicate a pattern of profitability in particular for businesses such as theatres where revenues tend to be seasonal. The financial results for the entire year should be examined, as well as comparative amounts for previous years to determine if the company has a trend of profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7A (a) Date Dec.

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

1 Cash ......................................................... 5,000 Note Payable .......................................

5,000

2 Equipment................................................ 5,500 Cash .....................................................

5,500

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

850 850

4 Cash ......................................................... 5,550 Accounts Receivable .......................... 7 Insurance Expense .................................. Cash .....................................................

365 365

9 Accounts Payable ................................... 2,900 Cash ..................................................... 10 Unearned Revenue .................................. Laundry Revenue ................................

2,900

800 800

11 Cash ......................................................... 1,350 Laundry Revenue ................................ 15 Supplies ................................................... Accounts Payable ...............................

5,550

1,350

400

20 Accounts Receivable .............................. 5,750 Laundry Revenue ................................

400

5,750

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7A (Continued) (a) (Continued) Dec. 22 Salaries Expense .................................... 1,450 Cash .....................................................

1,450

24 J. Cochrane, Drawings ............................ 3,000 Cash .....................................................

3,000

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

425

30 Note Payable ............................................ Interest Expense...................................... Cash .....................................................

500 25

31 Utilities Expense...................................... Accounts Payable ...............................

615

425

525

615

(b) and (c) Dec. 1 1 4 11 29

Bal.

Cash 2,800 Dec. 2 5,000 2 5,550 7 1,350 9 425 22 24 30 535

5,500 850 365 2,900 1,450 3,000 525

Accounts Receivable Dec. 1 6,800 Dec. 4 5,550 20 5,750 Bal. 7,000

Supplies Dec. 1 1,100 15 400 Bal. 1,500 J. Cochrane, Drawings Dec. 1 33,000 24 3,000 Bal. 36,000 Laundry Equipment Dec. 1 21,000 2 5,500 Bal. 26,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7A (Continued) (b) and (c) (Continued) Notes Payable Dec. 30 500 Dec. 1 5,000 Bal. 4,500 Accounts Payable Dec. 9 2,900 Dec. 1 5,765 15 400 31 615 Bal. 3,880 Unearned Revenue Dec. 10 800 Dec. 1 1,300 29 425 Bal. 925 J. Cochrane, Capital Dec. 1 19,500 Laundry Revenue Dec. 1 69,900 10 800 11 1,350 20 5,750 Bal. 77,800

Insurance Expense Dec. 1 4,015 7 365 Bal. 4,380 Rent Expense Dec. 1 9,350 2 850 Bal. 10,200 Salaries Expense Dec. 1 11,525 22 1,450 Bal. 12,975 Utilities Expense Dec. 1 6,875 31 615 Bal. 7,490 Interest Expense Dec. 30 25 Bal. 25

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7A (Continued) (d) COLLEGIATE LAUNDRY Trial Balance December 31, 2011 Debit

Credit

Cash............................................................. $ 535 Accounts receivable ................................... 7,000 Supplies ...................................................... 1,500 Laundry equipment .................................... 26,500 Note payable ............................................... $ 4,500 Accounts payable ....................................... 3,880 Unearned revenue ...................................... 925 J. Cochrane, capital .................................... 19,500 J. Cochrane, drawings ............................... 36,000 Laundry revenue ......................................... 77,800 Insurance expense ..................................... 4,380 Rent expense .............................................. 10,200 Salaries expense......................................... 12,975 Utilities expense ......................................... 7,490 Interest expense ......................................... 25 _______ $106,605 $106,605 Taking It Further The cash balance has decreased from $2,800 to $535 during the month of December. This is a substantial decrease from the opening balance and exposes the company to the possibility of not being able to pay its outstanding liabilities. The company borrowed $5,000 at the beginning of December and used this cash to purchase laundry equipment for $5,500. Had the company not purchased the additional equipment, the cash balance for the month would have been $1,560 ($535 + $5,500 $5,000 + $525 payment on the note payable). This still represents a substantial decrease from the November ending balance and is cause for concern.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7A (Continued) Taking It Further (Continued) During the month of January, the company should collect outstanding receivables as quickly as possible (in particular those amounts still outstanding from November) and reduce owner drawings. The company will also need to ensure the new pressing machine generates additional cash as soon as possible. The owner should also re-examine the amount and timing for the staff bonus.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-8A (a) ABRAMSON FINANCIAL SERVICES Income Statement Month Ended May 31, 2011

Revenues Service revenue .................................................. Expenses Interest expense ................................. $ 50 Rent expense ...................................... 2,400 Salaries expense................................. 2,475 Telephone expense ............................ 250 Total expenses ............................................... Loss .........................................................................

$4,100

5,175 $(1,075)

(b) ABRAMSON FINANCIAL SERVICES Statement of Owner's Equity Month Ended May 31, 2011

J. Abramson, capital, May 1, 2011.......................... Add: Investment ...................................................... Less: Loss .............................................. $ 1,075 Drawings ....................................... 1,600 J. Abramson, capital, May 31, 2011........................

0 50,000 50,000

2,675 $47,325

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-8A (Continued) (c) ABRAMSON FINANCIAL SERVICES Balance Sheet May 31, 2011 Assets Cash ........................................................................... $ 23,375 Accounts receivable ................................................. 500 Supplies ..................................................................... 1,250 Prepaid insurance ..................................................... 3,300 Prepaid rent ............................................................... 2,400 Office equipment ...................................................... 27,000 Total assets ........................................................... $57,825 Liabilities and Owner's Equity Liabilities Note payable ......................................................... $ 10,000 Unearned service revenue ................................... 500 10,500 Owner's Equity J. Abramson, Capital ............................................ 47,325 Total liabilities and owner's equity ................. $57,825 Taking It Further In its first month of operations Abramson Financial Services generated more expenses than revenues resulting in a loss of $1,075. Since this is a new business, it may take a few months for revenues to reach and exceed the level of expenses. Jacob will need to monitor the revenues generated as compared to expenses incurred to ensure the company reaches profitability as soon as possible.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9A (a)

GENERAL JOURNAL

Date

Account Titles and Explanation

Jan. 2

No entry.

Debit

Credit

Cash ....................................................... 5,000 L. Mataruka, Capital ..........................

5,000

Repair Parts Inventory .......................... 5,200 Accounts Payable .............................

5,200

Miscellaneous Expense ........................ 1,300 Cash...................................................

1,300

Cash ....................................................... 7,200 Accounts Receivable........................

7,200

Accounts Payable ................................. 6,500 Cash...................................................

6,500

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

600 600

Shop Equipment .................................... 4,800 Cash...................................................

4,800

Cash ....................................................... 5,000 Accounts Receivable ............................ 15,000 Repair Services Revenue .................

20,000

Wages Expense ..................................... 2,900 Cash...................................................

2,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9A (Continued) (a) (Continued) 30

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

900 900

L. Mataruka, Drawings .......................... Cash...................................................

500

1,800

Repair Parts Expense ........................... 4,500 Repair Parts Inventory .....................

500

4,500

(b) and (c)

Jan. 1 3 10

Bal.

Cash 2,000 5,000 Jan. 6 7,200 15 19 20 5,000 30 31 31 800

1,300 6,500 600 4,800 2,900 1,800 500

Accounts Receivable Jan. 1 16,500 29 15,000 Jan. 10 7,200 Bal. 24,300 Repair Parts Inventory Jan. 1 16,000 4 5,200 Jan. 31 4,500 Bal. 16,700 Prepaid Rent Jan. 30 900 Bal.

900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9A (Continued) (b) and (c) (Continued) Shop Equipment Jan. 1 28,000 20 4,800 Bal. 32,800

Repair Services Revenue Jan. 29 20,000

Accounts Payable Jan. 1 23,000 Jan. 15 6,500 4 5,200 Bal. 21,700 Unearned Revenue Jan. 1 2,000 Bal.

Advertising Expense Jan. 19 600 Miscellaneous Expense Jan. 6 1,300

Rent Expense Jan. 30 900

2,000

L. Mataruka, Capital Jan. 1 37,500 3 5,000 Bal. 42,500 L. Mataruka, Drawings Jan. 31 500

Repair Parts Expense Jan. 31 4,500

Wages Expense Jan. 30 2,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9A (Continued) (d) CYBERDYNE REPAIR SERVICE Trial Balance January 31, 2011 Debit Cash ................................................................. Accounts receivable ....................................... Repair parts inventory .................................... Prepaid rent ..................................................... Shop equipment .............................................. Accounts payable............................................ Unearned revenue ........................................... L. Mataruka, capital ......................................... L. Mataruka, drawings ..................................... Repair services revenue ................................. Advertising expense ....................................... Miscellaneous expense .................................. Rent expense ................................................... Repair parts expense ...................................... Wages expense ...............................................

Credit

$ 800 24,300 16,700 900 32,800 $21,700 2,000 42,500 500 20,000 600 1,300 900 4,500 2,900 _______ $86,200 $86,200

Taking It Further The purchase of repair parts inventory is a debit to an asset. When the repair parts are consumed as part of the service, the cost will be transferred to the income statement as an expense. The purchase is debited to an asset account because the costs of repair parts will benefit a future accounting period when the repair service is performed.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-10A (a) CYBERDYNE REPAIR SERVICE Income Statement Month Ended January 31, 2011 Revenues Repair services revenue.............................................

$20,000

Expenses Advertising expense .................................... 0$ 600 Miscellaneous expense ............................... 1,300 Rent expense ............................................... 900 Repair parts expense .................................. 4,500 Wages expense ............................................ 2,900 Total expenses .......................................................

10,200

Profit.................................................................................

$ 9,800

(b) CYBERDYNE REPAIR SERVICE Statement of Owner's Equity Month Ended January 31, 2011 L. Mataruka, capital, January 1, 2011 ............................. Add: Investment .............................................. $5,000 Profit ....................................................... 9,800 Less: Drawings ................................................. L. Mataruka, capital, January 31, 2011 ...........................

$37,500 14,800 52,300 500 $51,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-10A (Continued) (c) CYBERDYNE REPAIR SERVICE Balance Sheet January 31, 2011 Assets Cash ................................................................................... $ 800 Accounts receivable ......................................................... 24,300 Repair parts inventory ...................................................... 16,700 Prepaid rent ....................................................................... 900 Shop equipment ................................................................ 32,800 Total assets ................................................................... $75,500 Liabilities and Owner's Equity Liabilities Accounts payable ......................................................... $21,700 Unearned revenue ........................................................ 2,000 Total liabilities .......................................................... 23,700 Owner's Equity L. Mataruka, capital ......................................................

51,800

Total liabilities and owner's equity ......................... $75,500 Taking It Further I would explain to Leo that there is a difference between cash and profit. Although the company has earned revenue, which increases income, it has not collected the cash. Plus the company has purchased additional assets (equipment and repair parts inventory) which have used cash even though this has not reduced income. Therefore, Leo will need to invest more cash in the business to pay his accounts payable unless he can collect his accounts receivables quickly. Solutions Manual 2-74 Chapter 2 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11A (a) SUPER DELIVERY SERVICE Trial Balance August 31, 2011

Debit Credit Cash (to balance debits = credits*) ........... $ 6,765 Accounts receivable .................................. 4,275 Supplies ...................................................... 265 Prepaid insurance ...................................... 405 Delivery equipment .................................... 49,720 Notes payable ............................................. $19,500 Accounts payable....................................... 3,235 Salaries payable ......................................... 925 Unearned revenue ...................................... 675 J. Rowe, capital .......................................... 48,750 J. Rowe, drawings ...................................... 24,400 Service revenue .......................................... 37,780 Gas and oil expense ................................... 12,145 Insurance expense ..................................... 2,020 Interest expense ......................................... 975 Repair expense ........................................... 1,580 Salaries expense ........................................ 5,665 Supplies expense ....................................... 2,650 _______ $110,865 $110,865 * Total debits without cash = $104,100 $110,865 − $104,100 = $6,765

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11A (Continued) (b) SUPER DELIVERY SERVICE Income Statement Year Ended August 31, 2011 Revenues Service revenue .................................................... $37,780 Expenses Gas and oil expense ................................ $12,145 Insurance expense .................................. 2,020 Interest expense ...................................... 975 Repair expense ........................................ 1,580 Salaries expense...................................... 5,665 Supplies expense .................................... 2,650 Total expenses ................................................. 025,035 Profit .......................................................................... $12,745

SUPER DELIVERY SERVICE Statement of Owner's Equity Year Ended August 31, 2011 J. Rowe, capital, August 31, 2010 ............................ $48,750 Plus: Profit .............................................................. 12,745 61,495 Less: Drawings......................................................... 24,400 J. Rowe, capital, August 31, 2011 ............................ $37,095

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11A (Continued) (b) (Continued) SUPER DELIVERY SERVICE Balance Sheet August 31, 2011 Assets Cash ........................................................................... $ 6,765 Accounts receivable ................................................. 4,275 Supplies ..................................................................... 265 Prepaid insurance ..................................................... 044405 Delivery equipment ................................................... 49,720 Total assets ........................................................... $61,430 Liabilities and Owner's Equity Liabilities Notes payable ....................................................... $19,500 Accounts payable ................................................. 3,235 Salaries payable.................................................... 925 Unearned revenue ................................................ 675 Total liabilities .................................................. 24,335 Owner's Equity J. Rowe, capital ..................................................... 37,095 Total liabilities and owner's equity ................. $61,430

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11A (Continued) Taking It Further Jan Rowe has withdrawn more cash than profit. This has resulted in a net decrease to the owner’s capital account. Jan’s drawings have left the company with a low level of liquid assets (Cash of $6,765 + Accounts receivable of $4,275 = $11,040) to pay off liabilities (Notes payable of $19,500 + Accounts payable of $3,235 + Salaries payable of $925 = $23,660). Jan’s drawings should be based on her cash budget for the coming year and leave the company able to meet its liabilities with sufficient cash to be able to grow.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-12A (a)

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

Incorrect Incorrect Incorrect Incorrect Correct Incorrect Incorrect Incorrect Incorrect Incorrect

(b) 1 2

3 4

5 6 7 8

1 No

2 Accounts Receivable Yes Accounts Receivable Service Revenue No Interest Revenue Yes Salary Expense Drawings Yes None No Accounts Payable No Unearned Revenue Yes Cash Salaries Payable

3 Understated $297 Understated $2,000 Understated $2,000 Understated $750 Overstated $1,000 Understated $1,000 N/A Understated $5,000 Understated $500 Overstated $495 Overstated $495

4 Increase by $297 Increase by $2,000

Yes Yes

Yes Yes Yes Decrease by $495

5 Yes Increase by $2,000

Increase by $750 Yes

Yes Increase by $5,000 Increase by $500 Decrease by $495

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-12A (Continued) (b) (Continued) 9

1 2 Yes Equipment

Accounts Payable 10 Yes Utilities Expense Accounts Payable

3 Overstated $3,600 Overstated $3,600 Understated $650 Understated $650

4 Decrease by $3,600

5 Decrease by $3,600

Increase by $650

Taking It Further Disagree. Even though the trial balance is balanced, uncorrected errors misstate the financial position of the company. 2.

This error understates Service Revenue and shows a lower profit on the income statement. 4. This error overstates Salary Expense and thereby lowers profit on the income statement. 8. This error shows higher liabilities by overstating Salaries Payable and higher assets by overstating Cash. 9. This error shows higher liabilities by overstating Accounts Payable and higher assets by overstating Equipment. It will most likely lead to an overpayment for the equipment when the Accounts Payable are paid. 10. This error understates Utilities Expense and understates Accounts Payable. It results in a higher profit on the income statement because of the unrecorded expense that was consumed in generating the profits.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-13A (a) WINTER CO. Trial Balance June 30, 2011

Debit

Credit

Cash ($2,635 + $570 - $750) .................................. $ 2,455 Accounts receivable ($1,942 + $750 - $570 + $890 - $89) .................................................... 2,923 Prepaid insurance (correct balance provided) .... 565 Supplies ($500 + $360) .......................................... 860 Equipment ($6,400 - $360) .................................... 6,040 Accounts payable ($2,200 + $502 - $205) ............ $ 2,497 Unearned fees (correct balance provided) .......... 1,765 F. Winter, capital (correct balance provided) ...... 11,231 F. Winter, drawings ($800 + $400) ........................ 1,200 Fees earned ($2,680 - $2,680 + $2,860) ................ 2,860 Office expense ($1,010 + $700)............................. 1,710 Salaries expense ($3,000 - $400) .......................... 2,600 $18,353 $18,353 Taking It Further There could still be errors after correcting the items identified. The errors could be counter-balancing errors that affect both the debit and credit side equally, such as a transposition error in recording a journal entry that affects both the debit and credit sides, or errors that counter-balance on the debit side, or on the credit side, of the trial balance (items #1, 2 and 6). The trial balance could also be in balance and not show transactions that have been omitted but that should have been recorded.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-1B (a) Account Wages Payable Wages Expense W. Isaacson, Drawings

(1) Type of Account Liability Expense Drawings

W. Isaacson, Capital

Owner’s Capital

Unearned Medical Fees Rent Revenue Rent Expense Prepaid Rent Office Supplies Expense Office Supplies Office Equipment Notes Payable Medical Fees Earned Interest Expense Insurance Expense

Liability Revenue Expense Asset Expense Asset Asset Liability Revenue Expense Expense

Solutions Manual

(2) Financial Statement Balance Sheet Income Statement Statement of Owner’s Equity Balance Sheet and Statement of Owner’s Equity Balance Sheet Income Statement Income Statement Balance Sheet Income Statement Balance Sheet Balance Sheet Balance Sheet Income Statement Income Statement Income Statement

(3) Normal Balance Credit Debit Debit

(4)

(5)

Increase Credit Debit Debit

Decrease Debit Credit Credit

Credit

Debit

Credit Credit Debit Debit Debit Debit Debit Credit Credit Debit Debit

Debit Debit Credit Credit Credit Credit Credit Debit Debit Credit Credit

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-1B (Continued) (a) (Continued)

Account Furniture Computer Cash Accounts Receivable Accounts Payable

(1) Type of Account Asset Asset Asset Asset Liability

(2) Financial Statement Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet

(3) Normal Balance Debit Debit Debit Debit Credit

(4)

(5)

Increase Debit Debit Debit Debit Credit

Decrease Credit Credit Credit Credit Debit

Solutions Manual

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-2B (a)

Basic Type Expense Asset

Account Debited (2) Specific Account Rent Expense Sewing Supplies

Effect + $475 + $250

Asset

Cash

+ $750

(1) Transaction Feb. 1 2 6 7 10

No transaction at this point in time (see Feb. 15). Asset Cash + $250 Liability

Owner’s Equity Asset

Liability

Asset

K. Battistella, Drawings Accounts Receivable Accounts Payable Cash

28 28

Asset Asset

Cash Equipment

Solutions Manual

(3)

Account Credited (1) (2) Specific Basic Type Account Asset Cash Liability Accounts Payable Revenue Service Revenue

+ $700

Asset

+ $885

Revenue

- $250

Asset

+ $885

Asset

+ $2,000 + $2,500

Liability Asset

(3) Effect - $475 + $250 + $750

Unearned Revenue Cash

+ $250

Service Revenue Cash

+ $885

Accounts Receivable Note Payable Cash

- $885

- $700

- $250

+ $2,000 - $2,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-2B (Continued) (b) GENERAL JOURNAL Date Feb.

Account Titles and Explanation

Debit

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

475

2 Sewing Supplies .................................... Accounts Payable .............................

250

6 Cash ....................................................... Service Revenue ...............................

750

Credit

475

250

750

7 No transaction at this time. 10 Cash ....................................................... Unearned Revenue ...........................

250

12 K. Battistella, Drawings......................... Cash ...................................................

700

15 Accounts Receivable ............................ Service Revenue ...............................

885

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

250

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

885

28 Cash ....................................................... Notes Payable ...................................

2,000

28 Equipment.............................................. Cash ...................................................

2,500

250

700

885

250

885

2,000

2,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-2B (Continued) Taking It Further The normal balance of an account represents its position in the accounting equation. Assets have a normal debit balance because they represent the left side of the accounting equation. Therefore transactions that increase assets are reflected by a debit to an asset account and transactions that decrease assets are reflected by a credit to the asset account. Liabilities and owner’s equity accounts have a normal credit balance because they represent the right side of the accounting equation. Revenues and expenses represent changes in the owner’s equity account. Expenses reduce owner’s equity and increases in expenses reduce the right (credit) side of the accounting equation; expenses have a normal debit balance.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-3B (a) Date Apr.

GENERAL JOURNAL Account Titles and Explanation

Debit

Credit

1 Cash ......................................................... 50,000 D. Tanner, Capital ............................... 50,000 3 Land ...................................................... 175,000 Building ................................................. 80,000 Equipment............................................. 65,000 Cash .................................................. 25,000 Notes Payable .................................. 295,000 8 Advertising Expense ............................... 2,800 Accounts Payable ...............................

2,800

13 Prepaid Insurance ................................... 5,500 Cash .....................................................

5,500

15 Cash ......................................................... 2,700 Admissions Revenue..........................

2,700

16 Salaries Expense ..................................... 1,800 Cash .....................................................

1,800

20 Accounts Receivable .............................. 1,500 Admissions Revenue..........................

1,500

22 No entry required 29 Cash ......................................................... 1,500 Accounts Receivable ..........................

1,500

30 Cash ......................................................... 5,900 Admissions Revenue..........................

5,900

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-3B (Continued) (a) (Continued) Date

Account Titles and Explanation Ref.

Debit

Credit

30 Accounts Payable ................................... 1,650 Cash .....................................................

1,650

30 Interest Expense...................................... 1,250 Cash .....................................................

1,250

30 D. Tanner, Drawings ................................ Cash .....................................................

600 600

Taking It Further The purpose of the journal entries is to show the debit and credit effects of each transaction on specific accounts. This helps to prevent and locate errors because the debit and credit amounts in the entry have to balance. The journal entries also provide a chronological record of transactions as well as give an explanation of the transaction and identify source documents. The next step in the recording process is to transfer the information to the ledger by posting the transactions to specific ledger accounts. Dustin should find the information generated by this next step more useful since posting transactions to the ledger will update the ledger account balances. Once this step is completed, a trial balance can be prepared from the ledger accounts as well as financial statements.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4B (a) GENERAL JOURNAL Date

Account Titles and Explanation Ref.

Debit

May

1 Cash ............................................. 101 Office Equipment......................... 151 G. Mancini, Capital .................. 301

20,000 8,500

1 Rent Expense .............................. 726 Cash ......................................... 101

950

Credit

28,500

950

2 No entry—not a transaction. 3 Office Supplies ............................ 126 Accounts Payable ................... 201

950

11 Accounts Receivable .................. 112 Accounting Fees Earned ........ 400

2,275

17 Cash ............................................. 101 Accounting Fees Earned ........ 400

1,350

21 Cash ............................................. 101 Accounts Receivable ............. 112

1,200

22 Cash ............................................. 101 Unearned Accounting Fees.... 209

3,500

23 Accounts Payable ....................... 201 Cash ($950 x 60%) .................. 101

570

30 Telephone Expense ..................... 737 Accounts Payable ................... 201

215

950

2,275

1,350

1,200

3,500

570

215

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4B (Continued) (a) (Continued) May 31 Salaries Expense ......................... 729 Cash ......................................... 101

2,400

31 G. Mancini, Drawings .................. 306 Cash ......................................... 101

925

CASH

No. 101 Credit Balance

2,400

925

(b)

Date May

Explanation 1 1 17 21 12 23 31 31

Debit

J1 J1 J1 J1 J1 J1 J1 J1

20,000 950 1,350 1,200 3,500 570 2,400 925

ACCOUNTS RECEIVABLE Explanation Ref. Debit

Date May

Ref.

11 21

J1 J1

20,000 19,050 20,400 21,600 25,100 24,530 22,130 21,205

No. 112 Credit Balance

2,275 1,200

2,275 1,075

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4B (Continued) (b) (Continued)

Date May

3 23 31

950

OFFICE EQUIPMENT Explanation Ref. Debit

No. 151 Credit Balance

8,500

ACCOUNTS PAYABLE Explanation Ref. Debit

No. 201 Credit Balance

J1 J1 J1

950 570

G. MANCINI, CAPITAL Explanation Ref. Debit

Date May

Debit

No. 126 Credit Balance

UNEARNED ACCOUNTING FEES Explanation Ref. Debit

Date May

OFFICE SUPPLIES Explanation Ref.

215

950 380 595

No. 209 Credit Balance 3,500

3,500

Credit

No. 301 Balance

28,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4B (Continued) (b) (Continued)

G. MANCINI, DRAWINGS Explanation Ref. Debit

Date May

11 17

Date May

Credit

No. 306 Balance

925

ACCOUNTING FEES EARNED Explanation Ref. Debit

No. 400 Credit Balance

J1 J1

2,275 1,350

2,275 3,625

RENT EXPENSE Explanation Ref.

Debit

No. 726 Credit Balance

950

SALARIES EXPENSE Explanation Ref. Debit

No. 729 Credit Balance

2,400

TELEPHONE EXPENSE Explanation Ref. Debit

No. 737 Credit Balance

215

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-4B (Continued) (c) MANCINI ACCOUNTING SERVICES Trial Balance May 31, 2011

Debit

Credit

Cash ............................................................ $21,205 Accounts receivable .................................. 1,075 Office Supplies ........................................... 950 Office equipment ........................................ 8,500 Accounts payable....................................... $ 595 Unearned accounting fees......................... 3,500 G. Mancini, capital ...................................... 28,500 G. Mancini, drawings ................................. 925 Accounting fees earned ............................. 3,625 Rent expense .............................................. 950 Salaries expense ........................................ 2,400 Telephone expense .................................... 215 _______ $36,220 $36,220 Taking It Further A transaction should be recorded when it causes the company’s financial position (its assets, liabilities, and owner’s equity) to change. On May 2nd, an accounting transaction has not occurred. There is only an agreement between the employer, Mancini Accounting Services, and the employee to enter into a business transaction beginning on May 2nd. No asset, liability, revenue, expense or owner’s equity account has been affected. On May 30th, an accounting transaction has occurred; a liability and an expense have occurred since telephone services have been used by Mancini Accounting Services. Therefore, an accounting transaction needs to be recorded.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5B (a) Date Nov.

GENERAL JOURNAL Account Titles and Explanation 1 Cash .................................................... Office Equipment................................ H. Kiersted, Capital ........................

Debit

Credit

35,000 12,000 47,000

2 No entry—not a transaction. 3 Rent Expense ..................................... Prepaid Rent ....................................... Cash ................................................

2,140 2,140

4 Insurance Expense ............................. Cash ................................................

395

5 Office Equipment................................ Cash ................................................ Notes Payable ................................

18,000

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

1,550

7 Supplies .............................................. Cash ................................................

475

16 Cash .................................................... Service Revenue ............................

990

20 Accounts Receivable ......................... Service Revenue ............................

4,500

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

1,000

4,280

395

6,000 12,000

1,550

475

990

4,500

1,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5B (Continued) (a) (Continued) Date

Account Titles and Explanation

Debit

Nov. 27 Telephone Expense ............................ Accounts Payable ..........................

220

27 Cash .................................................... Unearned Service Revenue ...........

750

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

2,800

30 Interest Expense................................. Cash ................................................

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

2,825

30 H. Kiersted, Drawings ........................ Cash ................................................

700

30 H. Kiersted, Drawings ........................ Cash ................................................

1,150

Credit

220

750

2, 800

2,825

700

1,150

(b) Nov. 1 16 27 29

Bal.

Cash 35,000 Nov 3 990 4 750 5 2,800 7 26 30 30 30 30 22,655

4,280 395 6,000 475 1,000 60 2,825 700 1,150

Office Equipment Nov. 1 12,000 5 18,000 Bal. 30,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5B (Continued) (b) (Continued) H. Kiersted, Capital Nov. 1 47,000 Bal. 47,000

Nov. 3 Bal.

Prepaid Rent 2,140 2,140

Rent Expense Nov. 3 2,140 Bal. 2,140

Notes Payable Nov. 5 12,000

Accounts Payable Nov 26 1,000 Nov 6 1,550 Nov 27 220 Bal. 770

Bal.

Nov. 6 7 Bal.

Insurance Expense Nov. 4 395 Bal. 395

12,000

Supplies 1,550 475 2,025

Accounts Receivable Nov. 20 4,500 Nov 29 2,800 Bal. 1,700 H. Kiersted, Drawings Nov. 30 700 Nov. 30 1,150 Bal. 1,850 Unearned Service Revenue Nov 27 750 Bal. 750

Service Revenue Nov 16 990 20 4,500 Bal. 5,490 Telephone Expense Nov. 27 220 Bal. 220 Interest Expense Nov. 30 Bal.

60 60

Salaries Expense Nov 30 2,825 Bal. 2,825

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5B (Continued) (c) KIERSTED FINANCIAL SERVICES Trial Balance November 30, 2011 Debit Cash............................................................. $22,655 Accounts receivable ................................... 1,700 Supplies ...................................................... 2,025 Prepaid rent................................................. 2,140 Office equipment ........................................ 30,000 Accounts payable ....................................... Unearned service revenue ......................... Notes payable ............................................. H. Kiersted, capital ..................................... H. Kiersted, drawings ................................. 1,850 Service revenue .......................................... Insurance expense ..................................... 395 Interest expense ......................................... 60 Rent expense .............................................. 2,140 Salaries expense......................................... 2,825 Telephone expense .................................... 220 $66,010

Credit

$ 770 750 12,000 47,000 5,490

______ $66,010

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-5B (Continued) Taking It Further This is not true. The cash account shows an increase of $22,655 during the month of May, whereas the company shows a loss of $150 for the month ($5,490 - $60 - $2,140 - $2,825 - $220 - $395). The change in the cash account does not reflect profit or loss because not all transactions represent increases in revenues or expenses. One of the major sources of cash during the month is an investment by the owner of $35,000. This increases owner’s equity, but is not a source of revenue for the company. The company received cash in advance of doing work (unearned service revenue of $750) and performed services in advance of payment ($1,700), as well as making non-expense payments for services in advance (prepaid rent), payments for office equipment and for owner drawings. The statement of cash flows reconciles the changes in the cash account to its various uses and sources.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (a) Date July

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

2 Film Rental Expense ........................... Cash .................................................

800

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

625

Credit

800

625

3 No entry—not a transaction. 5 No entry—not a transaction. 10 Cash ..................................................... Admissions Revenue......................

1,950

11 Mortgage Payable................................ Interest Expense.................................. Cash .................................................

2,000 500

12 Repair Expense ................................... Cash .................................................

350

15 Film Rental Expense ........................... Accounts Payable ...........................

750

25 Cash ..................................................... Admissions Revenue......................

5,500

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

3,200

28 Prepaid Rentals ................................... Cash .................................................

700

1,950

2,500

350

750

5,500

3,200

700

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) (a) (Continued) 30 F. Ferguson, Drawings ........................ Cash .................................................

1,200

31 Cash ..................................................... Accounts Receivable .......................... Concession Revenue......................

260 260

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

1,900

1,200

520

1,900

(b) and (c) Cash Date July

Explanation 1 Balance 2 2 10 11 12 25 26 28 30 31 31

Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

Credit Balance

800 625 1,950 2,500 350 5,500 3,200 700 1,200 260 1,900

6,000 5,200 4,575 6,525 4,025 3,675 9,175 5,975 5,275 4,075 4,335 2,435

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) (b) and (c) (Continued) Accounts Receivable Explanation

Date July 31

Ref.

Debit

Credit Balance

260

Ref.

Debit

Credit Balance

700

Ref.

Debit

Credit Balance

Prepaid Rentals Explanation

Date July 28

Land Date July

Explanation

✓

1 Balance

90,000

Buildings Date July

Explanation

Ref.

Debit

✓

1 Balance

Credit Balance 80,000

Equipment Date July

Explanation 1 Balance

Ref. ✓

Debit

Credit Balance 25,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) (b) and (c) (Continued) Accounts Payable Explanation

Date July

Ref. ✓ J1 J1

1 Balance 15 26

Debit

Credit Balance

3,200

5,000 5,750 2,550

Debit

Credit Balance

2,000

125,000 123,000

Debit

Credit Balance

750

Mortgage Payable Explanation

Date July

1 Balance 11

Ref. ✓ J1

F. Ferguson, Capital Explanation

Date July

1 Balance

Ref. ✓

71,000

F. Ferguson, Drawings Date

Explanation

July 30

Ref.

Debit

Credit Balance

1,200

Debit

Credit Balance

Admissions Revenue Date July 10 25

Explanation

Ref. J1 J1

1,950 5,500

1,950 7,450

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) (b) and (c) (Continued) Concession Revenue Explanation

Date July 31

Ref.

Debit

Credit Balance 520

520

Advertising Expense Explanation

Date July

Ref.

Debit

Credit Balance

625

Ref.

Debit

Credit Balance

J1 J1

800 750

800 1,550

Ref.

Debit

Credit Balance

500

Ref.

Debit

Credit Balance

350

Film Rental Expense Explanation

Date July

2 15

Interest Expense Date

Explanation

July 11

Repairs Expense Date July 12

Explanation

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) (b) and (c) (Continued) Salaries Expense Date July 31

Explanation

Ref.

Debit

Credit Balance

1,900

(d) HIGHLAND THEATRE Trial Balance July 31, 2011

Debit

Credit

Cash ............................................................ $ 2,435 Accounts receivable .................................. 260 Prepaid rentals ........................................... 700 Land ............................................................ 90,000 Buildings ..................................................... 80,000 Equipment................................................... 25,000 Accounts payable....................................... $ 2,550 Mortgage payable ....................................... 123,000 F. Ferguson, capital ................................... 71,000 F. Ferguson, drawings ............................... 1,200 Admissions revenue .................................. 7,450 Concession revenue .................................. 520 Advertising expense .................................. 625 Film rental expense .................................... 1,550 Interest expense ......................................... 500 Repairs expense ......................................... 350 Salaries expense ........................................ 1,900 _______ $204,520 $204,520

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-6B (Continued) Taking It Further The trial balance shows a net profit for the month of July of $3,045 ($7,450 + $520 - $625 - $1,550 - $1,900 - $350 - $500). Although a positive net profit is a good indication of the company’s profitability, it is not sufficient information to determine whether Highland Theatre is a sound company. One month’s transactions does not indicate a pattern of profitability in particular for businesses such as theatres where revenues tend to be seasonal. The financial results for the entire year should be examined, as well as comparative amounts for previous years to determine if the company has a trend of profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (a) Date July

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

2 Rent Expense .......................................... 1,035 Cash .....................................................

1,035

3 Equipment................................................ 5,100 Cash ..................................................... Note Payable .......................................

1,500 3,600

5 Cash ......................................................... 3,285 Accounts Receivable ..........................

3,285

10 Unearned Revenue .................................. 1,920 Dry Cleaning Revenue ........................

1,920

11 Cash ......................................................... 4,730 Dry Cleaning Revenue ........................

4,730

13 Accounts Payable ................................... 9,742 Cash .....................................................

9,742

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

495 495

24 Accounts Receivable .............................. 5,950 Dry Cleaning Revenue ........................

5,950

25 Cash ......................................................... 5,200 Note Receivable .................................. Interest Revenue .................................

5,000 200

26 No entry—not a transaction.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (Continued) (a) (Continued) July 27 Cash ......................................................... Unearned Revenue .............................

650 650

28 Utilities Expense...................................... 1,320 Accounts Payable ...............................

1,320

29 Salaries Expense ..................................... 5,250 Cash .....................................................

5,250

31 E. Brisebois, Drawings............................ 3,370 Cash .....................................................

3,370

31 Note Payable ............................................ Interest Expense...................................... Cash .....................................................

300 20 320

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (Continued) (b) and (c) Cash Jul. 1 11,660 Jul. 2 3 5 3,285 11 4,730 13 25 27

Bal.

5,200 650

29 31 31

1,035 1,500 9,742

5,250 3,370 320

4,308

Accounts Receivable Jul. 1 5,845 Jul. 5 3,285 24 5,950 Bal. 8,510

Jul. Bal.

Notes Receivable 1 5,000 Jul. 25 5,000 0

Notes Payable Jul. 31 300 Jul. 3 Bal.

3,600 3,300

Accounts Payable Jul. 13 9,742 Jul. 1 13,090 14 495 28 1,320 Bal. 5,163 Unearned Revenue Jul. 10 1,920 Jul. 1 1,920 27 650 Bal. 650 E. Brisebois, Capital Jul. 1 55,920 E. Brisebois, Drawings Jul. 1 37,050 31 3,370 Bal. 40,420

Supplies Jul. 1 3,975 14 495 Bal. 4,470 Equipment Jul. 1 31,480 3 5,100 Bal. 36,580

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (Continued) (b) and (c) (Continued) Dry Cleaning Revenue Jul. 1 109,455 10 1,920 11 4,730 24 5,950 Bal. 122,055 Interest Revenue Jul. 25

200

Salaries Expense Jul. 1 57,750 29 5,250 Bal. 63,000

Bal.

Rent Expense 1 11,385 2 1,035 12,420

Jul.

Repair Expense 1 1,720

Jul.

Utilities Expense Jul. 1 14,520 28 1,320 Bal. 15,840 Interest Expense Jul. 31 20

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (Continued) (d) BRISEBOIS DRY CLEANERS Trial Balance July 31, 2011 Debit

Credit

Cash ............................................................ $ 4,308 Notes receivable ......................................... 0 Accounts receivable .................................. 8,510 Supplies ...................................................... 4,470 Equipment................................................... 36,580 Accounts payable....................................... $ 5,163 Note payable ............................................... 3,300 Unearned revenue ...................................... 650 E. Brisebois, capital ................................... 55,920 E. Brisebois, drawings ............................... 40,420 Dry cleaning revenue ................................. 122,055 Interest revenue.......................................... 200 Interest expense ......................................... 20 Rent expense .............................................. 12,420 Repair expense ........................................... 1,720 Salaries expense ........................................ 63,000 Utilities expense ......................................... 15,840 _______ $187,288 $187,288

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-7B (Continued) Taking It Further The cash balance has decreased from $11,660 to $4,308 during the month of July. This is a substantial decrease from the opening balance and exposes the company to the possibility of not being able to pay its outstanding liabilities. The company borrowed $3,600 at the beginning of July and used this cash to purchase equipment for $5,100. Had the company not purchased the additional equipment, the cash balance for the month would have been $6,128 ($4,308 + $1,500 + $320 payment on the note payable). This still represents a substantial decrease from the June ending balance. Depending on the timing of the repayment of the note payable, the company may be able to generate sufficient cash from the collection of its account receivable to be able to honour its commitments on its liabilities. During the month of August, the company should collect outstanding receivables as quickly as possible (in particular those amounts still outstanding from June) and reduce owner drawings. The company will also need to ensure the new machine generates additional cash as soon as possible.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-8B (a) KIERSTED FINANCIAL SERVICES Income Statement Month Ended November 30, 2011 Revenues Service revenue ..................................................... $ 5,490 Expenses Insurance expense .................................. $00,395 Interest expense ...................................... 60 Rent expense ........................................... 2,140 Salaries expense...................................... 2,825 Telephone expense ................................. 220 Total expenses .................................................. 5,640 Loss............................................................................. $ (150) (b) KIERSTED FINANCIAL SERVICES Statement of Owner's Equity Month Ended November 30, 2011 H. Kiersted, capital, November 1, 2011 .................. Add: Investment ....................................................

0 47,000 47,000

Less: Loss ................................................. $ 150 Drawings ......................................... 1,850 2,000 H. Kiersted, capital, November 30, 2011 ................ $45,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-8B (Continued) (c) KIERSTED FINANCIAL SERVICES Balance Sheet November 30, 2011 Assets Cash .......................................................................... Accounts receivable ................................................ Supplies .................................................................... Prepaid rent .............................................................. Office equipment ...................................................... Total assets ..........................................................

$22,655 1,700 2,025 2,140 30,000 $58,520

Liabilities and Owner's Equity Liabilities Note payable ........................................................ Accounts payable ................................................ Unearned service revenue .................................. Total liabilities .................................................

$12,000 770 750 13,520

Owner's Equity H. Kiersted, capital .............................................. Total liabilities and owner's equity ................

45,000 $58,520

Taking It Further In its first month of operations Kiersted Financial Services generated more expenses than revenues resulting in a loss of $150. Since this is a new business, it may take a few months for revenues to reach and exceed the level of expenses. Haakon will need to monitor the revenues generated as compared to expenses incurred to ensure the company reaches profitability as soon as possible.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9B (a)

GENERAL JOURNAL Account Titles and Explanation

Apr.

Debit

Credit

1 Cash ........................................................ 12,000 Note Payable ......................................

12,000

2 Accounts Payable .................................. 11,000 Cash ....................................................

11,000

3 Repair Parts Inventory ........................... 4,700 Accounts Payable ..............................

4,700

10 Cash ........................................................ 3,000 G. Hobson, Capital .............................

3,000

11 Miscellaneous Expense ......................... 2,050 Cash ....................................................

2,050

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

750 750

16 Cash ........................................................ 6,000 Accounts Receivable .........................

6,000

29 Cash ........................................................ 3,000 Accounts Receivable ............................. 7,000 Repair Services Revenue ..................

10,000

30 Wages Expense ...................................... 4,450 Cash ....................................................

4,450

30 G. Hobson, Drawings ............................. 1,000 Cash ....................................................

1,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9B (Continued) (a) (Continued) 30 Interest Expense..................................... Note Payable ........................................... Cash ....................................................

55 500 555

30 Rent Expense ......................................... 1,650 Cash ....................................................

1,650

30 Repair Parts Expense............................. 3,705 Repair Parts Inventory.......................

3,705

(b) and (c)

Apr.1 1 10 16 29

Bal.

Cash 2,600 12,000 2 11,000 3,000 11 2,050 13 750 6,000 3,000 30 4,450 30 1,000 30 555 30 1,650 5,145

Apr. 1 14,400 16 29 Bal

6,000

7,000 15,400

Repair Parts Inventory Apr. 1 17,400 3 4,700 30 3,705 Bal. 18,395

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9B (Continued) (b) and (c) (Continued) Shop Equipment Apr. 1 30,100 Accounts Payable Apr. 1 23,750 3 4,700 Apr. 2 11,000 Bal. 17,450 Note Payable Apr. 30 500 Apr. 1 12,000 Bal. 11,500 G. Hobson, Capital Apr. 1 40,750 10 3,000 Bal. 43,750 G. Hobson, Drawings Apr. 30 1,000

Repair Services Revenue Apr. 29 10,000 Advertising Expense Apr. 13 750 Miscellaneous Expense Apr. 11 2,050 Repair Parts Expense Apr.30 3,705 Wages Expense Apr. 30 4,450 Rent Expense Apr. 30 1,650 Interest Expense Apr. 30 55

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-9B (Continued) (d) SOFT-Q REPAIR SERVICE Trial Balance April 30, 2011

Debit Cash ............................................................. $ 5,145 Accounts receivable ................................... 15,400 Repair parts inventory ................................ 18,395 Shop equipment .......................................... 30,100 Accounts payable........................................ Note payable ................................................ G. Hobson, capital ....................................... G. Hobson, drawings .................................. 1,000 Repair services revenue ............................. Advertising expense ................................... 750 Interest expense .......................................... 55 Miscellaneous expense............................... 2,050 Rent expense ............................................... 1,650 Repair parts expense .................................. 3,705 Wages expense ........................................... 4,450 $82,700

Credit

$17,450 11,500 43,750 10,000

______ $82,700

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-10B (a) SOFT-Q REPAIR SERVICE Income Statement Month Ended April 30, 2011 Revenues Repair services revenue......................................... $10,000 Expenses Advertising expense ................................ $ 750 Interest expense ...................................... 55 Miscellaneous expense ........................... 2,050 Rent expense ........................................... 1,650 Repair parts expense............................... 3,705 Wages expense ........................................ 4,450 Total expenses ................................................... 12,660 Loss ............................................................................. ($ 2,660) (b) SOFT-Q REPAIR SERVICE Statement of Owner's Equity Month Ended April 30, 2011 G. Hobson, capital, April 1, 2011 ................................ $40,750 Add: Investment .......................................................... 3,000 43,750 Less: Loss .................................................. $2,660 Drawings ........................................... 1,000 3,660 G. Hobson, capital, April 30, 2011 .............................. $40,090

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-10B (Continued) (c) SOFT-Q REPAIR SERVICE Balance Sheet April 30, 2011 Assets Cash ............................................................................. $ 5,145 Accounts receivable ................................................... 15,400 Repair parts inventory ................................................ 18,395 Shop equipment .......................................................... 30,100 Total assets ............................................................. $69,040 Liabilities and Owner's Equity Liabilities Accounts payable ................................................... $17,450 Note payable ........................................................... 11,500 Total liabilities .................................................... 28,950 Owner's Equity G. Hobson, capital .................................................. 40,090 Total liabilities and owner's equity ................... $69,040 Taking It Further I would have concerns about buying this business. It incurred a loss in the month of April. Its receivables and inventory increased over the previous month. Cash increased but this was a result of a note payable and the investment by the owner. I would want to see information for more than a one-month period.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11B (a) LAZDOWSKI MARKETING SERVICES Trial Balance October 31, 2011

Debit Credit Cash ............................................................ $ 4,930 Accounts receivable .................................. 6,010 Office supplies ........................................... 1,240 Prepaid rent ................................................ 975 Office furniture ........................................... 56,685 Computer equipment ................................. 25,970 Notes payable ............................................. $48,850 Accounts payable....................................... 4,430 Unearned marketing fees........................... 3,555 D. Lazdowski, capital ................................. 57,410 D. Lazdowski, drawings ............................. 75,775 Marketing fees earned (to balance*) ......... 114,020 Advertising expense .................................. 14,970 Insurance expense ..................................... 2,020 Interest expense ......................................... 2,445 Office supplies expense ............................ 5,000 Rent expense .............................................. 11,700 Wages expense .......................................... 20,545 _______ $228,265 $228,265 *Total debits without Marketing fees earned = $114,245 $228,265 – $114,245 =$114,020

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11B (Continued) (b) LAZDOWSKI MARKETING SERVICES Income Statement Year Ended October 31, 2011 Revenues Marketing fees earned .......................................... $114,020 Expenses Advertising expense ................................ $14,970 Insurance expense .................................. 2,020 Interest expense ...................................... 2,445 Office supplies expense .......................... 5,000 Rent expense ........................................... 11,700 Wages expense ........................................ 20,545 Total expenses ................................................. 0 56,680 Profit .......................................................................... $57,340

LAZDOWSKI MARKETING SERVICES Statement of Owner's Equity Year Ended October 31, 2011 D. Lazdowski, capital, October 31, 2010 .................. $57,410 Plus: Profit .............................................................. 57,340 114,750 Less: Drawings......................................................... 75,775 D. Lazdowski, capital, October 31, 2011 .................. $38,975

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11B (Continued) (b) (Continued) LAZDOWSKI MARKETING SERVICES Balance Sheet October 31, 2011 Assets Cash ........................................................................... $ 4,930 Accounts receivable ................................................. 6,010 Office supplies .......................................................... 1,240 Prepaid rent ............................................................... 044975 Office furniture .......................................................... 56,685 Computer equipment ................................................ 25,970 Total assets ........................................................... $95,810 Liabilities and Owner's Equity Liabilities Notes payable ....................................................... $48,850 Accounts payable ................................................. 4,430 Unearned marketing fees ..................................... 3,555 Total liabilities .................................................. 56,835 Owner's Equity D. Lazdowski, capital ............................................ 38,975 Total liabilities and owner's equity ................. $95,810

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-11B (Continued) Taking It Further Donna Lazdowski has withdrawn more cash than profit. This has resulted in a net decrease to the owner’s capital account. Donna’s drawings have left the company with a low level of liquid assets (Cash of $4,930 + Accounts receivable of $6,010 = $10,940) to pay off liabilities (Notes payable of $48,850 + Accounts payable of $4,430 = $53,280). Donna’s drawings should be based on her cash budget for the coming year and leave the company able to meet its liabilities with sufficient cash to be able to grow.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-12B (a)

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

(b) Trans 1 1 No 2

2 Prepaid Insurance Yes Accounts Receivable Accounts Payable Yes Supplies

Accounts Payable Yes Wages Payable Cash

Yes Drawings

Cash

Wages Expense

3 Understated $3,600 Understated $500 Understated $500 Understated $270 Understated $270 Understated $1,200 Understated $1,200 Overstated $250 Understated $1,200 Overstated $1,200

4 Increase by $3,600 Increase by $500

5 Yes Increase by $500

Increase by $270

Increase by $1,200

Decrease by Yes $250 Yes Yes

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-12B (Continued) (b) (Continued) Trans 1 2 7 Yes Service Revenue Unearned Service Revenue 8 No Accounts Payable 9

3 Understated $400 Overstated $400

Overstated $500 = ($250 ×2) Yes Equipment Understated $1,800 Cash Understated $4,600 Accounts Understated Payable $6,400 Yes Accounts Understated Receivable $950 Service Understated Revenue $950

Yes

Decrease by $500

Increase by $6,400

Increase by $950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 2-12B (Continued) Taking It Further 1.

Disagree. Even though the trial balance is balanced, uncorrected errors misstate the financial position of the company. 2. This error understates Accounts Receivable and Accounts Payable. It may lead to liabilities being unpaid and receivables being uncollected. 3. This error understates Supplies and Accounts Payable. It may lead to the liability to the supplier being underpaid. 4. This error may lead to Wages to employees not being paid since the transaction was posted as a credit to Cash. It would show as already being paid. The error would also understate the company’s liabilities. 6. This error overstates Wages Expense. It results in lower profits on the income statement because of the additional expense . 7. This error shows higher liabilities by overstating Unearned Service Revenue. It results in lower profit on the income statement because of the understated Service Revenue. It may also lead to work being done twice to earn the revenue since the amount is recorded as unearned. 9. This error shows lower liabilities by understating Accounts Payable and lower assets by understating Equipment and Cash. It may lead to the supplier not being paid since the transaction shows the equipment as already paid. 10. This error understates Accounts Receivable and understates Service Revenue. It results in a lower profit on the income statement because of the unrecorded revenue.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 2-13B SHAWNEE SLOPES COMPANY Trial Balance June 30, 2011 Debit Cash ($5,875 + $230 - $320 +$650) .................... $ 6,435 Accounts receivable ($3,120 - $275 - $275) ...... 2,570 Prepaid insurance ($500 + $300) ....................... 800 Supplies ($0 + $650) ........................................... 650 Equipment ($14,200 - $650 + $2,000)................. 15,550 Note payable ....................................................... Accounts payable ($5,140 - $90 - $90 +$650) ... Property taxes payable ...................................... S. Shawnee, capital ($17,900 + $750) ................ S. Shawnee, drawings ........................................ 750 Service revenue ($6,847 - $140 + $410)............. Advertising expense ($1,132 - $230 + $320) ..... 1,222 Property tax expense ($1,100 + $300) ............... 1,400 Salaries expense ($4,150 + $350) ...................... 4,500 $33,877

Credit

$ 2,000 5,610 500 18,650 7,117

______ $33,877

Taking It Further There could still be errors after correcting the items identified. The errors could be counter-balancing errors that affect both the debit and credit side equally, such as a transposition error in recording a journal entry that affects both the debit and credit sides (item #6), or errors that counter-balance on the debit side, or on the credit side, of the trial balance (item #5). The trial balance could also be in balance and not show transactions that have been omitted but that should have been recorded.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a)

GENERAL JOURNAL Account Titles and Explanation

Nov.

J1 Debit

Credit

8 No entry required for cashing Canada Savings Bonds—this is a personal transaction. 8 Cash ....................................................... N. Koebel, Capital .............................

500

10 Advertising Supplies............................. Cash...................................................

175

12 Baking Supplies .................................... Cash...................................................

135

15 Baking Equipment ................................. N. Koebel, Capital .............................

500

175

135

500

16 Cash ....................................................... 2,000 Notes Payable ................................... 17 Baking Equipment ................................. Cash...................................................

900

20 Cash ....................................................... Teaching Revenue ............................

125

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

26 Accounts Receivable ............................ Teaching Revenue ............................

250

2,000

900

125

250

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) GENERAL JOURNAL

Account Titles and Explanation

Debit

Nov. 30 Telephone Expense............................... Accounts Payable .............................

Credit

75 75

(b) Cash Date Nov.

Explanation 8 10 12 16 17 20 25

Date Nov. 26

Date Nov. 10

Date Nov. 12

Ref. J1 J1 J1 J1 J1 J1 J1

Debits Credits Balance 500 175 135 2,000 900 125 25

500 325 190 2,190 1,290 1,415 1,440

Accounts Receivable Explanation Ref. Debits Credits Balance J1

250

Advertising Supplies Explanation Ref. Debits Credits Balance J1 Baking Supplies Explanation Ref. J1

175

Debits Credits Balance 135

135

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued) Baking Equipment Explanation Ref.

Date Nov. 15 17

Accounts Payable Explanation Ref.

Date Nov. 30

J1 Unearned Revenue Explanation Ref.

Date Nov. 25

J1 Notes Payable Explanation Ref.

Date Nov. 16

J1 N. Koebel, Capital Explanation Ref.

Date Nov.

J1 J1

8 15

Date Nov. 20 26

J1 J1 Teaching Revenue Explanation Ref. J1 J1

Debits Credits Balance 500 900

500 1,400

Debits Credits Balance 75

Debits Credits Balance 25

Debits Credits Balance 2,000

2,000

Debits Credits Balance 500 500

500 1,000

Debits Credits Balance 125 250

125 375

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued)

Date Nov. 30

Telephone Expense Explanation Ref. Debits Credits Balance J1

Debit

Credit

Cash ........................................................................ $1,440 Accounts receivable .............................................. 250 Advertising supplies .............................................. 175 Baking supplies ...................................................... 135 Baking equipment .................................................. 1,400 Accounts payable................................................... Unearned revenue .................................................. Note payable ........................................................... N. Koebel, capital ................................................... Teaching revenue ................................................... Telephone expense ................................................ ___75 $3,475

75 25 2,000 1,000 375 _____ $3,475

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Accounting Principles, Fifth Canadian Edition

BYP 2-1 FINANCIAL REPORTING PROBLEM (a)

Account

(1) Increase Side

(1) Decrease Side

(2) Normal Balance

Accounts Payable and accrued Liabilities

Credit

Debit

Credit

Accounts Receivable

Debit

Credit

Debit

Cash

Debit

Credit

Debit

Retail Revenue

Credit

Debit

Credit

Inventory

Debit

Credit

Debit

Interest Expense

Debit

Credit

Debit

Prepaid Expenses

Debit

Credit

Debit

(b) 1. 2. 3. 4. 5. 6.

Cash is increased. Retail Revenue is increased. Cash and/or Accounts Receivable are increased. Accounts Payable is increased or Cash is decreased. Cash is decreased or Interest Payable is increased. Cash is decreased.

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Accounting Principles, Fifth Canadian Edition

BYP 2-2 INTERPRETING FINANCIAL STATEMENTS (a) VITERRA INC. Trial Balance October 31, 2008 (in thousands)

Debit $ 183,536 486,129 773,830 91,183 837,943 7,645 1,154,859 69,238 322,254 61,875

Cash ........................................................ Short-term investments ......................... Accounts receivable .............................. Prepaid expenses and deposits ............ Inventories .............................................. Investments ............................................ Property, plant and equipment .............. Other assets ........................................... Goodwill and intangible assets ............. Future income taxes .............................. Bank indebtedness and short-term debt Accounts payable and accrued liabilities Other liabilities ....................................... Future income taxes liabilities .............. Long-term debt ....................................... Shareholders’ (owners’) equity November 1, 2007 ............................... Sales and operating revenues ............... Gain on disposal of assets .................... Cost of sales expense ............................ 5,750,735 Operating, general and administrative expense ............................................... 494,227 Depreciation expense ............................ 106,832 Interest expense ..................................... 37,785 Income tax expense ............................... 89,702 Other expenses ...................................... 11,266 Totals .................................................. $10,476,039

Credit

$ 18,424 928,596 64,183 166,476 610,088 1,912,443 6,777,566 1,263

________ $10,479,039

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Accounting Principles, Fifth Canadian Edition

BYP 2-2 (Continued) (b) Assets = Cash $183,536 + Short-term Investments $486,129 + Accounts Receivable $773,830 + Prepaid Expenses and deposits $91,183 + Inventories $837,943 + Investments $7,645 + PPE $1,154,859 + Other Assets $69,238 + Goodwill and Intangible Assets $322,254 + Future income taxes $61,875

Liabilities + Bank Indebtedness and Short-Term Debt $18,424 + Accounts Payable and Accrued Liabilities $928,596 + Other Liabilities $64,183 + Future Income Taxes Liabilities $166,476 + Long-term Debt $610,088

Owners’ Equity Shareholders’ (owners’) Equity $1,912,443 + Sales and Operating Revenues $6,777,566 + Gain on Disposal of Assets $1,263 Cost of Sales Expense $5,750,735 - Operating, General and Administrative Expense $494,227 Depreciation Expense $106,832 - Interest Expense $37,785 - Income Tax Expense $89,702 – Other Expenses $11,266

$3,988,492 =

$1,787,767 +

$2,200,725

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Accounting Principles, Fifth Canadian Edition

BYP 2-3 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, Fifth Canadian Edition

BYP 2-4 COMMUNICATION ACTIVITY MEMORANDUM To: From: Date: Subject:

Instructor Student Steps in the Recording Process

As requested, following is an explanation and illustration of the steps in the recording process as they relate to the March 15 transactions for White Glove Company: (1)

In the first transaction, bills totalling $6,000 were sent to customers for services performed. First, we analyze the transaction to determine the accounts involved and the debits/credits required. We determine that the asset Accounts Receivable is increased $6,000 and the revenue Cleaning Services Revenue is increased $6,000. Debits increase assets and credits increase revenues, so the next step is preparing the journal entry: Accounts Receivable ......................................... 6,000 Cleaning Services Revenue .......................... Billed customer for services performed.

6,000

The last step is posting the entry. The $6,000 amount is then posted to the debit side of the general ledger account Accounts Receivable and to the credit side of the general ledger account Cleaning Services Revenue.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP 2-4 (Continued) (2)

In the second transaction, $2,000 was paid in salaries to employees. First we analyze the transaction to determine the accounts involved and the debits/credits required. We determine that the expense Salaries Expense is increased $2,000 and the asset Cash is decreased $2,000. Debits increase expenses and credits decrease assets, so the next step is preparing the journal entry: Salaries Expense................................................ 2,000 Cash................................................................ 2,000 Paid salaries. The last step is posting the entry. The $2,000 amount is then posted to the debit side of the general ledger account Salaries Expense and to the credit side of the general ledger account Cash.

I trust that the foregoing is satisfactory. Please let me know if anything further is required.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP 2-5 ETHICS CASE (a)

The stakeholders in this situation are: Vu Hung, assistant chief accountant. Users of the company's financial statements (internal and external). Her supervisor (the chief accountant, who evaluates her).

(b) By adding $1,000 to the Equipment account, that account total is intentionally misstated. By not locating the error causing the imbalance, some other account(s) may also be misstated. If the amount of $1,000 is determined to be immaterial, and the intent is not to commit fraud (cover up an embezzlement or other misappropriation of assets), Vu’s action might not be considered unethical in the preparation of interim financial statements. However, she should disclose what she has done. Otherwise, if Vu is violating a company accounting policy by her action, then she is acting unethically. (c)

Vu's alternatives are: 1. Miss the deadline but find the error causing the imbalance. 2. Tell her supervisor of the imbalance and suffer the consequences. 3. Do as she did and locate the error later, making the adjustment (if any) in the next quarter.

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Accounting Principles, Fifth Canadian Edition

BYP 2-6 “All About You” Activity (a)

On September 1, 2010, my personal equity would be as follows: Cash Clothes Cell phone Total assets Less Student loan Personal equity, Sept. 1, 2010

$17,000 1,000 100 $18,100 (13,000) $5,100

(b) Personal Trial Balance December 15, 2010

Cash ............................................................... Clothes ........................................................... Cell phone ...................................................... Computer ....................................................... Student loan .................................................. Personal equity ............................................. Rent expense ................................................. Groceries expense ........................................ Tuition expense ............................................. Textbooks expense ....................................... Entertainment expense ................................. Cell phone expense....................................... Cable TV and internet expense .................... Bus fare expense........................................... Airfare expense .............................................

Debit $5,725 2,500 100 1,000

Credit

$ 13,000 5,100 1,600 1,200 2,800 600 1,500 200 250 175 450 $18,100

______ $18,100

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Accounting Principles, Fifth Canadian Edition

BYP 2-6 (Continued) (b) (Continued) Errors in the Trial Balance: • The cash amount should be the amount in the bank account at December 15th. This amount reflects the beginning balance of $17,000 less the total expenditures for the semester. • The computer was recorded at $100 rather than the actual cost of $1,000. • Groceries are an expense and should be listed in the debit column. (c) Personal equity, September 1 Net loss * Personal equity (deficit), December 15th Rent expense .............................................. Groceries expense ..................................... Tuition expense .......................................... Textbooks expense .................................... Entertainment expense .............................. Cell phone expense ................................... Cable TV and internet expense ................. Bus fare expense ....................................... Airfare expense .......................................... * Net loss .......................................................

$5,100 (8,775) $3,675 $1,600 1,200 2,800 600 1,500 200 250 175 450 $8,775

(d) Yes, unless I get a part-time job. The expenses for the semester totalled $8,775 and these expenses will re-occur the following semester. The cash balance available at the start of the second semester is only $5,725 and will not be sufficient to cover the same level of expenditures. In addition, the expenses do not include expenditures that are considered to be long-lasting, such as clothes and the new computer. Should additional long-lasting expenditures be required (such as additional clothes), this will add to the cash requirement for the second semester.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

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Accounting Principles, Fifth Canadian Edition

CHAPTER 3 Adjusting the Accounts ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems Set A

Problems Set B

1, 2

1, 5, 7

7, 8, 9, 10, 2, 3, 4, 5, 11, 16, 17, 6, 7, 12 18

3, 4, 5, 7, 8, 9, 10, *13

3. Prepare adjusting entries for accruals.

12, 13, 14, 15, 16, 17, 18

2, 8, 9, 10, 11, 12

3, 6, 7, 8, 9, 10

4. Describe the nature and purpose of an adjusted trial balance, and prepare one.

19, 20, 21, 22

9, 10, 11

2, 4, 5, 6, 2, 4, 5, 6, 7, 8, 9, 10, 7, 8, 9, 11, *12 10, 11, *12 3, 4, 5, 6, 3, 4, 5, 6, 7, 8, 9, 10, 7, 8, 9, 11, *13 10, 11, *13 7, 8, 9, 10, 7, 8, 9, 11, *13 10, 11, *13

*5. Prepare adjusting entries for the alternative treatment of prepayments (Appendix 3A)

*23, *24

*14, *15

*12, *13

Study Objectives

Questions

1. Explain the accrual basis of accounting, and revenue and expense recognition criteria.

1, 2, 3, 4, 5, 6

2. Prepare adjusting entries for prepayments.

*12, *13

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendix to each chapter.

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine profit on cash and accrual bases; recommend method.

Complex

20-25

Prepare and post transaction and adjusting entries for prepayments.

Moderate

25-35

Prepare entries for adjustments and subsequent entries for accruals.

Moderate

25-35

Prepare transaction and adjusting entries.

Moderate

25-35

Prepare adjusting entries.

Moderate

25-35

Prepare adjusting entries.

Moderate

25-35

Prepare accrual-based financial statements from cash-based information.

Complex

25-35

Prepare and post adjusting entries and prepare adjusted trial balance.

Moderate

50-60

Prepare and post adjusting entries and prepare adjusted trial balance and financial statements.

Moderate

50-60

10A

Prepare adjusting entries and financial statements.

Moderate

45-55

11A

Prepare adjusting entries, adjusted trial balance and financial statements.

Moderate

50-60

*12A

Prepare and post transaction and adjusting entries for prepayments.

Moderate

20-25

*13A

Prepare adjusting entries, adjusted trial balance and financial statements.

Moderate

55-65

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine profit on cash and accrual bases; recommend method.

Complex

20-25

Prepare and post transaction and adjusting entries for prepayments.

Moderate

25-35

Prepare entries for adjustments and subsequent transactions for accruals.

Moderate

25-35

Prepare transaction and adjusting entries.

Moderate

25-35

Prepare adjusting entries.

Moderate

25-35

Prepare adjusting entries.

Moderate

25-35

Prepare accrual-based financial statements from cash-based information.

Complex

25-35

Prepare and post adjusting entries and prepare adjusted trial balance.

Moderate

50-60

Prepare and post adjusting entries and prepare adjusted trial balance and financial statements.

Moderate

50-60

10B

Prepare adjusting entries and financial statements.

Moderate

45-55

11B

Prepare adjusting entries, adjusted trial balance and financial statements.

Moderate

50-60

*12B

Prepare and post transaction and adjusting entries for prepayments.

Moderate

20-25

*13B

Prepare adjusting entries, adjusted trial balance and financial statements.

Moderate

55-65

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Material Study Objectives 1. Explain the accrual basis of accounting, and revenue and expense recognition criteria. 2. Prepare adjusting entries for prepayments.

Knowledge Q3-1

3. Prepare adjusting entries for accruals.

Q3-17 BE3-2

Q3-9 Q3-17 BE3-2

Comprehension Q3-2 Q3-3 Q3-4 Q3-5 Q3-6 Q3-7 Q3-8 Q3-10 Q3-11 Q3-16 Q3-18 BE3-12 E3-3

Q3-12 Q3-13 Q3-16 Q3-18 BE3-12 E3-3

4. Describe the nature and purpose of an adjusted trial balance, and prepare one.

Q3-19 Q3-20 Q3-21 Q3-22

*5 Prepare adjusting entries for the alternative treatment of prepayments (Appendix 3A)

*Q3-23 *Q3-24

Broadening Your Perspective

BYP3-1 BYP3-6

Application BE3-1 P3-1B E3-1 P3-7B E3-2 P3-1A P3-7A BE3-3 P3-8A BE3-4 P3-9A BE3-5 P3-10A BE3-6 P3-11A BE3-7 *P3-12A E3-4 P3-2B E3-5 P3-4B E3-7 P3-5B E3-8 P3-6B E3-10 P3-7B *E3-13 P3-8B P3-2A P3-9B P3-4A P3-10B P3-5A P3-11B P3-6A *P3-12B P3-7A Q3-14 P3-8A Q3-15 P3-9A BE3-8 P3-10A BE3-9 P3-11A BE3-10 *P3-13A BE3-11 P3-3B E3-6 P3-4B E3-7 P3-5B E3-8 P3-6B E3-10 P3-7B P3-3A P3-8B P3-4A P3-9B P3-5A P3-10B P3-6A P3-11B P3-7A *P3-13B BE3-13 P3-11A E3-10 *P3-13A E3-11 P3-7B P3-7A P3-8B P3-8A P3-9B P3-9A P3-10B P3-10A P3-11B *P3-13B *BE3-14 *BE3-15 *E3-12 *E3-13

Analysis

Synthesis

E3-9

*P3-12A *P3-13A *P3-12B *P3-13B

Continuing Cookie Chronicle, Cumulative Coverage, BYP3-2 BYP3-3

BYP3-4

BYP3-5

Evaluation

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 1.

(a)

Accountants divide the life of a business into specific time periods so that they can provide feedback on how the business is doing. The periods chosen are of equal lengths in time so that the information provided is comparable, period to period. Management usually wants monthly financial statements. Investors want to view the results of publicly traded companies at least quarterly. The Canada Revenue Agency (CRA) requires financial statements to be filed with annual income tax returns. Consequently, accountants divide the life of a business into specific time periods, such as a month, a threemonth quarter, or a year.

(b)

A time period of less than one year is called an interim period. For publicly traded company an interim period for reporting to shareholders is a quarterly period of three months. A fiscal year is a period of twelve months.

Under the cash basis of accounting, events are only recognized in the period that cash is paid or received. Under the accrual basis, revenue is recognized when the goods sold are delivered or the services are rendered. As well, the expenses are recognized when services are obtained or goods are used or consumed, rather than when the cash is paid. The accrual basis provides the most useful information for decision making as it reflects transactions in the period in which they occur. Compared to the cash basis, the accrual basis gives a more realistic measure of the performance and future earnings potential of the business.

The college should recognize the revenue equally (1/4 each month) over the period September to December. This will result in the revenue being recognized in the period the service is provided.

The law firm should recognize the revenue in April. The revenue should be recognized in the accounting period in which it is earned (i.e., when the work is done).

Expenses of $3,000 ($500 + $2,500) should be deducted from the revenues in April since April was when the revenue was recognized as earned. Expense recognition is tied to revenue recognition when there is a direct association between costs incurred and the earning of revenue. Wages are the costs related to earning the fee revenue.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 6.

Adjusting entries are needed to ensure that revenue and expense recognition criteria are followed. Adjusting entries also make it possible to report the correct amounts of assets, liabilities, and owner’s equity on the balance sheet. For example, if a one-year insurance policy was purchased three months before the fiscal year end, the prepaid insurance and insurance expense accounts will need to be updated to reflect the amount of the policy that has expired. Or, if there are salaries earned but not paid, the salaries payable and salaries expense accounts will be understated. These omissions or misstatements would lead to the wrong conclusions concerning interpreting the business’ performance and financial position.

Prepaid expenses are costs paid before they are used or consumed. For example, rent or insurance is often paid in advance. Prepaid expenses need to be adjusted at the end of each accounting period to reflect the fact that part of the asset has been used up or consumed.

No. Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. Depreciation results in the presentation of the carrying amount of the asset, not its market value.

(a)

Depreciation Expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated Depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the total of all the depreciation that has been recognized from the date of acquisition of an asset to the balance sheet date.

(b)

Cost includes the amount paid to purchase the asset. Carrying amount is the cost of the asset reduced by the accumulated depreciation.

10. A contra account is offset (deducted) against a related account on the balance sheet or income statement. The Accumulated Depreciation contra account is used in order to show both the original cost of an asset and the portion of the cost that has been allocated to expense to date. 11. Unearned revenue exists when cash is received for goods or services to be provided in the future. It represents a liability and belongs on the balance sheet because the cash has not yet been earned – the company has a future obligation to provide the goods or services. As the business provides the goods or the services, adjusting journal entries are recorded at the end of the period to recognize the corresponding amount of revenue earned that will then appear on the income statement.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 12. It is necessary to prepare an adjusting entry to record the revenue in the period it is earned. The entry will record revenue for the period of time people have stayed up to March 31. It is also necessary to record an asset for the amount that is receivable in the future as a result of the revenue earned to March 31. An asset (a receivable) is increased and revenue is increased in the adjusting entry. 13. It is necessary to prepare an adjusting entry to recognize the expense in the period that it was incurred and to set up the corresponding liability (the company has a future obligation). Utility expense is increased and accounts payable is increased. 14. Accrued Revenue: On the balance sheet, assets (accounts receivable) are understated $900 and owner’s equity is understated $900. On the income statement, revenue is understated $900 and profit is understated $900. 15. Accrued Expense: On the balance sheet, liabilities (accounts payable) are understated $600 and owner’s equity is overstated $600. On the income statement, expenses are understated $600 and profit is overstated $600. 16. (a) Type of adjusting entry (b) Related account 1. Accrued revenue Revenue 2. Unearned revenue Revenue 3. Accrued expense Expense 4. Accrued expense, or prepaid expense Liabilities, or Assets 5. Prepaid expense Expenses 6. Accrued revenue, or unearned revenue Assets, or Liabilities 17. Disagree. The Cash account is never involved in adjusting journal entries. Adjusting entries are intended to implement the accrual basis of accounting. Accrued revenues and expenses are recorded by adjusting journal entries before the cash is received or paid. Prepayments and unearned revenues require adjustments after the cash has been received or paid. 18. Disagree. An adjusting entry affects only one balance sheet account and one income statement account in the same entry. 19. Both the trial balance and the adjusted trial balance list the balances of all accounts and prove the equality of the total debit and credit balances. The trial balance lists the balances in the accounts prior to adjusting entries; the adjusted trial balance lists the balances after all adjustments have been posted. The adjusted trial balance is used to prepare the financial statements.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 20. Disagree, an adjustment can be in either direction. Sometimes an adjustment is required to increase an account, and sometimes to decrease an account. For example, the Supplies account will be lower after recording the adjusting entry which recognizes the amount of supplies used during the period. 21. Disagree. Accounts Payable must be included in the adjusted trial balance even though there have been no adjustments made to it. The account balance must be included for the adjusted trial balance to balance and for the financial statements to accurately portray the company’s financial position. 22. Agree. Profit is added to the balance in Owner’s Equity (Capital account), which then appears on the balance sheet. *23. Disagree. While the statement is true prior to the preparation of adjusting journal entries, the balances are correctly stated after recording and posting the adjusting entry. Both approaches yield the same results after adjusting entries have been posted. *24. Disagree. It would be acceptable to credit revenue when cash is received in advance of providing a service, providing an adjusting entry was made to recognize any portion of revenue that remained unearned by the end of the accounting period.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1 Transaction

Cash

Profit

(a) Purchased supplies for cash, $100 (b) Used $60 of the supplies in (a) (c) Performed services on account, $1,000 (d) Received $800 cash from customers in payment of their account in (c) (e) Borrowed $4,000 cash on a note payable (f) On May 28 received $500 cash for services to be provided in June. (g) In June, provided services paid in (f) (h) Employees earned $800 in the month of June, which will be paid on July 3. (i) On July 3, paid salaries accrued in (h)

-$100 0 0

0 -60 +1,000

+800 +4,000

0 0

+500 0

0 +500

0 -800

-800 0

BRIEF EXERCISE 3-2 (a) Account title of other half of the entry 1. Salaries Expense is debited 2. Interest Payable is credited 3. Supplies is credited 4. Revenue is credited 5. Accumulated Depreciation is credited 6. Insurance Expense is debited 7. Interest Receivable is debited 8. Revenue is credited

(b) Type of adjustment To accrue salaries earned To accrue interest expense To record supplies used To record revenue earned To record depreciation To record insurance expired To accrue interest revenue To record revenue

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-3 A Co. B Co.

Supplies used: $875 + $3,230 − $1,295 = $2,810 Supplies on hand, May 31, 2011: $1,515 + $2,970 − x = $3,275 x = $1,210

BRIEF EXERCISE 3-4 (a)

Mar. 2

Cleaning Supplies .......................... 1,695 Accounts Payable .....................

1,695

(b) Cleaning Supplies used = $475 + $1,695 − $250 = $1,920 (c)

Dec. 31

Cleaning Supplies Expense .......... 1,920 Cleaning Supplies .....................

1,920

(d) Cleaning Supplies Jan. 1 475 Mar. 2 1,695 Dec. 31 1,920 Dec. 31 Bal. 250

Cleaning Supplies Expense Dec. 31 1,920

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-5 (a)

June 1 Prepaid Insurance ............................ 3,900 Cash .............................................

3,900

(b) Monthly cost: $3,900 ÷ 12 = $325/month; Number of months expired: June to December—7 months Amount expired in 2010: 7 months x $325 = $2,275 Number of months remaining: January to May—5 months Amount unexpired at December 31: 5 months x $325 = $1,625 Total $3,900 = $2,275 + $1,625 (c)

Dec. 31 Insurance Expense .......................... 2,275 Prepaid Insurance .......................

2,275

(d) Prepaid Insurance June 1 3,900 Dec. 31 2,275

Insurance Expense Dec. 31 2,275

Dec. 31 Bal. 1,625

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-6 (a) Jan. 1/10

Vehicles ........................................ 42,000 Cash .........................................

(b) Dec. 31/10 Depreciation Expense ................. 6,000 Accumulated Depreciation —Vehicles .............................. ($42,000 ÷ 7 = $6,000 per year) Dec. 31/11 Depreciation Expense ................. 6,000 Accumulated Depreciation —Vehicles ..............................

42,000

6,000

2010

Property, plant and equipment Vehicles ............................................... $42,000 Less: Accumulated depreciation ....... 12,000 Carrying amount.................................. $30,000

$42,000 6,000 $36,000

CREED CO. Income Statement (partial) Year Ended December 31

Depreciation Expense .............................

2011

2010

$6,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-7 (a)

June 1 Cash ................................................ 3,900 Unearned Insurance Revenue ....

3,900

(b) $3,900 ÷ 12 = $325 per month Number of months earned June to October—5 months Amount earned to October 31: 5 x $325 = $1,625 Number of months remaining November to May—7 months Amount unearned at October 31: 7 x $325 = $2,275 Total $3,900 = $1,625 + $2,275 (c)

Oct. 31 Unearned Insurance Revenue ......... 1,625 Insurance Revenue ......................

1,625

(d) Unearned Insurance Revenue June 1 3,900 Oct. 31 1,625 Oct. 31 Bal.

Insurance Revenue Oct. 31 1,625

2,275

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-8 (a)

An adjusting entry will be needed because services have been provided in November but will not be invoiced until the first of December.

(b) Nov. 30 Accounts Receivable ....................... Service Revenue .......................... (c)

595 595

No, Ullmann will not have to make a journal entry on December 1 when they invoice Rackets Plus because the November 30th adjusting entry already recorded the amount.

(d) Dec. 9

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

595 595

BRIEF EXERCISE 3-9 (a) May. 27 Salaries Expense.............................. 5,000 Cash ............................................. (b) May. 31 Salaries Expense.............................. 2,000 Salaries Payable .......................... (Monday and Tuesday at $1,000 each) (c)

June 3 Salaries Expense.............................. 3,000 Salaries Payable ............................... 2,000 Cash .............................................

5,000

2,000

5,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-10 (a) July 31/10 Vehicles .......................................... 40,000 Cash ......................................... Note Payable ........................... (b) Dec. 31/10 Interest Expense ........................... Interest Payable ...................... ($22,000 x 6% x 5/12)

18,000 22,000

550 550

(c) Jan. 31/11 Interest Expense ($550 ÷ 5) .......... 110 Interest Payable ............................ 550 Note Payable ................................. 22,000 Cash ........................................

22,660

BRIEF EXERCISE 3-11 (a)

An adjusting entry will be needed because services have been obtained in November but have not been invoiced until the first of December. Nov. 30 Maintenance Expense ...................... Accounts Payable........................

595 595

(b) No, Rackets Plus will not have to make a journal entry on December 1 when the invoice from Ullmann Maintenance is received because the November 30th adjusting entry already recorded the amount. (c)

Dec. 9

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

595 595

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-12 Owner's Assets Liabilities Equity Revenue Expenses Profit Prepaid expenses Unearned revenues Accrued revenues Accrued expenses

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 3-13 WINTERHOLT COMPANY Adjusted Trial Balance September 30, 2011

Debit

Credit

Cash ............................................................................... $ 1,100 Accounts receivable ..................................................... 6,730 Prepaid insurance ......................................................... 780 Equipment ..................................................................... 28,900 Accumulated depreciation—equipment $ 6,200 Accounts payable ......................................................... 3,570 Salaries payable............................................................ 875 Unearned service revenue ........................................... 840 C. Winterholt, capital .................................................... 15,450 C. Winterholt, drawings ................................................ 21,000 Service revenue ............................................................ 48,450 Depreciation expense ................................................... 3,100 Insurance expense ....................................................... 1,560 Salaries expense ........................................................... 12,215 $75,385 $75,385

A A A A A L L L C D R E E E

BS BS BS BS BS BS BS BS OE OE IS IS IS IS

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Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 3-14 (a)

Dec. 31 Cleaning Supplies Expense ............ Cleaning Supplies .......................

Cleaning Supplies Jan. 1 475 Dec.31 Dec. 31 Bal. 250

225

225 225

Cleaning Supplies Expense Mar. 2 1,695 Dec. 31 225 Dec. 31 Bal. 1,920

(b) The adjusted balances are the same. It does not matter whether the original entry is recorded to an asset or an expense account as long as the adjustment is done correctly.

*BRIEF EXERCISE 3-15 (a)

Oct. 31 Insurance Revenue .......................... 2,275 Unearned Insurance Revenue ....

Unearned Insurance Revenue Oct. 31 Oct. 31 Bal.

2,275 2,275

2,275

Insurance Revenue June 1 3,900 Oct. 31 2,275 Oct. 31 Bal. 1,625

(b) The adjusted balances are the same. It does not matter whether the original entry is recorded to an asset or an expense account as long as the adjustment is done correctly.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 3-1 (a) and (b) Revenue Expenses Operating Supplies Insurance Profit

Cash $22,000

Accrual $32,000

13,750 16,175 800 250 2,000 0 1,500 $ 5,450 $ 14,075

(1) (2) (3)

(1) $13,750 + $2,425 = $16,175 (2) $800 − $550 = $250 (3) $2,000 x 9 ÷ 12 = $1,500 (c)

The accrual basis provides the most useful information for decision making as it reflects transactions in the period in which they occur. Compared to the cash basis, the accrual basis gives a more realistic measure of the performance and future earnings potential of the business.

EXERCISE 3-2 (a)

When the flight takes place in December.

(b) When the home theatre is delivered. (c)

As the tickets are used over the season.

(d) Over the period of time the loan is outstanding. (e)

When the sweater is shipped in September.

(f)

As each magazine is delivered.

(g) When the gift card is redeemed in January.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-3 Type of Item Account 1. Expense 2. Revenue 3. Expense

Income Statement Increase or Account Name Decrease Interest Expense Increase Interest Revenue Increase Depreciation Increase Expense

Impact on Profit Decrease Increase Decrease

4. 5. 6. 7. 8.

Revenue Revenue Insurance Expense Salaries Expense Supplies Expense

Increase Increase Increase Increase Increase

Increase Increase Decrease Decrease Decrease

Increase or Decrease Increase Increase Increase

Impact on Owner's Equity Decrease Increase Decrease

Increase

Decrease Decrease Increase Decrease

Increase Decrease Decrease Decrease

Revenue Revenue Expense Expense Expense

Balance Sheet Type of Item Account 1. Liability 2. Asset 3. Contra Asset 4. Asset 5. 6. 7. 8.

Liability Asset Liability Asset

Account Name Interest Payable Interest Receivable Accumulated Depreciation Accounts Receivable Unearned Revenue Prepaid Insurance Salaries Payable Supplies

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-4 (a)

Apr. 1

Sept. 25

Nov. 1

Dec. 1

Various

(b) Dec. 31

Prepaid Insurance ............................ 4,740 Cash .............................................

4,740

Cash .................................................. 3,600 Unearned Game Revenue ...........

3,600

Prepaid Rent ..................................... 5,850 Cash .............................................

5,850

Prepaid Cleaning .............................. 2,100 Cash .............................................

2,100

Cash .................................................. 1,350 Unearned Gift Certificate Sales ..

1,350

Insurance Expense .......................... 3,555 Prepaid Insurance ....................... ($4,740 x 9/12 = $3,555)

3,555

Unearned Game Revenue ................ 1,080 Game Revenue............................. ($3,600 x 3/10 = $1,080)

1,080

Rent Expense ................................... 3,900 Prepaid Rent ................................ ($5,850 x 2/3 = $3,900)

3,900

Cleaning Expense ............................ 1,050 Prepaid Cleaning ......................... Unearned Gift Certificate Sales ....... Gift Certificate Sales ................... ($1,350 − $475 = $875)

1,050

875 875

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-4 (Continued) (c) Prepaid Insurance Apr. 1 4,740 Dec. 31 3,555 Dec. 31 Bal. 1,185

Nov. 1

Prepaid Rent 5,850 Dec. 31 3,900

Insurance Expense Dec. 31 3,555

Rent Expense Dec. 31 3,900

Dec. 31 Bal. 1,950

Prepaid Cleaning Dec. 1 2,100 Dec. 31 1,050 Dec. 31 Bal. 1,050

Cleaning Expense Dec. 31 1,050

Unearned Game Revenue Sep. 25 3,600 Dec. 31 1,080 Dec. 31 Bal. 2,520

Game Revenue Dec. 31 1,080

Unearned Gift Certificate Sales Various 1,350 Dec. 31 875

Gift Certificate Sales Dec. 31 875

Dec. 31 Bal.

475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-5 (a)

Dec. 31 Depreciation Expense..................... 2,200 Accumulated Depreciation— Furniture ..................................... ($8,800 ÷ 4 = $2,200 per year) 31 Depreciation Expense..................... 4,000 Accumulated Depreciation— Lighting Equipment .................... ($28,000 ÷ 7 = $4,000 per year) 31 Depreciation Expense..................... 4,200 Accumulated Depreciation— Computer Equipment ................ ($12,600 ÷ 3 = $4,200 per year)

2,200

4,000

4,200

(b) Furniture Cost Less: Accumulated Depreciation Carrying amount

$8,800

Lighting Equipment $28,000

Computer Equipment $12,600

2,200 $6,600

*12,000 $16,000

**10,500 $ 2,100

* $4,000 x 3 = $12,000 **$4,200 x 2.5 = $10,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-6 (a)

Dec. 31 Utility Expense ................................. Accounts Payable .......................

425 425

31 Salaries Expense ............................. 3,000 Salaries Payable .......................... ($3,500 x 6/7 = $3,000) 31 Interest Expense .............................. Interest Payable ........................... ($45,000 x 5% x 1/12 = $188)

188

31 Accounts Receivable ....................... Commission Revenue .................

490

31 Interest Receivable .......................... Interest Revenue ......................... ($6,000 x 6% x 2/12 = $60)

(b) Jan. 17 Accounts Payable ............................ Cash .............................................

425

188

490

425

2 Salaries Payable............................... 3,000 Salaries Expense ............................. 500 Cash .............................................

Feb.

3,000

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

188

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

490

3,500

188

1 Cash .................................................. 6,090 Interest Receivable ..................... Interest Revenue ($6,000 x 6% x 1/12) Note Receivable...........................

490

60 30 6,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-7 (a)

July

2 Prepaid Rent ..................................... Cash .............................................

750

10 Supplies ............................................ Cash .............................................

200

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

850

20 Cash .................................................. Unearned Service Revenue ........

700

750

200

850

700

25 Cash .................................................. 1,300 Service Revenue..........................

(b) July 31 Accounts Receivable ....................... Service Revenue..........................

800

31 Rent Expense ................................... Prepaid Rent ................................ ($750 ÷ 3 = $250)

250

31 Supplies Expense ............................ Supplies ....................................... ($1,100 + $200 − $800 = $500)

500

31 Depreciation Expense..................... Accumulated Depreciation —Equipment ............................... ($9,360 ÷ 6 x 1/12)

130

31 Unearned Service Revenue ............. Service Revenue..........................

900

1,300

800

250

500

130

900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-8 1.

Mar. 31 Depreciation Expense..................... 1,350 Accumulated Depreciation —Equipment ............................... ($21,600 ÷ 4 x 3/12) 31 Unearned Rent Revenue................. 6,975 Rent Revenue ($9,300 × 3/4) ...... 31 Interest Expense ............................. Interest Payable .......................... ($20,000 x 6% x 3/12)

1,350

6,975

300 300

31 Supplies Expense ........................... 1,950 Supplies ($2,800 − $850) ............ 31 Insurance Expense ($3,600 x 3/12) Prepaid Insurance ......................

900

31 Accounts Receivable ...................... Rent Revenue .............................

700

1,950

900

700

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-9 Answer (a)

Supplies purchased = $850

)

(b) Total premium = $4,800

(c)

Calculation Supplies Expense Add: Supplies (01/31/11) Less: Supplies (01/01/11) Supplies purchased

Total premium = Monthly premium x 12 $400 X 12 = $4,800

Purchase date = Aug. 1, 2010

Purchase date: On Jan. 31, there are 6 months coverage remaining ($400 x 6). Thus, the purchase date was 6 months earlier on Aug. 1, 2010.

Purchase date = Jan. 31, 2006

On Jan. 31/11, there is $4,800 in Accumulated Depreciation: $4,800 ÷ $80/month = 60 months Purchase date: 60 months or 5 years earlier than Jan. 31/11.

(d) Salaries paid = $2,300

Salaries Payable (12/31/10) Salaries Payable (01/31/11) Plus: Salaries Expense Salaries paid

(e)

$950 700 (800) $850)

Unearned revenue = $1,050

$1,200 (800) 400 1,900 $2,300

Service Revenue (01/31/11) $2,000 Unearned Revenue (01/31/11) 750 2,750 Cash received in Jan. 1,700 Unearned Revenue (12/31/10) $1,050

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-10 Aug. 31 Accounts Receivable ($9,230 − $8,700) . Service Revenue.................................

530 530

31 Office Supplies Expense ........................ 1,740 Office Supplies ...................................

1,740

31 Insurance Expense ................................. 1,250 Prepaid Insurance ..............................

1,250

31 Depreciation Expense ............................ 1,175 Accumulated Depreciation —Office Equipment ............................

1,175

31 Salaries Expense .................................... 1,125 Salaries Payable .................................

1,125

31 Unearned Service Revenue ($1,600 − $900) ........................................ Service Revenue .................................. 31 Interest Expense ..................................... Interest Payable ...................................

700 700 83 83

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-11 LIM COMPANY Income Statement Year Ended August 31, 2011

Revenues Service revenue ........................................................... Expenses Depreciation expense ................................... $ 1,175 Insurance expense ........................................ 1,250 Interest expense ............................................ 1,000 Office supplies expense ............................... 1,740 Rent expense ................................................. 15,000 Salaries expense ........................................... 18,125 Total expenses .......................................... Profit .................................................................................

$46,230

38,290 $ 7,940

LIM COMPANY Statement of Owner's Equity Year Ended August 31, 2011

E. Lim, capital, September 1, 2010.................................. Add: Profit .................................................................... Less: Drawings .............................................................. E. Lim, capital, August 31, 2011 ......................................

$5,600 7,940 13,540 10,000 $3,540

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 3-11 (Continued)

LIM COMPANY Balance Sheet August 31, 2011

Assets Cash .................................................................................. Accounts receivable ........................................................ Office supplies ................................................................. Prepaid insurance ............................................................ Office equipment ............................................... $14,100 Less: Accumulated depreciation ..................... 4,700 Total assets .................................................................

$9,583 9,230 710 2,525 9,400 $31,448

Liabilities and Owner's Equity Liabilities Accounts payable........................................................ Salaries payable .......................................................... Interest payable ........................................................... Unearned rent revenue ............................................... Notes payable .............................................................. Total liabilities .........................................................

$05,800 1,125 83 900 20,000 27,908

Owner's equity E. Lim, capital .............................................................. Total liabilities and owner's equity ........................

3,540 $31,448

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 3-12 (a)

Apr.

1 Insurance Expense ......................... 4,740 Cash ............................................

4,740

Sept. 25 Cash ................................................. 3,600 Game Revenue ...........................

3,600

Nov.

1 Rent Expense .................................. 5,850 Cash ............................................

5,850

1 Cleaning Expense ........................... 2,100 Cash ............................................

2,100

Various Cash ................................................. 1,350 Gift Certificate Sales ..................

1,350

Dec.

(b) Dec. 31 Prepaid Insurance ........................... 1,185 Insurance Expense ..................... ($4,740 x 3/12 = $1,185)

1,185

31 Game Revenue ................................ 2,520 Unearned Revenue ..................... ($3,600 x 7/10 = $2,520)

2,520

31 Prepaid Rent .................................... 1,950 Rent Expense.............................. ($5,850 x 1/3 = $1,950)

1,950

31 Prepaid Cleaning............................. 1,050 Cleaning Expense ...................... 31 Gift Certificate Sales ....................... Unearned Gift Certificate Sales .

1,050

475 475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 3-12 (Continued) (c) Prepaid Insurance Dec. 31 3,555

Insurance Expense Apr. 1 4,740 Dec. 31 3,555 Dec. 31 Bal. 1,185

Prepaid Rent Dec. 31 1,950

Rent Expense Nov. 1 5,850 Dec. 31 1,950 Dec. 31 Bal. 3,900

Prepaid Cleaning Dec. 31 1,050

Cleaning Expense Dec. 1 2,100 Dec. 31 1,050 Dec. 31 Bal. 1,050

Unearned Game Revenue Dec. 31 2,520

Game Revenue Sep. 25 3,600 Dec. 31 2,520 Dec. 31 Bal. 1,080

Unearned Gift Certificate Sales Dec. 31 475

Gift Certificate Sales Various 1,350 Dec. 31 475 Dec. 31 Bal. 875

(d) The adjusting entries required are different, but the ending balances in all accounts are the same.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 3-13 (a)

Jan.

2 Prepaid Insurance ........................... 1,320 Cash ............................................

1,320

15 Supplies .......................................... 1,400 Cash ............................................

1,400

25 Cash ................................................. 3,750 Unearned Service Revenue .......

3,750

31 Insurance Expense ......................... Prepaid Insurance ...................... ($1,320 x 1/12)

110

31 Supplies Expense ........................... Supplies ...................................... ($1,400 – $450 = $950)

950

110

31 Unearned Service Revenue ............ 1,900 Service Revenue.........................

Insurance Expense Jan. 31 110

Supplies Expense Jan. 31 950

950

1,900

Prepaid Insurance Jan. 2 1,320 Jan. 31 Jan. 31 Bal. 1,210

110

Supplies Jan. 15 1,400 Jan. 31 Jan. 31 Bal. 450

950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 3-13 (Continued) (a)

Continued Service Revenue Jan. 31 1,900

(b) Jan.

Unearned Service Revenue Jan. 25 3,750 Jan. 31 1,900 Jan. 31 Bal. 1,850

2 Insurance Expense ......................... 1,320 Cash ............................................

1,320

15 Supplies Expense ........................... 1,400 Cash ............................................

1,400

25 Cash ................................................. 3,750 Service Revenue.........................

3,750

31 Prepaid Insurance ........................... 1,210 Insurance Expense ..................... ($1,320 x 11/12) 31 Supplies ........................................... Supplies Expense....................... (given $450 of supplies on hand)

1,210

450

31 Service Revenue ............................. 1,850 Unearned Service Revenue ....... ($3,750 − $1,900 = $1,850)

450

1,850

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 3-13 (Continued) (b)

Continued

Prepaid Insurance Jan. 31 1,210

Jan. 31

Supplies 450

Unearned Service Revenue Jan. 31 1,850

(c)

Insurance Expense Jan. 2 1,320 Jan. 31 1,210 Jan. 31 Bal. 110

Supplies Expense Jan. 15 1,400 Jan. 31 Jan. 31 Bal. 950

450

Service Revenue Jan. 25 3,750 Jan. 31 1,850 Jan. 31 Bal. 1,900

The ending balances in all accounts are the same.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 3-1A Students may find this to be a fairly challenging problem, so here are a few points that should help: • Under the CASH BASIS, revenues are recorded when they are collected (received in cash), even if they were earned (the sale was made) earlier; • Under the ACCRUAL BASIS of accounting, revenues are recorded when they are earned (the sale is made) even if the cash is not collected until later, or is received prior to the revenue being earned; • Under the CASH BASIS, expenses are recorded when the cash is paid out; and • Under the ACCRUAL BASIS of accounting, expenses are recorded when the cost has “expired” or been “used up”, which is not always in the same time period as when the cash is paid out. For example, • Under the CASH BASIS, Supplies are recorded as expenses as soon as they are purchased and paid for, expenses, such as insurance, are recorded when items are paid for even if a portion relates to future periods; • Under the ACCRUAL BASIS of accounting, Supplies are not recorded as expenses until they have been used up. While the supplies are still on hand, they are recorded as assets because they have future benefits; • Under the CASH BASIS, amounts such as Unpaid Wages Owing at the end of 2010 would not be considered expenses until they are actually paid out in 2011; and • Under the ACCRUAL BASIS of accounting, Unpaid Wages Owing at the end of 2010 would be considered expenses in 2010, because the cost was incurred or “used up” during 2010, even though the cash will not be paid out until 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-1A (Continued) (a) and (b) $37,100

Cash basis income ($85,500 − $48,400)

-1,500

Accounts Payable owing at the end 2011 should be accrued; the related expense was incurred in 2011 and thus, reduces income.

+2,250

Accounts Payable owing at year end 2010 represent expenses of 2010. Amounts have been deducted from cash and must be added back for accrual basis profit.

+4,200

Accounts Receivable arise from sales that have been made in 2011, and thus, revenue must be recognized and recorded in 2011.

-2,700

Accounts Receivable collected in 2011 from sales made (and revenue that was earned) in 2010.

-1,300

Depreciation Expense is equal to the increase in accumulated depreciation from 2010 to 2011 ($11,300 − $10,000 = $1,300)

+1,500

Prepaid Insurance at year end 2011 is an asset rather than an expense. Amount has been deducted from cash basis and must be added back for accrual basis profit.

-1,300

Prepaid Insurance at year end 2010 has been used up and must be recorded as an expense during 2011 under the accrual basis.

+750

Supplies on hand at year end 2011 represent assets rather than an expense. Amount has been deducted from cash basis and must be added back for accrual basis profit.

-400

Supplies on hand at year end 2010 have been used up and must be recorded as an expense during 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-1A (Continued) (a) and (b) (Continued) -1,200

Unearned Revenue was received in cash in 2011 but has not been earned and thus, must be deducted.

+1,500

Unearned Revenue received in cash in 2010 has now been earned and must be recorded in 2011.

$38,900

Accrual basis income

Taking It Further: Recommend that Southlake Co. use the accrual basis of accounting. The cash basis does not correctly show when the revenue was earned or when the expenses were incurred. The cash basis of accounting is not in accordance with generally accepted accounting principles.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2A 1. (a) 1. Jan. 10 Office Supplies ................................ 3,400 Cash ............................................ 2.

3,400

Asset is overstated Expense is understated

3. Dec. 31 Supplies Expense ($3,400 − $925) . 2,475 Office Supplies ...........................

2,475

(b) Office Supplies Jan. 10 3,400 Dec. 31 2,475 Dec. 31 Bal. 925 2. (a) 1. Mar. 31

Supplies Expense Dec. 31 2,475

Equipment ....................................... 21,000 Cash ............................................

21,000

Asset is overstated (contra asset is understated) Expense is understated

3. Dec. 31 Depreciation Expense..................... 2,250 Accumulated Depreciation— Equipment ($21,000 ÷ 7 x 9/12) ..

2,250

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2A (Continued) Item 2 (Continued) (b)

Mar. 31

Equipment 21,000

Accumulated Depreciation—Equipment Dec. 31 2,250

Depreciation Expense Dec. 31 2,250

3. (a) 1. Apr.

1 Prepaid Insurance ........................... 3,780 Cash ............................................

3,780

Asset is overstated Expense is understated

3. Dec. 31 Insurance Expense ($3,780 x 9/12) 2,835 Prepaid Insurance ......................

2,835

(b) Prepaid Insurance Apr. 1 3,780 Dec. 31 2,835 Dec. 31 Bal. 945

Insurance Expense Dec. 31 2,835

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2A (Continued) 4. (a) 1. Sept. 1 Prepaid Truck Rental ...................... 6,000 Cash ............................................ 2.

6,000

Asset is overstated Expense is understated

3. Dec. 31 Truck Rent Expense ($6,000 x 4/12) 2,000 Prepaid Truck Rental..................

2,000

(b) Prepaid Truck Rental Sept. 1 6,000 Dec. 31 2,000 Dec. 31 Bal. 4,000

Truck Rent Expense Dec. 31 2,000

5. (a) 1. Oct. 15 Cash ................................................. 1,600 Unearned Service Revenue ....... 2.

1,600

Liability is overstated Revenue is understated

3. Dec. 31 Unearned Service Revenue ($1,600 x ¾) ..................................... 1,200 Service Revenue......................... (b) Unearned Service Revenue Oct. 15 1,600 Dec. 31 1,200 Dec. 31 Bal. 400 PROBLEM 3-2A (Continued)

1,200

Service Revenue Dec. 31 1,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

6. (a) 1. Dec.

Accounting Principles, Fifth Canadian Edition

1 Cash ................................................. 1,620 Unearned Rent Revenue ............

1,620

Liability is overstated Revenue is understated

3. Dec. 31 Unearned Rent Revenue ($1,620 x ⅓) 540 Rent Revenue .............................

540

(b) Unearned Rent Revenue Dec. 1 1,620 Dec. 31 540 Dec. 31 Bal. 1,080

Rent Revenue Dec. 31

540

Taking It Further: Ouellette & Associates cannot avoid recording adjusting journal entries at the end of the fiscal year. Had Ouellette originally recorded items 1 though 4 as expenses and items 5 and 6 as revenues, there would have been a requirement to adjust the asset and liability accounts at the end of the fiscal year in order to arrive at accurate balances.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-3A (a)

Dec. 31 Interest Expense ............................. Interest Payable .......................... ($30,000 x 5% x 2/12 = $250)

250 250

31 Salaries Expense ............................ 3,900 Salaries Payable ......................... ($6,500 ÷ 10 x 6 = $3,900) 31 Interest Receivable ......................... Interest Revenue ........................ ($10,000 x 8% x 1/12 = $67)

67 67

31 Accounts Receivable ...................... 3,750 Service Revenue.........................

(b)

31 Utilities Expense ............................. Accounts Payable ......................

550

Mar. 31 Interest Expense ............................. Interest Payable .............................. Cash ............................................ *($30,000 x 5% x 4/12 = $500)

500* 250

Jan. 5

Jan. 1

750

6,500

67 67

Jan. 18 Cash ................................................. 3,750 Accounts Receivable ................. Jan. 15 Accounts Payable ........................... Cash ............................................ PROBLEM 3-3A (Continued)

3,750

550

Salaries Expense ............................ 2,600* Salaries Payable.............................. 3,900 Cash ............................................ ($6,500 ÷ 10 x 4 = $2,600) Cash ................................................. Interest Receivable .....................

3,900

3,750

550 550

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

Taking It Further: The following revenue accounts would be understated by: Service Revenue ..................................................... $3,750 Interest Revenue ..................................................... 67 $ 3,817 The following expense accounts would be understated by: Interest Expense ..................................................... 250 Salaries Expense .................................................... 3,900 Utilities Expense ..................................................... 550 4,700 Profit would be overstated by ................................

883

Assets would be understated by: Interest Receivable ................................................. $ 67 Accounts Receivable .............................................. 3,750

$3,817

Liabilities would be understated by: Interest Payable ..................................................... 250 Accounts Payable .................................................. 550 Salaries Payable .................................................... 3,900

$4,700

Owner’s equity would be overstated by ................

$ 883

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4A 1. (a)

July 10 Office Supplies ................................ 1,070 Cash ............................................

(b) Dec. 31 Office Supplies Expense ($595 + $1,070 – $780)..................... Office Supplies ........................... 2. (a)

(c)

885 885

June 1 Cash ................................................. 25,000 Note Payable ...............................

(b) Dec. 31 Interest Expense ............................. Interest Payable ($25,000 x 5.25% x 7/12) ............. Mar.

1,070

25,000

766 766

1 Interest Expense ($25,000 x 5.25% x 2/12).................. 219 Interest Payable .............................. 766 Note Payable ................................... 25,000 Cash ............................................

25,985

2 Equipment ....................................... 23,500 Cash ............................................

23,500

(b) Dec. 31 Depreciation Expense..................... 1,371 Accumulated Depreciation– Equipment ($23,500 ÷ 10 x 7/12)

1,371

3. (a) June

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4A (Continued) 4. (a)

Sept.

Cash ($160 x 250) ............................ 40,000 Unearned Season Ticket Revenue

(b) Dec. 31 Unearned Season Ticket Revenue . 15,000 Season Ticket Revenue ($40,000 ÷ 8 x 3) .......................... 5. (a) Dec. 28 Wages Expense............................... 4,200 Cash ............................................ (b) Dec. 31 Wages Expense............................... 2,800 Wages Payable ($4,200 ÷ 6 x 4) . (c)

6. (a)

Jan. 4

Dec. 1

Wages Payable ................................ 2,800 Wages Expense ($4,200 ÷ 6 x 2)..... 1,400 Cash ............................................

Cash ................................................. Rental Revenue ..........................

350

(b) Dec. 31 Accounts Receivable ($500 − $350) Rental Revenue ..........................

150

(c)

650

Jan. 7

Cash ($150 + $500) .......................... Accounts Receivable ................. Rental Revenue ..........................

4,200

2,800

4,200

150

150 500

275

(c)

275

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

15,000

350

7. (b) Dec. 31 Telephone Expense ........................ Accounts Payable ...................... Jan. 10

40,000

275

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4A (Continued) Taking It Further: The three basic reasons that a trial balance may not contain complete or up to date data are: 1. Some events are not journalized daily because it is not efficient to do so. 2. Some costs are not journalized during the accounting period because they expire through the passage of time not daily transactions. 3. Some items may be unrecorded. The adjustment to record supplies used (Item 1) is an example of the first reason above. It is not practical to record an expense every time supplies are used. The adjustment to record depreciation (Item 3) is an example of the second reason above. The cost of a long-lived asset expires through the passage of time. The adjustment to record the telephone bill (Item 7) is an example of the third reason above. The bill was for the month of December but had not been recorded in the recording of daily transactions.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-5A 1.

7. 8.

10.

Sept. 30 Office Supplies Expense ($2,000 + $1,800 – $750) .................. 3,050 Office Supplies ...........................

3,050

30 Insurance Expense ($3,200 x 11/12) 2,933 Prepaid Insurance ......................

2,933

30 Interest Expense ............................. Interest Payable ($20,000 x 6% x 7/12) ..................

700

30 Depreciation Expense..................... Accumulated Depreciation– Equipment ($24,000 ÷ 15 x 7/12)

933

700

933

30 Unearned Revenue ......................... 1,000 Lesson Revenue ($1,500 x 4/6) ..

1,000

30 Rent Expense ($9,000 ÷ 9 x 2) ....... 2,000 Prepaid Rent ...............................

2,000

No entry required 30 Accounts Receivable ...................... 1,500 Lesson Revenue .........................

1,500

30 Wages Expense .............................. 2,900 Wages Payable ...........................

2,900

30 Utilities Expense ............................ Accounts Payable ......................

475 475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-5A (Continued) Taking It Further: The timing of the preparation of the adjusting journal entries in the accounting cycle depends completely on the business’ needs to communicate financial information to those who use it. If the business does not need financial statements monthly, that would be used to make decisions, and decides that financial statements are only needed on an annual basis, then the preparation of adjusting journal entries on an annual basis is adequate. Preparing adjusting journal entries monthly in that case would not be of any use as none of the information provided by the adjusted trial balance and financial statements would be of any use. On the other hand, the practice of recording adjusting journal entries at the end of each month should be adopted if doing so will provide feedback to the business on action that should be taken to rectify a business problem, or initiate changes in the way the business is managed.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-6A (a) 1.

Dec. 31 Advertising Expense ...................... 7,180 Prepaid Advertising ...................

7,180

A650 – $6,240 ÷ 12 = $520 per month for 10 months = .......................................... $5,200 B974 – $7,920 ÷ 24 = $330 per month for 6 months = ............................................ 1,980 $7,180 2.

Dec. 31 Depreciation Expense ($32,000 ÷ 6) .................................... 5,333 Accumulated Depreciation ........

5,333

Dec. 31 Depreciation Expense ($40,000 ÷ 5) .................................... 8,000 Accumulated Depreciation ........

8,000

Dec. 31 Interest Expense ............................. 3,471 Interest Payable .......................... ($85,000 × 7% × 7/12 mos. = $3,471)

Dec. 31 Salaries Expense ............................ 5,250 Salaries Payable ......................... 6 x $750 x 5/6 days = ................... 3 x $600 x 5/6 days = ................... Total .............................................

3,471

5,250

$3,750 1,500 $5,250

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-6A (Continued) (a) (Continued) 5.

Dec. 31 Unearned Rent Revenue................. 68,000 Rent Revenue .............................

68,000

5 × $4,000 × 2 = ............................. $40,000 4 × $7,000 × 1 =............................... 28,000 Total rent earned ............................ $68,000

(b) Truck 1, Accumulated depreciation = $5,333 x 4 = $21,332 Carrying amount = $32,000 − $21,332 = $10,668 Truck 2, Accumulated depreciation = $8,000 x 19/12 = $12,667 Carrying amount = $40,000 − $12,667 = $27,333 Taking It Further: The purpose of depreciation is to allocate the cost of a long-lived asset to expense over the useful life of the asset in a systematic and rational manner. Land is not depreciated because it has an unlimited useful life.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-7A (a) Cash = $88,850 − $86,250 = $2,600 (b) EXOTIC DESIGNS Income Statement Year Ended December 31, 2011 ______________________________________________________ Revenues Design revenue ($60,350 + (7) $5,200) ....................... Expenses Salaries ($19,850 + (6) $550) ........................ $20,400 Supplies expense ($8,200 − (2) $850).......... 7,350 Rent expense ($9,800 − (3) $800) ................ 9,000 Advertising expense ................................... 3,400 Depreciation expense ($18,000 ÷ (1) 6) ....... 3,000 Telephone expense ($1,020 + (5) $200) ....... 1,220 Insurance expense ($1,980 x 10/12 (4)) ....... 1,650 Total expenses ........................................................ Profit .................................................................................

$65,550

46,020 $19,530

EXOTIC DESIGNS Statement of Owner's Equity Year Ended December 31, 2011

C. Moritaka, capital, January 1, 2011 .............................. $ 0 Add: Investment ............................................................. 28,500 Profit ....................................................................... 19,530 48,030 Less: Drawings ................................................................ 24,000 C. Moritaka, capital, December 31, 2011 ........................ $24,030

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-7A (Continued) (b) (Continued) EXOTIC DESIGNS Balance Sheet December 31, 2011 __________________________________________________________________

Assets Cash .................................................................................. Accounts receivable (7) ................................................... Prepaid insurance [$1,980 x 2/12 (4)] ............................. Rent deposit (3)................................................................ Supplies (2) ...................................................................... Equipment ......................................................... $18,000 Less: Accumulated depreciation (1)................ 3,000 Total assets .................................................................

$ 2,600 5,200 330 800 850 15,000 $24,780

Liabilities and Owner’s Equity Liabilities Salaries payable (6) ..................................................... Accounts payable (5) .................................................. Total liabilities ......................................................... Owner’s equity C. Moritaka, capital...................................................... Total liabilities and owner’s equity ........................

550 200 750

24,030 $24,780

Taking It Further: Some of the expenses on the accrual basis income statement do not involve the payment of cash. An example is depreciation expense. Some of the expenses on the income statement are from accruals and have not yet involved cash. Some cash payments were made to purchase assets and did not represent expenses of the year. Finally, total payments included drawings from the owner that are not expenses.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (a) 1.

July 31 Insurance Expense ($6,100 × 9/12) 4,575 Prepaid Insurance ......................

4,575

31 Depreciation Expense ($13,440 ÷ 8) 1,680 Accumulated Depreciation— Office Equipment ........................

1,680

31 Depreciation Expense ($140,400 ÷ 12)................................. 11,700 Accumulated Depreciation—Buses

11,700

31 Supplies Expense ........................... Supplies ($860 − $210) ............... 31 Interest Expense ($54,000 x 7% x 1/12) ...................... Interest Payable ..........................

650 650

315 315

31 Unearned Fees Revenue ................ 4,200 Fees Earned ($1,400 x 3) ............

4,200

31 Salaries Expense ............................ 2,125 Salaries Payable ($425 x 5) ........

2,125

31 Accounts Receivable ...................... 1,150 Fees Earned ................................

1,150

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

620 620

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) CASH Date

Explanation

Ref.

Debit

Credit Balance

✓

July 31 Balance

3,000

ACCOUNTS RECEIVABLE Date

Explanation

Ref. ✓ J2

July 31 Balance 31

Debit

Credit Balance

1,150

2,360 3,510

PREPAID INSURANCE Date

Explanation

July 31 Balance 31

Ref.

Debit

✓ J2

Credit Balance

4,575

6,100 1,525

SUPPLIES Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

650

860 210

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) OFFICE EQUIPMENT Date

Explanation

July 31 Balance

Ref.

Debit

Credit Balance

✓

13,440

ACCUMULATED DEPRECIATION—OFFICE EQUIPMENT Date

Explanation

July 31 Balance 31

Ref.

Debit

✓ J2

Credit Balance

1,680

8,400 10,080

BUSES Date

Explanation

July 31 Balance

Ref.

Debit

Credit Balance

✓

140,400

ACCUMULATED DEPRECIATION—BUSES Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

11,700

58,500 70,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) ACCOUNTS PAYABLE Date

Explanation

Ref.

Debit

✓ J2

July 31 Balance 31

Credit Balance

620

1,900 2,520

NOTES PAYABLE Date

Explanation

Ref.

Debit

Credit Balance

✓

July 31 Balance

54,000

INTEREST PAYABLE Date

Explanation

July 31

Ref.

Debit

Credit Balance 315

315

SALARIES PAYABLE Date

Explanation

July 31

Ref.

Debit

Credit Balance 2,125

2,125

UNEARNED FEES Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

4,200

14,000 9,800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) F. ROSENTHAL, CAPITAL Date

Explanation

Ref.

Debit

Credit Balance

✓

July 31 Balance

25,000

F. ROSENTHAL, DRAWINGS Date

Explanation

Ref.

Debit

Credit Balance

✓

July 31 Balance

47,000

FEES EARNED Date

Explanation

Ref.

Debit

✓ J2 J2

July 31 Balance 31 31

Credit Balance

4,200 1,150

110,600 114,800 115,950

ADVERTISING EXPENSE Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

620

820 1,440

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) DEPRECIATION EXPENSE Date

Explanation

July 31 31

Ref.

Debit

Credit Balance

J2 J2

1,680 11,700

1,680 13,380

GAS AND OIL EXPENSE Date

Explanation

Ref.

Debit

✓

July 31 Balance

Credit Balance 7,170

INSURANCE EXPENSE Date

Explanation

July 31

Ref.

Debit

Credit Balance

4,575

INTEREST EXPENSE Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

315

1,575 1,890

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) RENT EXPENSE Date

Explanation

Ref.

Debit

✓

July 31 Balance

Credit Balance 2,175

SALARIES EXPENSE Date

Explanation

Ref. ✓ J2

July 31 Balance 31

Debit

Credit Balance

2,125

46,875 49,000

SUPPLIES EXPENSE Date

Explanation

July 31 Balance 31

Ref. ✓ J2

Debit

Credit Balance

650

625 1,275

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) (c) ALPINE TOURS Adjusted Trial Balance July 31, 2011 ________________________________________________________ Debit $ 3,000 3,510 1,525 210 13,440

Credit

Cash .................................................................. Accounts receivable ........................................ Prepaid insurance ............................................ Supplies............................................................ Office equipment ............................................. Accumulated depreciation—office equipment $ 10,080 Buses ................................................................ 140,400 Accumulated depreciation—buses ................ 70,200 Accounts payable ............................................ 2,520 Notes payable .................................................. 54,000 Interest payable ............................................... 315 Salaries payable............................................... 2,125 Unearned fees .................................................. 9,800 F. Rosenthal, capital ........................................ 25,000 F. Rosenthal, drawings.................................... 47,000 Fees earned ...................................................... 115,950 Advertising expense ........................................ 1,440 Depreciation expense ...................................... 13,380 Gas and oil expense ........................................ 7,170 Insurance expense .......................................... 4,575 Interest expense .............................................. 1,890 Rent expense ................................................... 2,175 Salaries expense .............................................. 49,000 Supplies expense ............................................ 1,275 $289,990 $289,990

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8A (Continued) Taking It Further: The carrying amount of the buses at July 31, 2011 is $140,400 − $70,200 = $70,200 or half of the purchase price. Since the carrying amount is half of the purchase price, the buses are half depreciated though their useful life estimated at 12 years. Consequently the buses are 6 years old. The carrying amount of the office equipment at July 31, 2011 is $13,440 − $10,080 = $3,360 or 25% of the purchase price. Since the carrying amount is 25% of the purchase price, the office equipment is 75% depreciated though its useful life estimated at 8 years. Consequently the office equipment is 6 years old (75% x 8 years).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (a) 1.

9. 10.

Aug. 31 Insurance Expense ($6,360 x 1/12) Prepaid Insurance ......................

530

31 Supplies Expense ($995 − $690) .... Supplies ......................................

305

530

305

31 Depreciation Expense [($150,000 ÷ 50) x 1/12] ................... 250 Accumulated Depreciation—Cottages

250

31 Depreciation Expense [($33,000 ÷ 10) x 1/12] ..................... 275 Accumulated Depreciation—Furniture

275

31 Unearned Rent Revenue................. 11,000 Rent Revenue ............................. [(155 − 45) x $100] 31 Interest Expense ($96,000 x 6.5% x 1/12).................... Interest Payable .......................... 31 Salaries Expense ............................ Salaries Payable .........................

11,000

520 520 840

31 Utilities Expense ............................. 1,560 Accounts Payable ......................

840

1,560

No Transaction 31 Accounts Receivable ...................... 1,350 Rent Revenue ...........................

1,350

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) CASH Date

Explanation

Ref.

Debit

Credit Balance

✓

Aug. 31 Balance

18,900

ACCOUNTS RECEIVABLE Date

Explanation

Aug. 31

Ref.

Debit

Credit Balance

1,350

PREPAID INSURANCE Date

Explanation

Aug. 31 Balance 31

Ref.

Debit

✓ J1

Credit Balance

530

5,300 4,770

SUPPLIES Date

Explanation

Aug. 31 Balance 31

Ref. ✓ J1

Debit

Credit Balance

305

995 690

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) (Continued) LAND Date

Explanation

Aug. 31 Balance

Ref.

Debit

Credit Balance

✓

35,000

COTTAGES Date

Explanation

Aug. 31 Balance

Ref.

Debit

Credit Balance

✓

150,000

ACCUMULATED DEPRECIATION—COTTAGES Date

Explanation

Aug. 31 Balance 31

Ref.

Debit

✓ J1

Credit Balance

250

44,750 45,000

FURNITURE Date

Explanation

Aug. 31 Balance

Ref. ✓

Debit

Credit Balance 33,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) (Continued) ACCUMULATED DEPRECIATION—FURNITURE Date

Explanation

Ref.

Debit

✓ J1

Aug. 31 Balance 31

Credit Balance

275

12,925 13,200

ACCOUNTS PAYABLE Date

Explanation

Ref.

Debit

✓ J1

Aug. 31 Balance 31

Credit Balance

1,560

6,500 8,060

UNEARNED RENT REVENUE Date

Explanation

Ref. ✓ J1

Aug. 31 Balance 31

Debit

Credit Balance

11,000

15,500 4,500

SALARIES PAYABLE Date Aug. 31

Explanation

Ref. J1

Debit

Credit Balance 840

840

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) (Continued) INTEREST PAYABLE Date

Explanation

Aug. 31

Ref.

Debit

Credit Balance 520

520

MORTGAGE PAYABLE Date

Explanation

Ref.

Debit

✓

Aug. 31 Balance

Credit Balance 96,000

K. MACPHAIL, CAPITAL Date

Explanation

Ref.

Debit

✓

Aug. 31 Balance

Credit Balance 85,000

K. MACPHAIL, DRAWINGS Date

Explanation

Aug. 31 Balance

Ref. ✓

Debit

Credit Balance 42,735

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) (Continued) RENT REVENUE Date

Explanation

Ref.

Debit

✓ J1 J1

Aug. 31 Balance 31 31

Credit Balance

11,000 1,350

249,150 260,150 261,500

DEPRECIATION EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

250 275

5,775 6,025 6,300

✓ J1 J1

Aug. 31 31 31

INSURANCE EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

530

5,830 6,360

Debit

Credit Balance

520

4,840 5,360

✓ J1

Aug. 31 Balance 31

INTEREST EXPENSE Date

Explanation

Aug. 31 Balance 31

Ref. ✓ J1

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (b) (Continued) REPAIR EXPENSE Date

Explanation

Ref.

Debit

✓

Aug. 31 Balance

Credit Balance 14,400

SALARIES EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

840

153,000 153,840

Debit

Credit Balance

305

2,450 2,755

Debit

Credit Balance

1,560

37,600 39,160

✓ J1

Aug. 31 Balance 31

SUPPLIES EXPENSE Date

Explanation

Ref. ✓

Aug. 31 Balance 31 J1

UTILITIES EXPENSE Date

Explanation

Aug. 31 Balance 31

Ref. ✓ J1

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (c) HIGHLAND COVE RESORT Adjusted Trial Balance August 31, 2011 ________________________________________________________ Debit Credit Cash ................................................................... $ 18,900 Accounts receivable ......................................... 1,350 Prepaid insurance ............................................. 4,770 Supplies............................................................. 690 Land ................................................................... 35,000 Cottages ............................................................ 150,000 Accumulated depreciation—cottages ............. $ 45,000 Furniture ............................................................ 33,000 Accumulated depreciation—furniture ............. 13,200 Accounts payable ............................................. 8,060 Unearned rent revenue ..................................... 4,500 Salaries payable................................................ 840 Interest payable ................................................ 520 Mortgage payable ............................................. 96,000 K. MacPhail, capital .......................................... 85,000 K. MacPhail, drawings ...................................... 42,735 Rent revenue ..................................................... 261,500 Depreciation expense ....................................... 6,300 Insurance expense ........................................... 6,360 Interest expense ............................................... 5,360 Repair expense ................................................. 14,400 Salaries expense ............................................... 153,840 Supplies expense ............................................. 2,755 Utilities expense ............................................... 39,160 _______ $514,620 $514,620

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (d) HIGHLAND COVE RESORT Income Statement Year Ended August 31, 2011

Revenues Rent revenue ............................................... $261,500 Expenses Depreciation expense ................................ $ 6,300 Insurance expense ...................................... 6,360 Interest expense .......................................... 5,360 Repair expense ............................................ 14,400 Salaries expense ......................................... 153,840 Supplies expense ........................................ 2,755 Utilities expense .......................................... 39,160 Total expenses ........................................ 228,175 Profit ................................................................. $ 33,325

HIGHLAND COVE RESORT Statement of Owner's Equity Year Ended August 31, 2011

K. MacPhail, capital, September 1, 2010 ........................ $ 85,000 Add: Profit ........................................................................ 33,325 118,325 Less: Drawings ................................................................ 42,735 K. MacPhail, capital, August 31, 2011 ............................ $ 75,590

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) (d) (Continued) HIGHLAND COVE RESORT Balance Sheet August 31, 2011

Assets Cash .................................................................... $ 18,900 Accounts receivable .......................................... 1,350 Prepaid insurance .............................................. 4,770 Supplies.............................................................. 690 Land .................................................................... 35,000 Cottages ............................................................ $150,000 Less: Accumulated depreciation ...................... 45,000 105,000 Furniture ............................................................. $ 33,000 Less: Accumulated depreciation ...................... 13,200 19,800 Total Assets ................................................... $185,510 Liabilities and Owner's Equity Liabilities Accounts payable........................................................ $ 8,060 Unearned rent revenue ............................................... 4,500 Salaries payable .......................................................... 840 Interest payable .......................................................... 520 Mortgage payable ........................................................ 96,000 Total liabilities ......................................................... 109,920 Owner's equity K. MacPhail, capital ..................................................... 75,590 Total liabilities and owner's equity ........................ $185,510

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9A (Continued) Taking It Further: The balance of the owner’s capital account that appears on the adjusted trial balance on August 31, 2011 does not correspond to the amount of the owner’s capital that appears on the balance sheet at that date. The reason for the difference is that the owner’s capital account in the trial balance does not include the amount of the profit and the drawings taken by the owner for the year ended August 31, 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10A (a)

Nov. 30 Accounts Receivable ...................... 1,100 Advertising Revenue .................. ($14,750 − $13,650)

1,100

30 Art Supplies Expense ..................... 5,935 Art Supplies ................................

5,935

30 Insurance Expense ......................... 1,600 Prepaid Insurance ......................

1,600

30 Depreciation Expense..................... 5,500 Accumulated Depreciation— Printing Equipment ....................

5,500

30 Rent Expense ($7,750 − $7,150) ..... Accounts Payable ......................

600

30 Interest Expense ............................. Interest Payable ..........................

125

30 Unearned Advertising Revenue ..... Advertising Revenue .................. ($7,100 − $6,200)

900

600

125

30 Salaries Expense ............................ 1,475 Salaries Payable .........................

900

1,475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10A (Continued) (b) QUEEN STREET ADVERTISING AGENCY Income Statement Year Ended November 30, 2011

Revenues Advertising revenue .................................... Expenses Art supplies expense .................................. $ 5,935 Depreciation expense ................................. 5,500 Insurance expense ...................................... 1,600 Interest expense .......................................... 1,000 Rent expense ............................................... 7,750 Salaries expense ......................................... 14,350 Total expenses ........................................ Profit .................................................................

$60,750

36,135 $24,615

QUEEN STREET ADVERTISING AGENCY Statement of Owner's Equity Year Ended November 30, 2011

S. Dufferin, capital, December 1, 2010 ........................... Add: Profit ........................................................................ Less: Drawings ................................................................ S. Dufferin, capital, November 30, 2011 .........................

$17,800 24,615 42,415 27,200 $15,215

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10A (Continued) (b) (Continued) QUEEN STREET ADVERTISING AGENCY Balance Sheet November 30, 2011

Assets Cash .................................................................... Accounts receivable .......................................... Art supplies ........................................................ Prepaid insurance .............................................. Printing equipment ............................................ $66,000 Less: Accumulated depreciation ...................... 34,000 Total Assets ..............................................

$ 9,000 14,750 1,265 800 32,000 $57,815

Liabilities and Owner’s Equity Liabilities Notes payable .............................................................. Accounts payable........................................................ Interest payable ........................................................... Unearned advertising revenue ................................... Salaries payable .......................................................... Total liabilities .........................................................

$30,000 4,800 125 6,200 1,475 42,600

Owner’s Equity S. Dufferin, capital ....................................................... Total liabilities and owner’s equity ........................

15,215 $57,815

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10A (Continued) (c)

$30,000 x ? x 8/12 = $1,000 $1,000 interest for 8 months is equivalent to $1,500 interest for 12 months. $1,500 ÷ $30,000 = 5% interest per year

(d) Salaries Expense, $14,350 less Salaries Payable on Nov. 30, 2011, $1,475 = $12,875 payment made for fiscal year 2011 salaries. Total Payments, $15,250 – $12,875 = $2,375 Salaries Payable on Nov. 30, 2010

Payments

Salaries Payable Nov. 30/10 15,250 Expense

2,375 14,350

Nov. 30/11

1,475

Taking It Further: The advertising agency has managed to generate a profit for the year of $24,615. This would appear to be a strong result in comparison to the amount of revenue. Your friend should find out how much effort the owner put into the business to generate this profit, without receiving a salary. The profit might be too low for the amount of the work done. A worrisome figure that appears on the balance sheet is the notes payable balance of $30,000. Depending on when this liability is due to be repaid, the business financial position appears weak. As well, there are considerably more liabilities than there is equity which will make the business less attractive as an investment, and lenders will find it a high risk borrower.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11A (a) 1.

8. 9.

10.

Mar. 31 Insurance Expense ($1,980 x 9/12) ................................. 1,485 Prepaid Insurance ......................

1,485

31 Supplies Expense ........................... 2,580 Supplies ($845 + $2,445 − $710)

2,580

31 Depreciation Expense ($7,395 ÷ 3) 2,465 Accumulated Depreciation— Computer Equipment .................

2,465

31 Depreciation Expense ($8,780 ÷ 10) Accumulated Depreciation— Furniture .....................................

878 878

31 Unearned Consulting Revenue ...... 1,915 Consulting Fees Earned ($3,740 − $1,825) ......................... 31 Interest Expense ($5,500 × 6% × 5/12) ........................ Interest Payable .......................... 31 Salaries Expense ............................ Salaries Payable .........................

1,915

138 138 655 655

No entry required. 31 Accounts Receivable ...................... 2,675 Consulting Fees Earned ............ 31 Telephone Expense ........................ Accounts Payable ......................

2,675

155 155

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11A (Continued) (b) SCHOLZ CONSULTING CO. Adjusted Trial Balance March 31, 2011

Debit Credit Cash ................................................................... $ 2,485 Accounts receivable ($7,270 + $2,675) ............ 9,945 Supplies ($3,290 − $2,580)................................ 710 Prepaid insurance ($1,980 − $1,485) ................ 495 Computer equipment ........................................ 7,395 Accumulated depreciation— computer equipment ($2,465 + $2,465) ......... $ 4,930 Furniture ............................................................ 8,780 Accumulated depreciation—furniture ($4,390 + $878) ................................................ 5,268 Notes payable ................................................... 5,500 Accounts payable ($3,495 + $155) ................... 3,650 Interest payable ................................................ 138 Salaries payable................................................ 655 Unearned consulting revenue ($3,740 − $1,915) 1,825 R. Scholz, capital .............................................. 9,160 R. Scholz, drawings .......................................... 59,500 Consulting fees earned ($106,750 + $1,915 + $2,675)........................... 111,340 Depreciation expense ($2,465 + $878) ............. 3,343 Insurance expense ........................................... 1,485 Interest expense ............................................... 138 Rent expense .................................................... 9,625 Salaries expense ($33,475 + $655) ................... 34,130 Supplies expense ............................................. 2,580 Telephone expense ($1,700 + $155) ................ 1,855 _______ $142,466 $142,466

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11A (Continued) (c) SCHOLZ CONSULTING CO. Income Statement Year Ended March 31, 2011

Revenues Consulting revenue ...................................... $111,340 Expenses Depreciation expense .................................. $ 3,343 Insurance expense ....................................... 1,485 Interest expense ........................................... 138 Rent expense ................................................ 9,625 Salaries expense .......................................... 34,130 Supplies expense ......................................... 2,580 Telephone expense ...................................... 1,855 Total expenses ......................................... 53,156 Profit .................................................................. $ 58,184

SCHOLZ CONSULTING CO. Statement of Owner's Equity Year Ended March 31, 2011

R. Scholz, capital, April 1, 2010 ......................................... $ 9,160 Add: Profit ........................................................................... 58,184 67,344 Less: Drawings ................................................................... 59,500 R. Scholz , capital, March 31, 2011 .................................... $ 7,844

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Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11A (Continued) (c) (Continued) SCHOLZ CONSULTING CO. Balance Sheet March 31, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Supplies............................................................. Prepaid insurance ............................................. Computer equipment ........................................ Less: Accumulated depreciation ..................... Furniture ............................................................ Less: Accumulated depreciation ..................... Total Assets .............................................

$ 2,485 9,945 710 495 $7,395 4,930 $8,780 5,268

2,465 3,512 $19,612

Liabilities and Owner's Equity Liabilities Notes payable .............................................................. Accounts payable........................................................ Interest payable ........................................................... Salaries payable .......................................................... Unearned consulting revenue .................................... Total liabilities .........................................................

$ 5,500 3,650 138 655 1,825 11,768

Owner's equity R. Scholz, capital ......................................................... Total liabilities and owner's equity ........................

7,844 $19,612

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Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11A (Continued) Taking It Further: Scholz Consulting Co. is performing very well. Profit is positive and expenses represent only 48% of total revenues. A negative indicator in these financial statements is the amount of drawings the owner has taken. This amount exceeds the profit for the year. The financial position of Scholz Consulting is also positive, total cash and accounts receivable ($12,430) exceeds total liabilities of $11,768. As long as all accounts receivable are collected there should be adequate cash to pay all outstanding liabilities. If Scholz Consulting wishes to purchase additional assets, the company may require additional cash. This will have to be obtained from R. Scholz by additional investment of cash or bank financing will have to be obtained.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12A (a) 1.

Jan. 15 Supplies ........................................... Cash ............................................ Apr.

Nov.

960 960

1 Prepaid Insurance ........................... 3,090 Cash ............................................

3,090

1 Cash ................................................. 1,750 Unearned Service Revenue .......

1,750

Dec. 31 Supplies Expense ($960 − $245) .... Supplies ......................................

715

Dec. 31 Insurance Expense ........................ 2,318 Prepaid Insurance ...................... ($3,090 ÷ 12 x 9) Dec. 31 Unearned Service Revenue ............ 1,050 Service Revenue ($1,750 x 3/5)..

715

2,318

1,050

3. Jan. 15 Dec. 31 Bal.

Supplies 960 Dec. 31

Supplies Expense Dec.31 715 715

245

Prepaid Insurance Apr. 1 3,090 Dec. 31 2,318 Dec. 31 Bal. 772

Insurance Expense Dec. 31 2,318

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12A (Continued) (a) (Continued) Unearned Service Revenue Nov. 1 1,750 Dec. 31 1,050 Dec. 31 Bal. 700

Service Revenue Dec. 31 1,050

(b) 1.

Jan. 15 Supplies expense............................ Cash ............................................ Apr.

Nov.

960 960

1 Insurance Expense ......................... 3,090 Cash ............................................

3,090

1 Cash ................................................. 1,750 Service Revenue.........................

1,750

Dec. 31 Supplies ........................................... Supplies Expense.......................

245

Dec. 31 Prepaid Insurance ($3,090 ÷ 12 x 3) Insurance Expense .....................

772

Dec. 31 Service Revenue ($350 x 2) ............ Unearned Service Revenue .......

700

245

772

700

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12A (Continued)

(b) (Continued) 3. Dec. 31

Supplies 245

Prepaid Insurance Dec. 31 772

Unearned Service Revenue Dec. 31 700

Supplies Expense Jan. 15 960 Dec. 31 Dec. 31 Bal. 715

245

Insurance Expense Apr. 1 3,090 Dec. 31 772 Dec. 31 Bal. 2,318

Service Revenue Nov. 1 1,750 Dec. 31 700 Dec. 31 Bal. 1,050

Taking It Further: The adjusting entries required are different but the ending balances in all accounts are the same.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13A (a) 1.

June 30 Supplies ........................................... Supplies Expense....................... 30 Interest Expense ($22,000 x 5% x 4/12) ...................... Interest Payable ..........................

825 825

367 367

30 Prepaid Insurance ($2,880 x 7/12) .. 1,680 Insurance Expense .....................

1,680

30 Graphic Design Revenue................ 1,250 Unearned Graphic Revenue.......

1,250

30 Accounts Receivable ...................... 1,975 Graphic Design Revenue ...........

1,975

30 Depreciation Expense ($42,800 ÷ 8 x 5/12) .......................... 2,229 Accumulated Depreciation— Equipment ...................................

2,229

30 Prepaid Rent .................................... Rent Expense..............................

500 500

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13A (Continued) (b) GLOBAL GRAPHICS COMPANY Adjusted Trial Balance June 30, 2011

Debit Credit Cash ................................................................... $ 8,300 Accounts receivable ($13,000 + $1,975) .......... 14,975 Supplies............................................................. 825 Prepaid insurance ............................................. 1,680 Prepaid rent ....................................................... 500 Equipment ......................................................... 42,800 Accumulated depreciation—equipment .......... $ 2,229 Note payable ..................................................... 22,000 Accounts payable ............................................. 7,480 Interest payable ................................................ 367 Unearned consulting revenue .......................... 1,250 B. Batke, capital ................................................ 35,000 B. Batke, drawings ............................................ 20,000 Graphic design revenue ($60,700 + $1,975 − $1,250) ..................... 61,425 Depreciation expense ....................................... 2,229 Insurance expense ($2,880 − $1,680) .............. 1,200 Interest expense ............................................... 367 Rent expense ($3,500 − $500) .......................... 3,000 Salaries expense ............................................... 29,950 Supplies expense ($2,950 − $825) ................... 2,125 Utilities expense ............................................... 1,800 _______ $129,751 $129,751

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13A (Continued) (c) GLOBAL GRAPHICS COMPANY Income Statement Six Months Ended June 30, 2011

Revenues Graphic design revenue............................... Expenses Depreciation expense .................................. $ 2,229 Insurance expense ....................................... 1,200 Interest expense ........................................... 367 Rent expense ................................................ 3,000 Salaries expense .......................................... 29,950 Supplies expense ......................................... 2,125 Utilities expense ........................................... 1,800 Total expenses ......................................... Profit ..................................................................

$61,425

40,671 $20,754

GLOBAL GRAPHICS COMPANY Statement of Owner's Equity Six Months Ended June 30, 2011

B. Batke, capital, January 1, 2011 .................... Add: Investments ............................................ Profit ........................................................ Less: Drawings ................................................. B. Batke, capital, June 30, 2011 .......................

0 35,000 20,754 55,754 20,000 $35,754

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13A (Continued) (c) (Continued) GLOBAL GRAPHICS COMPANY Balance Sheet June 30, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Supplies............................................................. Prepaid insurance ............................................. Prepaid rent ....................................................... Equipment ......................................................... $42,800 Less: Accumulated depreciation .................... 2,229 Total Assets .............................................

$ 8,300 14,975 825 1,680 500 40,571 $66,851

Liabilities and Owner's Equity Liabilities Note payable ................................................................ Accounts payable........................................................ Interest payable ........................................................... Unearned consulting revenue .................................... Total liabilities .........................................................

$22,000 7,480 367 1,250 31,097

Owner's equity B. Batke, capital ......................................................... Total liabilities and owner's equity ........................

35,754 $66,851

Taking It Further: The required adjusting journal entries would be different but the adjusted balances would remain the same.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-1B Students may find this to be a fairly challenging problem, so here are a few points that should help: • Under the CASH BASIS of accounting, revenues are recorded when they are collected (received in cash), even if they were earned (the sale was made) in a earlier accounting period; • Under the ACCRUAL BASIS of accounting, revenues are recorded when they are earned (the sale is made) even if the cash is not collected until later, or is received prior to the revenue being earned; • Under the CASH BASIS of accounting, expenses are recorded when the cash is paid out; and • Under the ACCRUAL BASIS of accounting, expenses are recorded when the cost has “expired” or been “used up”, which is not always in the same time period as when the cash is paid out. For example: • Under the CASH BASIS of accounting, Supplies are recorded as expenses as soon as they are purchased and paid for. Expenses, such as insurance, are recorded when items are paid for even if a portion relates to future periods; • Under the ACCRUAL BASIS of accounting, Supplies are not recorded as expenses until they have been used up. While the supplies are still on hand, they are recorded as assets because they have future benefits; • Under the CASH BASIS of accounting, amounts such as Unpaid Wages Owing at the end of 2010 would not be considered expenses until they are actually paid out in 2011; and • Under the ACCRUAL BASIS of accounting, Unpaid Wages Owing at the end of 2010 would be considered expenses in 2010, because the cost was incurred or “used up” during 2010, even though the cash will not be paid out until 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-1B (Continued) (a) and (b) $27,500

Cash basis income ($136,200 − $108,700)

−3,990

Accounts Payable owing at the end 2011 should be accrued; the related expense was incurred in 2011 and thus, reduces income.

+1,460

Accounts Payable owing at year end 2010 represents expenses of 2010. Amount has been deducted from cash and must be added back for accrual basis profit.

+6,100

Accounts Receivable arise from sales that have been made in 2011, and thus, revenue must be recognized and recorded in 2011.

−13,200

Accounts Receivable collected in 2011 from sales made (and revenue that was earned) in 2010.

−3,250

Depreciation Expense is equal to the increase in accumulated depreciation from 2010 to 2011 ($18,250 − $15,000 = $3,250)

+620

Prepaid Insurance at year end 2011 is an asset rather than an expense. Amount has been deducted from cash basis and must be added back for accrual basis profit.

−1,530

Prepaid Insurance at year end 2010 has been used up and must be recorded as an expense during 2011.

+550

Supplies on hand at year end 2011 represent assets rather than an expense. Amount has been deducted from cash basis and must be added back for accrual basis profit.

−2,350

Supplies on hand at year end 2010 have been used up and must be recorded as an expense during 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-1B (Continued) (a) and (b) (Continued) −7,400

Unearned Revenue was received in cash in 2011 but has not been earned and thus, must be taken away.

+1,560

Unearned Revenue received in cash in 2010 has now been earned and must be recorded in 2011.

$6,070

Accrual basis income

Taking It Further: Recommend that Northland Co. use the accrual basis of accounting. The cash basis does not correctly show when the revenue was earned or the expenses were incurred. The cash basis of accounting is not in accordance with generally accepted accounting principles.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2B 1. (a) 1. Jan. 2.

9 Office Supplies ................................ 2,950 Cash ............................................

2,950

Asset is overstated Expense is understated

3. Dec. 31 Supplies Expense ($2,950 − $770) . 2,180 Office Supplies ...........................

2,180

(b) Office Supplies Jan. 9 2,950 Dec. 31 2,180 Dec. 31 Bal. 770 2. (a) 1. Feb. 2.

Supplies Expense Dec. 31 2,180

1 Prepaid Insurance ........................... 5,040 Cash ............................................

5,040

Asset is overstated Expense is understated

3. Dec. 31 Insurance Expense ($5,040 x 11/12) 4,620 Prepaid Insurance ......................

4,620

(b) Prepaid Insurance Feb. 1 5,040 Dec. 31 4,620 Dec. 31 Bal. 420

Insurance Expense Dec. 31 4,620

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2B (Continued) 3. (a) 1. June 1

Equipment ....................................... 30,800 Cash ............................................ 30,800

Asset is overstated (contra asset is understated) Expense is understated

3. Dec. 31 Depreciation Expense..................... 2,567 Accumulated Depreciation— Equipment [$30,800 ÷ 7 x (7/12)]

2,567

(b)

June 1

Equipment 30,800

Accumulated Depreciation—Equipment Dec. 31 2,567

Depreciation Expense Dec. 31 2,567

4. (a) 1. Sept. 1 Prepaid Equipment Rental ............. 1,500 Cash ............................................ 2.

1,500

Asset is overstated Expense is understated

3. Dec. 31 Equipment Rent Expense .............. 1,000 Prepaid Equipment Rental ......... ($1,500 x 4/6 = $1,000)

1,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2B (Continued) Item 4 (Continued) (b) Prepaid Equipment Rental Sept. 1 1,500 Dec. 31 1,000 Dec. 31 Bal. 500 5. (a) 1. Aug.

Equipment Rent Expense Dec. 31 1,000

1 Cash ($350 x 8) ................................ 2,800 Unearned Rent Revenue ............

2,800

Liability is overstated Revenue is understated

3. Dec. 31 Unearned Rent Revenue ................ 1,750 Rent Revenue ............................. ($2,800 x 5/8 = $1,750)

1,750

(b) Unearned Rent Revenue Aug. 1 2,800 Dec. 31 1,750 Dec. 31 Bal. 1,050

Rent Revenue Dec. 31 1,750

6. (a) 1. Nov. 15 Cash ................................................. 1,425 Unearned Service Revenue ....... 2.

1,425

Liability is overstated Revenue is understated

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Accounting Principles, Fifth Canadian Edition

PROBLEM 3-2B (Continued) Item 6 (Continued) 3. Dec. 31 Unearned Service Revenue ($475 x 2) ......................................... Service Revenue......................... (b) Unearned Service Revenue Nov. 15 1,425 Dec. 31 950 Dec. 31 Bal. 475

950

Service Revenue Dec. 31

950

Taking It Further: Burke Bros. cannot avoid recording adjusting journal entries at the end of the fiscal year. Had Burke originally recorded items 1 though 4 as expenses and items 5 and 6 as revenues, there would have been a need to adjust to asset and liability accounts at the end of the fiscal year in order to arrive at accurate balances.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-3B (a)

Dec. 31 Interest Expense ............................. Interest Payable .......................... ($40,000 x 5% x 1/12 = $167)

167 167

31 Salaries Expense ............................ 7,500 Salaries Payable ......................... 31 Interest Receivable ......................... Interest Revenue ........................ ($10,000 x 7% x 2/12 = $117)

117 117

31 Accounts Receivable ...................... 12,000 Rental Revenue ..........................

(b)

31 Utilities Expense ............................. Accounts Payable ......................

255

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

167 167

7,500

350 117 233

Jan. 4 Cash ................................................. 16,800 Accounts Receivable ................. Rental Revenue .......................... Jan. 10 Accounts Payable ........................... Cash ............................................

12,000

255

Jan. 2 Salaries Payable.............................. 7,500 Cash ............................................ Apr. 30 Cash ($10,000 x 7% x 6/12) ............. Interest Receivable ..................... Interest Revenue ($10,000 x 7% x 4/12) ..................

7,500

12,000 4,800

255 255

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-3B (Continued) Taking It Further: The following revenue accounts would be understated by: Rental Revenue .................................................. $12,000 Interest Revenue .................................................. 117 $12,117 The following expense accounts would be understated by: Interest Expense ..................................................... 167 Salaries Expense .................................................... 7,500 Utilities Expense ............................................... 255 7,922 Profit would be understated by .............................

$ 4,195

Assets would be understated by: Interest Receivable ................................................. 117 Accounts Receivable .............................................. 12,000 $12,117 Liabilities would be understated by: Interest Payable ..................................................... 167 Accounts Payable .................................................. 255 Salaries Payable .................................................... 7,500 Owner’s equity would be understated by .............

7,922 $ 4,195

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4B 1. (a)

Office Supplies ................................ 1,770 Cash ............................................

1,770

(b) Nov. 30 Office Supplies Expense ($550 + $1,770 − $440) .................... 1,880 Office Supplies ...........................

1,880

2. (a)

Feb. 17

June 1 Cash ................................................. 7,000 Note Payable ...............................

(b) Nov. 30 Interest Expense ............................. Interest Payable ($7,000 x 5.5% x 6/12) ................. (c)

193 193

1 Interest Expense ($7,000 x 5.5% x 2/12) ..................... 64 Interest Payable .............................. 193 Note Payable ................................... 7,000 Cash ............................................

7,257

Cash ($210 x 150) ............................ 31,500 Unearned Season Ticket Revenue

31,500

(b) Nov. 30 Unearned Season Ticket Revenue . 9,450 Season Ticket Revenue ($31,500 ÷ 10 x 3) ........................

9,450

3. (a)

Feb.

7,000

Aug.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4B (Continued) 4. (a)

Nov. 24 Wages Expense............................... 4,500 Cash ............................................

4,500

(b) Nov. 30 Wages Expense............................... 4,500 Wages Payable ...........................

4,500

(c)

5. (a)

Dec.

Nov.

1 Wages Payable ................................ 4,500 Cash ............................................

1 Cash ................................................. Rent Revenue .............................

100

(b) Nov. 30 Accounts Receivable ($450 − $100) Rent Revenue .............................

350

(c)

800

Dec.

4 Cash ($350 + $450) ......................... Accounts Receivable ................. Rent Revenue .............................

100

350

350 450

6. (b) Nov. 30 Utilities Expense ............................. Accounts Payable ......................

935

(c)

935

Dec. 10 Accounts Payable ........................... Cash ............................................

4,500

935

7. (b) Nov. 30 Depreciation Expense ($39,000 ÷ 6) 6,500 Accumulated Depreciation—Truck

935

6,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 3-4B (Continued) Taking It Further: The three basic reasons that a trial balance may not contain complete or up to date data are: 1. Some events are not journalized daily because it is not efficient to do so; 2. Some costs are not journalized during the accounting period because they expire through the passage of time not daily transactions; 3. Some items may be unrecorded. The adjustment to record supplies used (Item 1) is an example of the first reason above. It is not practical to record an expense every time supplies are used. The adjustment to record depreciation (Item 7) is an example of the second reason above. The cost of a long-lived asset expires through the passage of time. The adjustment to record the utility bill (Item 6) is an example of the third reason above. The bill was for the month of December but had not been recorded in the recording of daily transactions.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-5B 1.

7. 8.

9. 10.

Oct. 31 Depreciation Expense..................... 1,500 Accumulated Depreciation– Equipment ($9,000 ÷ 6)...............

1,500

31 Office Supplies Expense ($1,000 + $2,500 – $980) .................. 2,520 Office Supplies ...........................

2,520

31 Insurance Expense ($3,600 x 5/12) 1,500 Prepaid Insurance ......................

1,500

31 Interest Expense ............................. Interest Payable ($28,000 x 6% x 4/12) ..................

560

31 Rent Expense ................................ Prepaid Rent ...............................

800

560

800

31 Unearned Revenue ......................... 2,200 Lesson Revenue [$200 x (14 − 3)]

2,200

No entry required 31 Accounts Receivable ...................... 1,550 Lesson Revenue ......................... 31 Wages Expense ($125 x 2 x 3)........ Wages Payable ...........................

750

31 Utilities Expense ............................ Accounts Payable ......................

360

1,550

750 360

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-5B (Continued) Taking It Further: The timing of the preparation of the adjusting journal entries in the accounting cycle depends completely on the business’ needs to communicate financial information to those who use it. If the business does not need financial statements monthly, that would be used to make decisions, and decides that financial statements are only needed on an annual basis, then the preparation of adjusting journal entries on an annual basis is adequate. Preparing adjusting journal entries monthly in that case would not be of any use as none of the information provided by the adjusted trial balance and financial statements would be used. On the other hand, the practice of recording adjusting journal entries at the end of each month should be adopted if doing so will provide feedback to the business on action that should be taken to rectify a business problem, or initiate changes in the way the business is managed.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-6B (a) 1.

Prepaid Insurance – before adjustments A2958 – $ 5,700 B4564 – 8,500 $14,200

($10,200 x 20/24)

Unearned Subscription Revenue – before adjustments Oct. 1 Nov. 1 Dec. 1

$13,000 18,000 23,000 $54,000

(325 x $40) (450 x $40) (575 x $40)

(b) 1.

Dec. 31 Interest Receivable ......................... Interest Revenue ........................ $25,000 x 7% x 3/12 = $438

438

Dec. 31 Insurance Expense ......................... 7,950 Prepaid Insurance ......................

438

7,950

Prepaid Insurance at December 31, 2010: B4564 $10,200 x 8/24 $3,400 A2958 $ 5,700 x 12/24 2,850 $6,250 Expired insurance and adjustment = $14,200 − $6,250 = $7,950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-6B (Continued) (b) (Continued) 3.

Dec. 31 Depreciation Expense ($127,500 ÷ 30)................................. 4,250 Accumulated Depreciation— Building .......................................

4,250

31 Depreciation Expense ($164,000 ÷ 40)................................. 4,100 Accumulated Depreciation— Building .......................................

4,100

Dec. 31 Unearned Subscription Revenue ... 8,167 Rent Subscription Revenue .......

8,167

Unearned Subscription Revenue at December 31, 2010: October 325 x $40 x 9/12 = $ 9,750 November 450 x $40 x 10/12 = 15,000 December 575 x $40 x 11/12 = 21,083 $45,833 Earned Revenue and adjustment = $54,000 − $45,833 = $8,167 5.

Dec. 31 Salaries Expense ............................ 6,000 Salaries Payable .........................

6,000

6 x $625 = $3,750 3 x $750 = 2,250 Total $6,000 (c)

First building, Accumulated Depreciation = $4,250 x 12 = $51,000 + 4 months for 1998 ($4,250 x 4/12 = $1,417) = $52,417 Carrying amount = $127,500 − $52,417 = $75,083 Second building, Accumulated Depreciation = $4,100 x 7 = $28,700 + 8 months for 2003 ($4,100 x 8/12 = $2,733) = $31,433 Carrying amount = $164,000 − $31,433 = $132,567

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-6B (Continued) Taking It Further: The purpose of depreciation is to allocate the cost of a long-lived asset to expense over the useful life of the asset in a systematic and rational manner. Land is not depreciated because it has an unlimited useful life.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-7B (a) Cash = ($63,250 − $41,800) = $21,450 (b) THE RADICAL EDGE Income Statement Six Months Ended April 30, 2011

Revenues Repair services ($33,250 + $720) ................. Expenses Wages expense ($3,600 + $120) .................. Rent expense ($2,275 − $325) ...................... Advertising expense .................................... Depreciation expense ($24,000 ÷ 8 x 6/12) Insurance expense ($1,800 x 6/12) .............. Supplies expense ($2,700 − $450) ............... Utilities expense ........................................... Total expenses .................................................. Profit ..................................................................

$33,970 $3,720 1,950 475 1,500 900 2,250 950 11,745 $22,225

THE RADICAL EDGE Statement of Owner's Equity Six Months Ended April 30, 2011

D. Charron, capital, November 1, 2010 ........................... Add: Investments by owner ............................................ Profit ........................................................................ Less: Drawings ............................................................... D. Charron, capital, April 30, 2011 ..................................

$ 0 30,000 22,225 52,225 6,000 $46,225

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-7B (Continued) (b) (Continued) THE RADICAL EDGE Balance Sheet April 30, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Supplies............................................................. Prepaid rent ...................................................... Prepaid insurance ............................................. Equipment ......................................................... $24,000 Less: Accumulated depreciation .................... 1,500 Total assets ..............................................

$21,450 720 450 325 900 22,500 $46,345

Liabilities and Owner’s Equity Liabilities Wages payable ............................................................

Owner’s equity D. Charron, capital ..................................................... Total liabilities and owner’s equity ........................

46,225 $46,345

120

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (a) 1.

Dec. 31 Accounts Receivable ...................... 1,750 Service Revenue.........................

1,750

31 Insurance Expense ($3,840 × 10/12) 3,200 Prepaid Insurance ......................

3,200

31 Supplies Expense ........................... 2,025 Supplies ($2,550 − $525) ............

2,025

31 Depreciation Expense— Automobiles .................................... 12,000 Accumulated Depreciation— Automobiles ($60,000 ÷ 5)..........

12,000

31 Depreciation Expense—Furniture . 1,600 Accumulated Depreciation— Furniture ($16,000 ÷ 10) .............

1,600

31 Interest Expense ($46,000 x 7% x 3/12) ...................... Interest Payable .......................... 31 Salaries Expense ............................ Salaries Payable ($230 x 3) ........

805 805 690

31 Unearned Revenue ......................... 2,000 Service Revenue ($500 x 4)........

690

2,000

31 No adjustment required

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) CASH Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

12,100

ACCOUNTS RECEIVABLE Date

Explanation

Ref.

Debit

Credit Balance

1,750

3,200 4,950

✓ J2

Dec. 31 Balance 31

PREPAID INSURANCE Date

Explanation

Dec. 31 Balance 31

Ref.

Debit

✓ J2

Credit Balance

3,200

3,840 640

PREPAID RENT Date

Explanation

Dec. 31 Balance

Ref. ✓

Debit

Credit Balance 1,150

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) (Continued) SUPPLIES Date

Explanation

Ref.

Debit

✓ J2

Dec. 31 Balance 31

Credit Balance

2,025

2,550 525

AUTOMOBILES Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

60,000

ACCUMULATED DEPRECIATION—AUTOMOBILES Date

Explanation

Ref.

Debit

✓ J2

Dec. 31 Balance 31

Credit Balance

12,000

12,000 24,000

OFFICE FURNITURE Date

Explanation

Dec. 31 Balance

Ref. ✓

Debit

Credit Balance 16,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) (Continued) ACCUMULATED DEPRECIATION—OFFICE FURNITURE Date

Explanation

Ref.

Debit

✓ J2

Dec. 31 Balance 31

Credit Balance

1,600

10,400 12,000

NOTES PAYABLE Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

46,000

UNEARNED REVENUE Date

Explanation

Ref. ✓ J2

Dec. 31 Balance 31

Debit

Credit Balance

2,000

3,000 1,000

INTEREST PAYABLE Date Dec. 31

Explanation

Ref. J2

Debit

Credit Balance 805

805

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) (Continued) SALARIES PAYABLE Date

Explanation

Dec. 31

Ref.

Debit

Credit Balance 690

690

B. OKEKE, CAPITAL Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

41,000

B. OKEKE, DRAWINGS Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

30,100

SERVICE REVENUE Date

Explanation

Dec. 31 Balance 31 31

Ref. ✓ J2 J2

Debit

Credit Balance

1,750 2,000

116,600 118,350 120,350

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) (Continued) SALARIES EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

690

57,500 58,190

Debit

Credit Balance

805

2,415 3,220

Debit

Credit Balance

✓ J2

Dec. 31 Balance 31

INTEREST EXPENSE Date

Explanation

Dec. 31 Balance 31

Ref. ✓ J2

RENT EXPENSE Date

Explanation

Dec. 31 Balance

Ref. ✓

13,800

REPAIR EXPENSE Date

Explanation

Dec. 31 Balance

Ref. ✓

Debit

Credit Balance 6,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (b) (Continued) GAS AND OIL EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

✓

Dec. 31 Balance

20,345

INSURANCE EXPENSE Date

Explanation

Dec. 31

Ref.

Debit

Credit Balance

3,200

DEPRECIATION EXPENSE—AUTOMOBILES Date

Explanation

Dec. 31

Ref.

Debit

Credit Balance

12,000

DEPRECIATION EXPENSE—FURNITURE Date

Explanation

Dec. 31

Ref.

Debit

Credit Balance

1,600

SUPPLIES EXPENSE Date Dec. 31

Explanation

Ref.

Debit

Credit Balance

2,025

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) (c) OKEKE LIMO SERVICE Adjusted Trial Balance December 31, 2011

Debit Credit Cash ................................................................... $ 12,100 Accounts receivable ......................................... 4,950 Prepaid insurance ............................................. 640 Prepaid rent ....................................................... 1,150 Supplies............................................................. 525 Automobiles ...................................................... 60,000 Accumulated depreciation—automobiles ....... $ 24,000 Office Furniture ................................................. 16,000 Accumulated depreciation—office furniture ... 12,000 Notes payable ................................................... 46,000 Unearned revenue ............................................ 1,000 Interest payable ................................................ 805 Salaries payable................................................ 690 B. Okeke, capital ............................................... 41,000 B. Okeke, drawings ........................................... 30,100 Service revenue ................................................ 120,350 Salaries expense ............................................... 58,190 Interest expense ............................................... 3,220 Rent expense .................................................... 13,800 Repair expense ................................................. 6,000 Gas and oil expense ......................................... 20,345 Insurance expense ........................................... 3,200 Depreciation expense—automobiles .............. 12,000 Depreciation expense—office furniture .......... 1,600 Supplies expense ............................................. 2,025 _______ $245,845 $245,845

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-8B (Continued) Taking It Further: The carrying amount of the automobiles at December 31, 2011 is $60,000 − $24,000 = $36,000 or 60% of the purchase price. The automobiles are 40% depreciated. Since the useful life is estimated at 5 years, the automobiles are 2 years old (40% of 5 years). The carrying amount of the office equipment at December 31, 2011 is $16,000 − $12,000 = $4,000 or 25% of the purchase price. Since the carrying amount is 25% of the purchase price, the office equipment is 75% depreciated though its useful life estimated at 10 years. Consequently the office equipment is 7.5 years old (75% x 10 years).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (a) 1.

9. 10.

May 31 Insurance Expense ($5,460 x 1/12) Prepaid Insurance ......................

455

31 Supplies Expense ($975 − $760) .... Supplies ......................................

215

455

215

31 Depreciation Expense ($180,000 ÷ 40) x 1/12 ..................... 375 Accumulated Depreciation—Lodge

375

31 Depreciation Expense ($18,000 ÷ 5) x 1/12 .......................... Accumulated Depreciation— Furniture .....................................

300

31 Unearned Rent Revenue................. 3,000 Rent Revenue (60 x $50) ............ 31 Interest Expense ............................. Interest Payable .......................... ($146,400 × 7.5% × 1/12)

915

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

975

3,000

915

975

31 Utilities Expense ............................. 1,525 Accounts Payable ......................

1,525

No entry required – no transaction in May. 31 Accounts Receivable ...................... Rent Revenue .............................

950 950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) CASH Date

Explanation

Ref.

Debit

Credit Balance

✓

May 31 Balance

2,365

ACCOUNTS RECEIVABLE Date

Explanation

May 31

Ref.

Debit

Credit Balance

950

PREPAID INSURANCE Date

Explanation

May 31 Balance 31

Ref.

Debit

✓ J1

Credit Balance

455

2,275 1,820

SUPPLIES Date

Explanation

May 31 Balance 31

Ref. ✓ J1

Debit

Credit Balance

215

975 760

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) (Continued) LAND Date

Explanation

May 31 Balance

Ref.

Debit

Credit Balance

✓

80,000

LODGE Date

Explanation

May 31 Balance

Ref.

Debit

Credit Balance

✓

180,000

ACCUMULATED DEPRECIATION—LODGE Date

Explanation

May 31 Balance 31

Ref.

Debit

✓ J1

Credit Balance

375

62,625 63,000

FURNITURE Date

Explanation

May 31 Balance

Ref. ✓

Debit

Credit Balance 18,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) (Continued) ACCUMULATED DEPRECIATION—FURNITURE Date

Explanation

Ref.

Debit

✓ J1

May 31 Balance 31

Credit Balance

300

14,100 14,400

ACCOUNTS PAYABLE Date

Explanation

Ref.

Debit

✓ J1

May 31 Balance 31

Credit Balance

1,525

4,700 6,225

UNEARNED RENT REVENUE Date

Explanation

Ref. ✓ J1

May 31 Balance 31

Debit

Credit Balance

3,000

8,750 5,750

SALARIES PAYABLE Date May 31

Explanation

Ref. J1

Debit

Credit Balance 975

975

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) (Continued) INTEREST PAYABLE Date

Explanation

May 31

Ref.

Debit

Credit Balance 915

915

MORTGAGE PAYABLE Date

Explanation

Ref.

Debit

✓

May 31 Balance

Credit Balance 146,400

M. RUNDLE, CAPITAL Date

Explanation

Ref.

Debit

✓

May 31 Balance

Credit Balance 60,880

M. RUNDLE, DRAWINGS Date

Explanation

May 31 Balance

Ref. ✓

Debit

Credit Balance 28,055

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) (Continued) RENT REVENUE Date

Explanation

Ref.

Debit

✓ J1 J1

May 31 Balance 31 31

Credit Balance

3,000 950

102,100 105,100 106,050

ADVERTISING EXPENSE Date

Explanation

Ref.

Debit

✓

May 31 Balance

Credit Balance 500

DEPRECIATION EXPENSE Date

Explanation

Ref. ✓ J1 J1

May 31 Balance 31 31

Debit

Credit Balance

375 300

7,425 7,800 8,100

SALARIES EXPENSE Date

Explanation

May 31 Balance 31

Ref. ✓ J1

Debit

Credit Balance

975

49,350 50,325

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (b) (Continued) SUPPLIES EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

215

2,240 2,455

Debit

Credit Balance

915

10,065 10,980

✓ J1

May 31 Balance 31

INTEREST EXPENSE Date

Explanation

Ref. ✓ J1

May 31 Balance 31

INSURANCE EXPENSE Date

Explanation

Ref.

Debit

Credit Balance

455

5,005 5,460

Debit

Credit Balance

1,525

13,300 14,825

✓ J1

May 31 Balance 31

UTILITIES EXPENSE Date

Explanation

May 31 Balance 31

Ref. ✓ J1

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (c) MOUNTAIN BEST LODGE Adjusted Trial Balance May 31, 2011

Debit Credit Cash ................................................................... $ 2,365 Accounts receivable ......................................... 950 Prepaid insurance ............................................. 1,820 Supplies............................................................. 760 Land ................................................................... 80,000 Lodge ................................................................. 180,000 Accumulated depreciation—lodge .................. $ 63,000 Furniture ............................................................ 18,000 Accumulated depreciation—furniture ............. 14,400 Accounts payable ............................................. 6,225 Unearned rent revenue ..................................... 5,750 Salaries payable................................................ 975 Interest payable ................................................ 915 Mortgage payable ............................................. 146,400 M. Rundle, capital ............................................. 60,880 M. Rundle, drawings ......................................... 28,055 Rent revenue ..................................................... 106,050 Advertising expense ......................................... 500 Depreciation expense ....................................... 8,100 Salaries expense ............................................... 50,325 Supplies expense ............................................. 2,455 Interest expense ............................................... 10,980 Insurance expense ........................................... 5,460 Utilities expense ............................................... 14,825 _______ $404,595 $404,595

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (d) MOUNTAIN BEST LODGE Income Statement Year Ended May 31, 2011

Revenues Rent revenue ................................................ $106,050 Expenses Advertising expense .................................... $ 500 Depreciation expense .................................. 8,100 Salaries expense .......................................... 50,325 Supplies expense ......................................... 2,455 Interest expense ........................................... 10,980 Insurance expense ....................................... 5,460 Utilities expense ........................................... 14,825 Total expenses ......................................... 92,645 Profit .................................................................. $ 13,405

MOUNTAIN BEST LODGE Statement of Owner's Equity Year Ended May 31, 2011

M. Rundle, capital, June 1, 2010 ..................................... Add: Profit ...................................................................... Less: Drawings ............................................................... M. Rundle, capital, May 31, 2011 .....................................

$60,880 13,405 74,285 28,055 $46,230

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) (d) (Continued) MOUNTAIN BEST LODGE Balance Sheet May 31, 2011

Assets Cash ................................................................... $ 2,365 Accounts receivable ......................................... 950 Prepaid insurance ............................................. 1,820 Supplies............................................................. 760 Land ................................................................... 80,000 Lodge ................................................................. $180,000 Less: Accumulated depreciation .................... 63,000 117,000 Furniture ............................................................ $18,000 Less: Accumulated depreciation .................... 14,400 3,600 Total assets .............................................. $206,495 Liabilities and Owner's Equity Liabilities Accounts payable........................................................ $ 6,225 Unearned rent revenue ............................................... 5,750 Salaries payable .......................................................... 975 Interest payable ........................................................... 915 Mortgage payable ........................................................ 146,400 Total liabilities ......................................................... 160,265 Owner's equity M. Rundle, capital ........................................................ 46,230 Total liabilities and owner's equity ........................ $206,495

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-9B (Continued) Taking It Further: The balance of the owner’s capital account that appears on the adjusted trial balance on May 31, 2011 does not correspond to the amount of the owner’s capital that appears on the balance sheet at that date. The reason for the difference is that the owner’s capital account in the trial balance does not include the amount of the profit and the drawings taken by the owner for the year ended May 31, 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10B (a)

Sept. 30 Accounts Receivable ...................... 1,100 Commission Revenue ................ ($7,435 – $6,335) 30 Supplies Expense ........................... Supplies ......................................

1,100

675 675

30 Rent Expense ($2,400 − $1,050) ..... 1,350 Prepaid Rent ............................... 30 Depreciation Expense..................... Accumulated Depreciation— Equipment ...................................

500

30 Interest Expense ............................. Interest Payable ..........................

30 Unearned Revenue ($875 − $550) .. Commission Revenue ................

325

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

940

30 Utilities Expense ($920 − $610) ...... Accounts Payable ......................

310

1,350

500

325

940

310

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10B (Continued) (b) SAINTE-CHATERINE INTERIOR DESIGN CO. Income Statement Quarter Ended September 30, 2011

Revenues Commission revenue ................................... Expenses Depreciation expense .................................. $ 500 Interest expense ........................................... 100 Rent expense ................................................ 1,350 Salaries expense .......................................... 13,990 Supplies expense ......................................... 675 Utilities expense ........................................... 920 Total expenses ......................................... Loss ..................................................................

$15,845

17,535 $ (1,690)

SAINTE-CHATERINE INTERIOR DESIGN CO. Statement of Owner’s Equity Quarter Ended September 30, 2011

C. Larocque, capital, July 1, 2011 ................................... Less: Loss ........................................................ $ 1,690 Drawings ................................................ 2,700 C. Larocque, capital, September 30, 2011 ......................

$10,000 4,390 $ 5,610

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10B (Continued) (b) (Continued) SAINTE-CHATERINE INTERIOR DESIGN CO. Balance Sheet September 30, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Supplies............................................................. Prepaid rent ....................................................... Equipment ......................................................... $16,000 Less: Accumulated depreciation .................... 5,000 Total assets ..............................................

$ 3,250 7,435 1,075 1,050 11,000 $23,810

Liabilities and Owner’s Equity Liabilities Notes payable .............................................................. Accounts payable........................................................ Interest payable ........................................................... Unearned rent revenue ............................................... Salaries payable .......................................................... Total liabilities .........................................................

$12,000 4,660 50 550 940 18,200

Owner’s equity C. Larocque, capital .................................................... Total liabilities and owners’ equity ........................

5,610 $23,810

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-10B (Continued) (c)

Interest of 5% per year equals a monthly rate of 0.417%; monthly interest is $50 ($12,000 x 0.417%). Since total interest expense is $100, the note has been outstanding two months.

Taking It Further: The company is not performing well. It incurred a loss for the quarter of $1,690. Salary expense is very high in relation to the revenue. Another negative indicator is the amount of drawings Catherine Larocque has taken. This further reduces the amount of owner’s equity and cash available to pay the notes payable. The financial position of Sainte-Catherine appears tenuous. Total cash and accounts receivable ($10,685) are not enough to pay all liabilities outstanding ($18,200). If all accounts receivable are not collected, there may not be adequate cash to repay all liabilities. And even if all of the accounts receivable are collected, it might not be in time to pay the liabilities, depending on when the liabilities must be paid.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11B (a) 1.

8. 9.

10.

May 31 Insurance Expense ($1,890 x 8/12) 1,260 Prepaid Insurance ......................

1,260

31 Supplies Expense ........................... 2,455 Supplies ($525 + $2,405 − $475)

2,455

31 Depreciation Expense ($7,650 ÷ 3) 2,550 Accumulated Depreciation— Computer Equipment .................

2,550

31 Depreciation Expense ($19,640 ÷ 10)1,964 Accumulated Depreciation— Furniture .....................................

1,964

31 Unearned Consulting Revenue ...... 3,650 Consulting Revenue ...................

3,650

31 Interest Receivable ($7,500 × 5.5% × 2/12) ..................... Interest Revenue ........................ 31 Salaries Expense ............................ Salaries Payable .........................

69 69 890 890

No entry required. 31 Accounts Receivable ...................... 2,925 Consulting Revenue ................... 31 Telephone Expense ........................ Accounts Payable ......................

2,925

155 155

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11B (Continued) (b) MAHADEO CONSULTING CO. Adjusted Trial Balance May 31, 2011

Debit 2,825 6,685 7,500 69 475 630 7,650

Credit

Cash ................................................................... $ Accounts receivable ($3,760 + $2,925) ............ Note receivable ................................................. Interest receivable ............................................ Supplies ($2,930 − $2,455)................................ Prepaid insurance ($1,890 − $1,260) ................ Computer equipment ........................................ Accumulated depreciation— computer equipment ($1,275 + $2,550) ......... $ 3,825 Furniture ............................................................ 19,640 Accumulated depreciation—furniture ($8,838 + $1,964) ............................................. 10,802 Accounts payable ($21,470 + $155) ................. 21,625 Salaries payable................................................ 890 Unearned consulting revenue ($5,280 − $3,650) 1,630 M. Mahadeo, capital .......................................... 18,752 M. Mahadeo, drawings...................................... 82,140 Consulting revenue ($117,350 + $3,650 + $2,925)........................... 123,925 Interest revenue ................................................ 69 Depreciation expense ($2,550 + $1,964) .......... 4,514 Insurance expense ........................................... 1,260 Rent expense .................................................... 10,120 Salaries expense ($32,950 + $890) ................... 33,840 Supplies expense ............................................. 2,455 Telephone expense ($1,560 + $155) ................ 1,715 $181,518 $181,518

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11B (Continued) (c) MAHADEO CONSULTING CO. Income Statement Year Ended May 31, 2011

Revenues Consulting revenue ...................................... $123,925 Interest revenue ........................................... 69 Total revenue ........................................... 123,994 Expenses Depreciation expense .................................. $ 4,514 Insurance expense ....................................... 1,260 Rent expense ................................................ 10,120 Salaries expense .......................................... 33,840 Supplies expense ......................................... 2,455 Telephone expense ...................................... 1,715 Total expenses ......................................... 53,904 Profit .................................................................. $ 70,090

MAHADEO CONSULTING CO. Statement of Owner's Equity Year Ended May 31, 2011

M. Mahadeo, capital, June 1, 2010 .................................. Add: Profit ...................................................................... Less: Drawings .............................................................. M. Mahadeo, capital, May 31, 2011 .................................

$18,752 70,090 88,842 82,140 $ 6,702

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11B (Continued) (c) (Continued) MAHADEO CONSULTING CO. Balance Sheet May 31, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Note receivable ................................................. Interest receivable ............................................ Supplies............................................................. Prepaid insurance ............................................. Computer equipment ........................................ $ 7,650 Less: Accumulated depreciation .................... 3,825 Furniture ............................................................ $19,640 Less: Accumulated depreciation .................... 10,802 Total assets ..................................................

$ 2,825 6,685 7,500 69 475 630 3,825 8,838 $30,847

Liabilities and Owner's Equity Liabilities Accounts payable........................................................ Salaries payable .......................................................... Unearned consulting revenue .................................... Total liabilities ......................................................... Owner's equity M. Mahadeo, capital .................................................... Total liabilities and owner's equity ........................

$21,625 890 1,630 24,145 6,702 $30,847

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 3-11B (Continued) Taking It Further: Mahadeo Consulting Co. is performing very well. Profit is positive and expenses represent only 43% of total revenues. On the other hand, Mohammed Mahadeo has withdrawn an excessive amount of cash from the company and consequently the cash and the owner’s equity is depleted. As a result, the ability of the business to pay its liabilities is in jeopardy. Total cash and accounts receivable ($9,505) fall far below the amount of the total liabilities ($24,145). M. Mahadeo will have to invest further cash into the business or bank financing will have to be obtained.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12B (a) 1.

Jan.

Feb.

Dec.

1 Supplies ........................................... 1,250 Cash ............................................

1,250

1 Prepaid Insurance ........................... 2,820 Cash ............................................

2,820

1 Cash ................................................. 1,200 Unearned Service Revenue .......

1,200

Dec. 31 Supplies Expense ($1,250 − $375) . Supplies ......................................

875 875

Dec. 31 Insurance Expense ........................ 2,585 Prepaid Insurance ...................... ($2,820 ÷ 12 x 11) Dec. 31 Unearned Service Revenue ............ Service Revenue.........................

2,585

300 300

Jan. 1 Dec. 31 Bal.

Supplies 1,250 Dec. 31

Supplies Expense Dec. 31 875 875

375

Prepaid Insurance Mar. 1 2,820 Dec. 31 2,585 Dec. 31 Bal. 235

Insurance Expense Dec. 31 2,585

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12B (Continued) (a) 3. (Continued) Unearned Service Revenue Dec. 1 1,200 Dec. 31 300 Dec. 31 Bal. 900

(b) 1. Jan.

Feb.

Dec.

Service Revenue Dec. 31

300

1 Supplies expense............................ 1,250 Cash ............................................

1,250

1 Insurance Expense ......................... 2,820 Cash ............................................

2,820

1 Cash ................................................. 1,200 Service Revenue.........................

1,200

Dec. 31 Supplies ........................................... Supplies Expense.......................

375

Dec. 31 Prepaid Insurance ($2,820 ÷ 12 x 2) Insurance Expense .....................

235

Dec. 31 Service Revenue ............................. Unearned Service Revenue .......

900

375

235

900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-12B (Continued)

(b) (Continued) 3. Dec. 31

Supplies 375

Prepaid Insurance Dec. 31 235

Unearned Service Revenue Dec. 31 900

Supplies Expense Jan. 1 1,250 Dec. 31 Dec. 31 Bal. 875

375

Insurance Expense Mar. 1 2,820 Dec. 31 235 Dec. 31 Bal. 2,585

Service Revenue Dec. 1 1,200 Dec. 31 900 Dec. 31 Bal. 300

Taking It Further: The adjusting entries required are different but the ending balances in all accounts are the same.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13B (a) 1.

Dec. 31 Supplies ........................................... Supplies Expense....................... 31 Interest Expense ($25,000 × 6% × 2/12) ...................... Interest Payable ..........................

585 585

250 250

31 Prepaid Insurance ($2,220 x 7/12) .. 1,295 Insurance Expense ..................... 31 Graphics Fees Earned .................... 1,400 Unearned Consulting Fees ........ ($6,500 – $5,100 = $1,400) 31 Depreciation Expense ($46,500 ÷ 12 x 5/12) ........................ 1,615 Accumulated Depreciation— Equipment ................................... 31 Utilities Expense ............................. Accounts Payable ......................

225

31 Prepaid Rent .................................... Rent Expense..............................

575

1,295

1,400

1,615

225

575

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13B (Continued) (b) ROYAL GRAPHICS COMPANY Adjusted Trial Balance December 31, 2011

Debit Credit Cash ................................................................... $ 7,250 Accounts receivable ........................................ 7,450 Supplies............................................................. 585 Prepaid insurance ............................................. 1,295 Prepaid rent ....................................................... 575 Equipment ......................................................... 46,500 Accumulated depreciation ............................... $ 1,615 Note payable ..................................................... 25,000 Accounts payable ($6,190 + $225) ................... 6,415 Interest payable ................................................ 250 Unearned graphics fees ................................... 1,400 J. Bejar, capital ................................................. 34,500 J. Bejar, drawings ............................................. 17,400 Graphic fees earned ($62,525 − $1,400) .......... 61,125 Depreciation expense ....................................... 1,615 Insurance expense ($2,220 − $1,295) .............. 925 Interest expense ............................................... 250 Rent expense ($4,025 − $575) .......................... 3,450 Salaries expense ............................................... 38,280 Supplies expense ($3,350 − $585) ................... 2,765 Utilities expense ($1,740 + $225) ..................... 1,965 _______ $130,305 $130,305

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13B (Continued) (c) ROYAL GRAPHICS COMPANY Income Statement Six Months Ended December 31, 2011

Revenues Graphic fees earned ..................................... Expenses Depreciation expense .................................. $ 1,615 Insurance expense ....................................... 925 Interest expense ........................................... 250 Rent expense ................................................ 3,450 Salaries expense .......................................... 38,280 Supplies expense ......................................... 2,765 Utilities expense ........................................... 1,965 Total expenses ......................................... Profit ..................................................................

$61,125

49,250 $11,875

ROYAL GRAPHICS COMPANY Statement of Owner's Equity Six Months Ended December 31, 2011

J. Bejar, capital, July 1, 2011........................................... Add: Investment ............................................................. Profit ....................................................................... Less: Drawings ................................................................ J. Bejar, capital, December 31, 2011...............................

0 34,500 11,875 46,375 17,400 $28,975

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 3-13B (Continued) (c) (Continued) ROYAL GRAPHICS COMPANY Balance Sheet December 31, 2011

Assets Cash ................................................................... Accounts receivable ......................................... Supplies............................................................. Prepaid insurance ............................................. Prepaid rent ....................................................... Equipment ......................................................... $46,500 Less: Accumulated depreciation .................... 1,615 Total assets ..............................................

$ 7,250 7,450 585 1,295 575 44,885 $62,040

Liabilities and Owner's Equity Liabilities Note payable ................................................................ Accounts payable........................................................ Interest payable ........................................................... Unearned consulting fees........................................... Total liabilities ......................................................... Owner's equity J. Bejar, capital ............................................................ Total liabilities and owner's equity ........................

$25,000 6,415 250 1,400 33,065 28,975 $62,040

Taking It Further: The required adjusting journal entries would be different but the adjusted balances would remain the same.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Nov. 30 Advertising Supplies Expense ................. 100 Advertising Supplies ............................ ($175 − $75) 30 Baking Supplies Expense ........................ Baking Supplies ...................................

30 Depreciation Expense .............................. Accumulated Depreciation—Baking Equipment............................................. [($500 + $900) ÷ 36 months]

30 Interest Expense ....................................... Interest Payable .................................... ($2,000 × 3% × 1/12 × ½)

100

Cash Date

Explanation

Ref.

Debit

✓

Nov. 30 Balance

Credit Balance 1,440

Accounts Receivable Date

Explanation

Nov. 30 Balance

Ref. ✓

Debit

Credit Balance 250

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) Advertising Supplies Date

Explanation

Nov. 30 Balance 30

Ref.

Debit

✓ J2

Credit Balance

100

175 75

Baking Supplies Date

Explanation

Nov. 30 Balance 30

Ref.

Debit

✓ J2

Credit Balance

135 100

Baking Equipment Date

Explanation

Nov. 30 Balance

Ref.

Debit

Credit Balance

✓

1,400

Accumulated Depreciation—Baking Equipment Date

Explanation

Nov. 30

Ref.

Debit

Credit Balance 39

Accounts Payable Date

Explanation

Nov. 30 Balance

Ref. ✓

Debit

Credit Balance 75

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) Interest Payable Date

Explanation

Nov. 30

Ref.

Debit

Credit Balance 3

Unearned Revenue Date

Explanation

Nov. 30 Balance

Ref.

Debit

✓

Credit Balance 25

Notes Payable Date

Explanation

Nov. 30 Balance

Ref.

Debit

✓

Credit Balance 2,000

N. Koebel, Capital Date

Explanation

Nov. 30 Balance

Ref.

Debit

✓

Credit Balance 1,000

Teaching Revenue Date

Explanation

Nov. 30 Balance

Ref. ✓

Debit

Credit Balance 375

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) Telephone Expense Date

Explanation

Ref.

Debit

Credit Balance

✓

Nov. 30

Advertising Supplies Expense Date

Explanation

Nov. 30

Ref.

Debit

Credit Balance

100

Baking Supplies Expense Date

Explanation

Nov. 30

Ref.

Debit

Credit Balance

Ref.

Debit

Credit Balance

Debit

Credit Balance

Depreciation Expense Date

Explanation

Nov. 30

Interest Expense Date Nov. 30

Explanation

Ref. J2

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) COOKIE CREATIONS Adjusted Trial Balance November 30, 2010

Debit $1,440 250 75 100 1,400

Cash .................................................................... Accounts receivable .......................................... Advertising supplies.......................................... Baking supplies ................................................. Baking equipment .............................................. Accumulated depreciation—baking equipment Accounts payable .............................................. Interest payable ................................................. Unearned revenue ............................................. Note payable ...................................................... N. Koebel, capital ............................................... Teaching revenue .............................................. Telephone expense............................................ 75 Advertising supplies expense .......................... 100 Baking supplies expense .................................. 35 Depreciation expense ........................................ 39 Interest expense ................................................ 3 Totals ............................................................. $3,517

Credit

39 75 3 25 2,000 1,000 375

______ $3,517

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (c) COOKIE CREATIONS Income Statement Month Ended November 30, 2010

Revenues Teaching revenue ................................................... Expenses Telephone expense ................................................ $ 75 Advertising supplies expense ............................... 100 Baking supplies expense....................................... 35 Depreciation expense ............................................ 39 Interest expense ..................................................... 3 Profit ............................................................................

$375

252 $123

[Note: Statement of Owner’s Equity is not required – shown for information purposes only.] COOKIE CREATIONS Statement of Owner's Equity Month Ended November 30, 2010

N. Koebel, capital, November 1 ........................................... $ 0 Add: Investment ................................................................... 1,000 Profit ............................................................................ 123 N. Koebel, capital, November 30 ......................................... $1,123

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (c) (Continued) [Note: Balance Sheet is not required – shown for information purposes only.] COOKIE CREATIONS Balance Sheet November 30, 2010

Assets Cash .................................................................... Accounts receivable .......................................... Advertising supplies.......................................... Baking supplies ................................................. Baking equipment .............................................. $1,400 Less: Accumulated depreciation. .................... 39 Total assets ...................................................

$1,440 250 75 100 1,361 $3,226

Liabilities and Owner's Equity Liabilities Notes payable .................................................................. $2,000 Accounts payable............................................................ 75 Interest payable ............................................................... 3 Unearned revenue ........................................................... 25 Total liabilities ............................................................. 2,103 Owner's equity N. Koebel, capital ............................................................ 1,123 Total liabilities and owner's equity ............................ $3,226 (d)

Yes, Cookie Creations was profitable in November. It has a profit of $123 which is almost equal to one third of the revenue earned in November. It is better to measure profitability after preparing and posting the adjusting journal entries instead of before. By implementing accrual accounting, a better measure of the amount of revenue and expenses for the accounting period is achieved, and consequently, a fairer report of profit performance.

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (a), (c), and (e) Cash Date Sep.

Explanation

Ref. ✓ J102 J102 J102 J102 J102 J102 J102 J102

1 Balance 1 8 10 12 20 22 25 29

Debit

Credit

10,000 1,100 1,200 3,400 4,500 500 1,200 700

Balance 1,880 11,880 10,780 11,980 15,380 10,880 10,380 9,180 9,880

Accounts Receivable Date Sep.

Explanation 1 Balance 10 27

Ref. ✓ J102 J102

Debit

Credit

Balance

1,200

3,720 2,520 3,420

Credit

Balance

1,020

800 2,300 1,280

900

Supplies Date Sep.

Explanation 1 Balance 17 30 Adj. entry

Ref. ✓ J102 J103

Debit

1,500

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (c), and (e) (Continued) Store Equipment Date Sep.

Explanation

Ref. ✓ J102

1 Balance 1

Debit

Credit

Balance 15,000 18,000

3,000

Accumulated Depreciation—Store Equipment Date Sep.

Explanation

Ref.

Debit

✓ J103

1 Balance 30

Credit

Balance

250

1,500 1,750

Credit

Balance

Accounts Payable Date Sep.

Explanation

Ref. ✓ J102 J102 J102

1 Balance 17 20 30

Debit

3,000

3,100 4,600 100 3,100

Credit

Balance

700

400 1,100 450

1,500 4,500

Unearned Service Revenue Date Sep.

Explanation 1 Balance 29 30 Adj. entry

Ref. ✓ J102 J103

Debit

650

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (a), (c), and (e) (Continued) Salaries Payable Explanation

Date Sep.

1 Balance 8 30 Adj. entry

Ref.

Debit

✓ J102 J103

Credit

Balance

775

700 0 775

Credit

Balance

Credit

Balance

10,000

Credit

Balance

700

Interest Payable Explanation

Date Sep. 30

Ref.

Debit

J103 Notes Payable Explanation

Date Sep.

Ref.

Debit

J102

R. Pitre, Capital Date Sep.

Explanation 1 Balance

Ref.

Debit

✓

15,700

Service Revenue Date

Explanation

Ref.

Debit

Credit

Balance

Sep. 12 J102 3,400 3,400 27 J102 900 4,300 30 Adj. entry J103 650 4,950 CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued)

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Accounting Principles, Fifth Canadian Edition

(a), (c), and (e) (Continued) Depreciation Expense Explanation

Date

Sep. 30 Adj. entry

Ref.

Debit

J103

250

Credit

Balance 250

Supplies Expense Explanation

Date

Sep. 30 Adj. entry

Ref.

Debit

J103

1,020

Credit

Balance 1,020

Salaries Expense Explanation

Date Sep.

8 25 30 Adj. entry

Ref.

Debit

J102 J102 J103

400 1,200 775

Credit

Balance 400 1,600 2,375

Rent Expense Date

Explanation

Sep. 22

Ref.

Debit

J102

500

Credit

Balance 500

Interest Expense Date Sep. 30

Explanation

Ref.

Debit

J103

Credit

Balance 42

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (b) GENERAL JOURNAL Date Sep.

Account Titles and Explanation

J102 Debit

Credit

1 Cash ........................................................... 10,000 Notes Payable ....................................... 10,000 8 Salaries Payable........................................ 700 Salaries Expense ...................................... 400 Cash ......................................................

1,100

10 Cash ........................................................... 1,200 Accounts Receivable ...........................

1,200

12 Cash ........................................................... 3,400 Service Revenue...................................

3,400

17 Supplies ..................................................... 1,500 Accounts Payable ................................

1,500

20 Accounts Payable ..................................... 4,500 Cash ......................................................

4,500

22 Rent Expense ............................................ 500 Cash ......................................................

500

25 Salaries Expense ...................................... 1,200 Cash ......................................................

1,200

27 Accounts Receivable ................................ 900 Service Revenue...................................

900

29 Cash ........................................................... 700 Unearned Service Revenue .................

700

30 Store Equipment ....................................... 3,000 Accounts Payable ................................

3,000

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (d) and (f) PITRE EQUIPMENT REPAIR Unadjusted and Adjusted Trial Balances September 30, 2011 ________________________________________________________ Unadjusted Dr. Cr. $ 9,880 3,420 2,300 18,000

Adjusted Dr. Cr. $ 9,880 3,420 1,280 18,000

Cash Accounts receivable Supplies Store equipment Accumulated depreciation —store equipment $ 1,500 $ 1,750 Accounts payable 3,100 3,100 Unearned service revenue 1,100 450 Salaries payable 0 775 Interest payable 0 42 Notes payable 10,000 10,000 R. Pitre, capital 15,700 15,700 Service revenue 4,300 4,950 Depreciation expense 0 250 Interest expense 0 42 Rent expense 500 500 Salaries expense 1,600 2,375 Supplies expense 0 ______ 1,020 _ _____ $35,700 $35,700 $36,767 $36,767

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (e) GENERAL JOURNAL Date 1.

Account Titles and Explanation

J103 Debit

Credit

Sep. 30 Supplies Expense .............................. 1,020 Supplies ($2,300 − $1,280) ............

1,020

30 Salaries Expense................................ 775 Salaries Payable ............................

775

30 Depreciation Expense ........................ 250 Accumulated Depreciation —Store Equipment ........................ [($15,000 ÷ 5 years) x 1/12]

250

30 Unearned Service Revenue ............... 650 Service Revenue ($400 + $700 − $450)

650

30 Interest Expense ($10,000 x 5% x 1/12) 42 Interest Payable .............................

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (g) PITRE EQUIPMENT REPAIR Income Statement Month Ended September 30, 2011

Revenues Service revenue........................................... Expenses Depreciation expense ................................. Interest expense .......................................... Rent expense ............................................... Salaries expense ......................................... Supplies expense ........................................ Total expenses ......................................... Profit ..................................................................

$4,950 $ 250 42 500 2,375 1,020 4,187 $ 763

PITRE EQUIPMENT REPAIR Statement of Owner's Equity Month Ended September 30, 2011

R. Pitre, capital, September 1, 2011 .................................. $15,700 Add: Profit ........................................................................ 763 R. Pitre, capital, September 30, 2011 ................................ $16,463

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE: CHAPTERS 2 TO 3 (Continued) (g) (Continued) PITRE EQUIPMENT REPAIR Balance Sheet September 30, 2011

Assets Cash .................................................................... Accounts receivable .......................................... Supplies.............................................................. Store equipment ................................................ $18,000 Less: Accumulated depreciation. .................... 1,750 Total assets ...................................................

$ 9,880 3,420 1,280 16,250 $30,830

Liabilities and Owner's Equity Liabilities Accounts payable........................................................ Salaries payable .......................................................... Interest payable ........................................................... Unearned service revenue .......................................... Notes payable .............................................................. Total liabilities .........................................................

$ 3,100 775 42 450 10,000 14,367

Owner's equity R. Pitre, capital ............................................................ Total liabilities and owner's equity ........................

16,463 $30,830

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Accounting Principles, Fifth Canadian Edition

BYP 3-1 FINANCIAL REPORTING PROBLEM (a)

The title the Forzani Group uses for its income statement is “Consolidated Statements of Operations.”

(b) The types of revenues reported include revenue from corporately owned stores, wholesale sales to, and fees from, franchise stores and others. (See Note 2(h) to the statements). (c)

Prepayments: Prepaid expenses are reported on the balance sheet total $2,827,000. A schedule in note 4 to the financial statements provides the details of the items making up this total. They include: Prepaid advertising of $1,348,000, prepaid service contract of $785,000 and other prepayments of $694,000. In adjusting this account the other side of the entry would be an expense account, for example advertising expense. There are no unearned revenues reported.

(d) Accruals: Accounts Receivable ($84,455,000) may include some accrued revenue amounts. In adjusting this account the other side of the entry would be a revenue account. Accrued expenses are included in the line Accounts Payable and Accrued Liabilities ($277,820,000). The notes to the financial statements do no provide any further details of the amounts making up this total. The other accounts used in preparing adjustments for this account would be expense accounts.

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Accounting Principles, Fifth Canadian Edition

BYP 3-2 INTERPRETING FINANCIAL STATEMENTS (a)

Revenue from monthly subscriber fees are recognized on a prorata basis as the service is provided.

(b) Rogers should record unearned revenue from its subscription services when customers prepay their account, before the service is provided. It should record unearned revenue for its Blue Jays home game admission revenue when tickets are purchased in advance of the games. (c)

If unearned revenue were recorded as revenue, profit and therefore owner’s equity would be overstated. Liabilities would be omitted and therefore, would be understated.

(d) Recording depreciation on new installation costs over the useful life of the related assets is an appropriate method of expense recognition. The benefit received from the asset is obtained over several years from the earning of revenues. The expense of the installation costs should be allocated to the same periods of benefit by using depreciation expense.

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Accounting Principles, Fifth Canadian Edition

BYP 3-3 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, Fifth Canadian Edition

BYP 3-4 COMMUNICATION ACTIVITY Memorandum To: From: Date: Re:

Student Cash versus accrual basis of accounting for profit

The accrual basis of calculating profit recognizes revenues as they are earned and expenses when they are incurred. The cash basis of calculating profit recognizes revenues when cash is received and expenses when cash is paid. The accrual basis of calculating profit is a better measure of performance than the cash method of calculating profit because earnings reflect economic events in the period that they occur. Using the revenue and expense recognition principles ensures that the effect of events are recorded in the same period and provides a better measure of a company’s economic performance. It is possible for management to manipulate profit using both the cash basis and accrual basis of accounting. Using the cash basis, profit can be manipulated by changing the timing of payments, for example deferring payment of expenses. Using the accrual basis, profits can be manipulated by changing estimates in calculating expenses, for example management can increase profit by increasing the useful life of long-lived assets.

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Accounting Principles, Fifth Canadian Edition

BYP 3-5 ETHICS CASE (a)

The stakeholders in this situation are: • • • •

Carole Chiasson, controller The president of Die Hard Company The shareholders of Die Hard Company The external users of Die Hard’s financial information

(b) 1. It is unethical for the president to place pressure on Carole to misstate profits by requesting her to prepare incorrect adjusting entries. 2. It is a common occurrence for adjusting entries to be dated as of the balance sheet date although the entries are prepared at a later date. It is impractical to expect that all adjusting entries could be prepared at December 31. Carole did nothing unethical by dating the adjusting entries December 31. (c)

Carole should not “aggressively” accrue revenues and defer expenses. But Carole can accrue revenues and defer expenses through the preparation of adjusting entries and be ethical so long as the entries reflect economic reality. Intentionally misrepresenting the company’s financial condition and its results of operations is unethical (it is also illegal).

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Accounting Principles, Fifth Canadian Edition

BYP 3-6 “ALL ABOUT YOU” ACTIVITY (a)

Chapter 1 introduced the concept and definition of an asset as a resource owned and controlled by the entity that is capable of producing future services or benefits. The benefits are generally focussed around the production of revenue to make profits and increase the equity (wealth) of the owner(s). While education costs resemble payments made by a business as an investment toward the production of future earning of revenue, there is too much uncertainty to record these costs as assets. Education is generally acquired by a person in the hopes of obtaining knowledge that will be useful in earning employment or other income. This advantage is non transferable and the likelihood of realizing the future production of revenue is uncertain and cannot be reasonably measured. Consequently it should be treated as an expense. When a business spends money training its employees, that cost is also expensed.

(b) The program of study chosen by a student might enhance the likelihood of earning income if the program of study will help the student in obtaining a profession or a job that is in high demand. However, the risk that education will not lead to better earning potential for the student remains too strong to warrant treating these costs as an asset. Consequently, we would still conclude that education costs should be expensed. (c)

Cost-benefit analysis is unconsciously applied to purchases or expenditures made by individuals. But the benefit received may be consumed in the present. An example would be the rest and relaxation obtained from a vacation to Hawaii. It is only when the expenditure will result in a future benefit that it can be recorded as an asset.

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Accounting Principles, Fifth Canadian Edition

BYP3-6 (Continued) (c) (Continued) As an education may result in a future benefit, it is more reasonable to consider recording the cost of your education as an asset than the cost of a vacation that doesn’t have a future benefit. But as already discussed, the benefit is still too uncertain to record your education costs as an asset. (d) When applying for a loan, an applicant will present to the financial institution, a list of assets, a list of debts and an employment history to demonstrate an ability to repay the loan. If the assets listed are understated, the loan application might be unsuccessful. If the assets presented to the bank are overstated and the expenses understated, the bank might be more receptive to the loan application. However, if it is later determined that you falsified your application then this could result in the bank calling your loan or in damage to your credit rating.

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Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

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Accounting Principles, Fifth Canadian Edition

CHAPTER 4 Completion of the Accounting Cycle ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems Set A

Problems Set B

Study Objectives

Questions

1. Prepare closing entries and a postclosing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. *6. Prepare a work sheet (Appendix 4A).

1, 2 ,3, 4, 5, 6

1, 2, 3, 4

1, 2, 3, 4, *13

1, 2, 3, 7, *10

1, 2, 3, 7 *10

7, 8, 9

5, 6

10, 11

7, 8

6, 7

5, 6

12, 13, 14, 15, 16, 17 18, 19, 20

9, 10

8, 9, 10

11, 12

10, 11

2, 3, 7, *10 7, 8

*21, *22

*13, *14

*12

*9, *10

*7. Prepare reversing entries (Appendix 4B).

*23, *24

*15, *16

*13, *14

*11, *12

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendix to each chapter.

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze account data; prepare closing entries and post-closing trial balance, discuss.

Moderate

25-35

Prepare financial statements, closing entries and post-closing trial balance.

Simple

70-80

Prepare adjusting entries, adjusted trial balance, financial statements and closing entries.

Simple

60-70

Complete all steps in accounting cycle.

Moderate

90-120

Analyze errors and prepare corrections.

Moderate

60-70

Determine impact of errors on financial statements and correct.

Moderate

60-70

Calculate capital account balance; prepare classified balance sheet and liquidity ratios.

Moderate

30-40

Calculate working capital, current ratio and acidtest ratio; comment on liquidity.

Moderate

30-35

*9A

Prepare work sheet.

Moderate

50-60

*10A

Prepare work sheet, classified balance sheet, adjusting and closing entries and post-closing trial balance.

Moderate

70-80

*11A

Prepare and post transaction entries, with and without reversing entries.

Moderate

40-50

*12A

Prepare adjusting, reversing and subsequent cash entries.

Simple

40-50

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze account data, prepare closing entries and post-closing trial balance and discuss.

Moderate

25-35

Prepare financial statements, closing entries and post-closing trial balance.

Simple

70-80

Prepare adjusting entries, adjusted trial balance, financial statements and closing entries.

Simple

60-70

Complete all steps in accounting cycle

Moderate

90-120

Analyze errors and prepare corrections.

Moderate

60-70

Determine impact of errors on financial statements and correct.

Moderate

60-70

Calculate capital account balance; prepare classified balance sheet and liquidity ratios.

Moderate

30-40

Calculate working capital and current ratio and comment on liquidity.

Moderate

30-35

Prepare work sheet.

Moderate

50-60

10B

Prepare work sheet, classified balance sheet, adjusting and closing entries and post-closing trial balance.

Moderate

70-80

*11B

Prepare and post transaction entries, with and without reversing entries.

Moderate

40-50

*12B

Prepare adjusting, reversing and subsequent cash entries.

Simple

40-50

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Accounting Principles, Fifth Canadian Edition

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

Knowledge

Comprehension

Application

Analysis Synthesis

1. Prepare closing Q4-6 entries and a post- BE4-1 closing trial balance

Q4-1 Q4-2 Q4-3 Q4-4 Q4-5

BE4-2 BE4-3 BE4-4 E4-1 E4-2 E4-3 E4-4 *E4-13

P4-2A P4-1A P4-3A P4-1B P4-7A *P4-10A P4-2B P4-3B P4-7B *P4-10B

2. Explain the steps BE4-5 in the accounting Q4-7 cycle including Q4-8 optional steps. 3. Prepare correcting entries.

Q4-9

BE4-6 E4-5 P4-4A P4-4B BE4-7 BE4-8 E4-6 E4-7

P4-5A P4-6A P4-5B P4-6B

Prepare a Q4-17 classified balance BE4-9 sheet. E4-8

Q4-12 Q4-13 Q4-14 Q4-15 Q4-16

Illustrate BE4-11 measures used to evaluate liquidity.

Q4-18 Q4-19 Q4-20

Q4-10 Q4-11

*6. Prepare a work sheet (Appendix 4A)

*Q4-21 *Q4-22

*7. Prepare reversing entries (Appendix 4B)

*Q4-23 *Q4-24

Broadening Your Perspective

BYP4-3 BYP4-4

P4-7A E4-10 *P4-10A P4-2B P4-3B P4-7B *P4-10B BE4-12 E4-10 P4-7A P4-7B E4-11 P4-8A P4-8B *BE4-13 *P4-9A *BE4-14 *P4-10A *E4-12 *P4-9B *P4-10B *BE4-15 *BE4-16 *E4-13 *E4-14 *P4-11A *P4-11B *P4-12A *P4-12B Continuing Cookie BYP4-2 Chronicles BYP4-6 Cumulative Coverage BYP4-1

Evaluation

BE4-7 BE4-10 E4-9 P4-2A P4-3A

BYP4-5

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 1.

Permanent accounts are those accounts that appear on the balance sheet and are never closed at the end of the annual accounting year. Temporary accounts, on the other hand, get closed at the end of the year and the net result of the closing entries updates the equity account Capital which in turn is a permanent account on the Balance sheet.

Closing entries are made at the end of an accounting period after preparation of the financial statements to: a. transfer revenue, expense, and drawings account balances to the owner’s capital account and b. reset these temporary accounts to zero.

The Income Summary account is used to avoid having a lot of detailed entries on the permanent owner’s capital account. The types of summary data that are posted to this account are the totals of revenue and expense accounts. If an Income Summary account was not used the owner’s capital account would be credited when closing the individual revenue accounts and it would be debited when closing the individual expense accounts.

The drawings account is not closed with the expense accounts because it is not part of profit. Drawings represent a withdrawal of the owner’s capital and are reported on the statement of owner’s equity, not the income statement. However, it is also a temporary account and therefore requires a closing entry.

(1) The balance in Income Summary, immediately before the final closing entry to transfer the balance to the owner’s capital account, should equal the profit (or loss) reported in the income statement. (2) All temporary accounts (revenues, expenses, owner’s drawings, and Income Summary) should have zero balances. (3) The balance in the capital account should equal the ending balance reported in the statement of owner’s equity and balance sheet.

The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the equality of the permanent account balances that are carried forward into the next accounting period.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 7.

a) Daily: Analyze transaction and journalize transactions. b) Periodic: Post to ledger, prepare a trial balance, journalize and post adjusting entries, prepare an adjusted trial balance, prepare financial statements. c) Fiscal year end: Journalize and post closing entries, prepare a post closing trial balance.

Trial balances are prepared before the preparation of the adjusting journal entries (called trial balance), after the preparation of the adjusting journal entries (called adjusted trial balance) and after the preparation and posting of the closing entries (post-closing trial balance).

Yes. The work sheet is a convenient and efficient tool for completing some of the steps (step 4 trial balance, 5 adjusting entries, 6 adjusted trial balance) and for assisting with step 7 (prepare financial statements) in the accounting cycle.

10.

Correcting entries differ from adjusting entries because they (1) are not a required part of the accounting cycle if no errors have been made, (2) may be made at any time, and (3) may affect any combination of accounts. Adjusting entries are a necessary part of the account cycle, are normally made prior to the preparation of financial statements, and affect both an income statement account and a balance sheet account.

11.

In order to properly correct for entry errors, it is important to understand which account should have been involved in a transaction and which accounts were involved in the transaction that has been recorded in error. As well, it is important to determine if the error is only in the amount that has been recorded as opposed to recording to the wrong general ledger accounts. Once the correct and incorrect entries have been arrived at, the correcting entry can be recorded. The accounts that are not in error can be omitted in the correcting entry. An alternative is to reverse the incorrect entry and to then record the correct entry.

12.

Classifying the assets and liabilities on the balance sheet provides users with more information. The classification provides the amount of assets and liabilities that will be realized and that come due in the coming year. This enables users to evaluate the company’s liquidity. It also provides information on long-term assets and liabilities.

13.

A company’s operating cycle is the average time it takes to go from starting with cash and ending with cash in producing revenues.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 14.

Current assets are normally cash and other assets that will be converted to cash, sold, or used up in one year from the balance sheet date. Some companies use a period longer than one year to classify assets as current because they have an operating cycle that is longer than one year. For private businesses in Canada, current assets are listed in the order of their liquidity; that is in the order in which they are expected to be converted to cash. For publicly traded companies following IFRS, although there are variations, current assets may be listed in inverse liquidity order: with the least liquid current assets listed first.

15.

Long-term investments are assets that can be realized in cash; however, the conversion is not expected within one year. They include shares and bonds of other companies. Both property, plant, and equipment, and intangible assets are resources that are used in the business and not intended for resale. The difference between the two is property, plant, and equipment have physical substance while intangibles do not.

* 16.

The major differences between current liabilities and long-term liabilities are: Difference

Current Liabilities

Long-term Liabilities

Source of payment. Existing current assets or other current liabilities.

Other than existing current assets or creating current liabilities.

Time of expected payment.

Within one year.

Beyond one year.

Nature of items.

Debts pertaining to the operating cycle and other short-term debts.

Mortgages, bonds and other long-term liabilities.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 17.

Under both Canadian Accounting Standards and International Financial Reporting Standards (IFRS) titles “Balance Sheet” and “Statement of Financial Position” are allowed. Traditionally Canadian companies used “Balance Sheet” and companies following IFRS use “Statement of Financial Position.” The content of the balance sheet is the same as to amounts and key sub-totals but the sequence of the major categories of the elements in the balance sheet may change. The traditional Canadian standards call for the presentation of assets in the balance sheet to follow the order: current assets (in decreasing liquidity order), followed by long-term investment, properly plant and equipment followed by intangible assets. Current liabilities, long-term debt and owners’ or shareholders’ equity then complete the balance sheet. For the IFRS format, the presentation often follows the this sequence: long-term assets, including properly plant and equipment and then intangible assets, current assets (in increasing liquidity order), shareholders’ equity, non-current liabilities and current liabilities. But public Canadian companies will still have the choice to follow their current conventions.

18.

Liquidity is the ability of a company to pay its obligations that become due within the next year. One measure of liquidity is working capital. Other measures include the current and acid-test ratios.

19.

Ratios should never be interpreted without considering certain factors: (1) general economic and industry conditions need to be considered; (2) other specific financial information about the company over time needs to be considered, and (3) the ratios should be compared to the ratios for other companies in the same or related industries.

20.

The acid-test ratio is a measure of the company’s immediate short-term liquidity. The acid-test ratio is calculated by dividing the sum of cash, short term investments and accounts receivable by current liabilities. The current ratio is a measure of the short-term debt-paying ability that is determined by dividing all current assets by current liabilities.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) *21. To calculate the income on a worksheet each of the financial statement columns must be totalled. The profit or loss for the period is then found by calculating the difference between the totals of the two income statement columns. If a company has profit the amount is then entered in the income statement debit column and the balance sheet credit column. If the company has a loss the amount is entered in the credit column on the income statement and in the debit column on the balance sheet. *22. It is still necessary to journalize and post adjusting entries that have been made on the worksheet because the worksheet is not part of the company’s permanent accounting records. The general ledger and journal must contain all of the adjusting data. If this were not done the balance for the start of the next year would be incorrect. *23. A reversing entry is the exact opposite, both in amount and in account titles, of an adjusting entry for an accrual. If an account was debited in an adjusting entry it will be credited for the same amount in a reversing entry. Adjusting entries are required, while reversing entries are an optional step in the accounting cycle. In some accounting systems, they simplify the recording of subsequent transactions related to the adjustments. *24. It is helpful to use reversing entries for accruals because then the payment can be processed in the normal manner without having to check if there has been an accrual, i.e. all cash payments can be debited to the appropriate expense account. Reversing prepayments would not simplify the recording of subsequent transactions, which are required in prepayments.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1 1. (P) Accounts payable 2. (P) Accounts receivable 3. (T) Depreciation expense 4. (T) General and operating expenses 5. (P) Property taxes payable 6. (T) Interest on long-term debt expense 7. (P) S. Young, capital 8. (P) Long-term debt 9. (T) Other revenues 10. (P) Prepaid expenses 11. (P) Equipment 12. (T) S. Young, drawings 13. (P) Accumulated depreciation 14. (P) Short-term investments

BRIEF EXERCISE 4-2 (a) Sept. 30 Service Revenue................................. 53,800 Income Summary ...........................

53,800

30 Income Summary ............................... 30,900 Salaries Expense ........................... Rent Expense ................................. Supplies Expense ..........................

15,400 12,000 3,500

30 Income Summary ............................... 22,900 B. Willis, Capital .............................

22,900

30 B. Willis, Capital ................................. 22,000 B. Willis, Drawings .........................

22,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-2 (continued) (b)

The closing balance of the B. Willis Capital at September 30, 2011 is $67,900 calculated as follows: B. Willis, Capital 67,000 22,900 22,000 Bal.

67,900

BRIEF EXERCISE 4-3 (a) Oct

31 Golf Fees Earned ................................ 150,000 Income Summary ...........................

150,000

31 Income Summary ............................... 115,000 Maintenance Expense ................... Rent Expense ................................. Salaries Expense ...........................

23,000 10,000 82,000

31 Income Summary ............................... 35,000 N. Mosquera, Capital .....................

35,000

31 N. Mosquera, Capital .......................... 45,000 N. Mosquera, Drawings .................

45,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-3 (continued) (b) Income Summary 115,000 150,000 35,000 35,000 0

N. Mosquera, Capital 75,000 35,000 45,000 65,000

N. Mosquera, Drawings 45,000 45,000

Golf Fees Earned 150,000 150,000 0

Maintenance Expense 23,000 23,000 0

Rent Expense 10,000 10,000 0

Salaries Expense 82,000 82,000 0

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-4 MOSQUERA GOLF CLUB Post-Closing Trial Balance October 31, 2011

Debit Cash .................................................................... $ 5,500 Prepaid expenses ............................................... 3,000 Equipment........................................................... 85,000 Accumulated depreciation—equipment ........... Accounts payable............................................... Unearned golf fees ............................................. N. Mosquera, capital .......................................... $93,500

Credit

$15,000 12,000 1,500 65,000 $93,500

BRIEF EXERCISE 4-5 The proper sequencing of the required steps in the accounting cycle is as follows: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Analyze business transactions Journalize the transactions Post to the ledger accounts Prepare a trial balance Journalize and post the adjusting entries Prepare an adjusted trial balance Prepare the financial statements Journalize and post the closing entries Prepare a post-closing trial balance

Filling in the blanks, the answers are 9, 6, 1, 4, 2, 8, 7, 5, 3.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-6 (a)

Mar. 2

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

750 750

(b) Mar. 2

(c)

Supplies Expense

Mar. 31 Supplies Expense ............................ Supplies .......................................

Mar. 2 Bal.

Supplies 750

Supplies 750 Mar. 31 200

550

Supplies Expense Mar.31 550 550

(d) Mar. 31 Income Summary............................. Supplies Expense ....................... Income Summary Mar. 31 550

550

Supplies Expense Mar.31 550 Mar. 31 Bal. 0

550

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-7

1. 2. 3. 4. 5.

Balance Sheet Income Statement Owner's Assets Liabilities Equity Revenue Expenses Profit U NE U U NE U NE O U U NE U NE NE NE NE O U O/U U NE NE NE NE U U NE NE NE NE

BRIEF EXERCISE 4-8 1.

Cash ....................................................... Service Revenue.............................

980

Unearned Service Revenue .................. Service Revenue.............................

600

Roch Hébert, Drawings ......................... Salary Expense ...............................

500

980

600

500

Office Supplies ...................................... 1,850 Equipment ....................................... Accounts Payable .......................... Cash ($720 − $270) ................................ Accounts Payable ..........................

1,580 270

450 450

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-9 1 5 3 1 6

(a) Supplies (b) Accounts Payable (c) Building (d) Prepaid Insurance (e) Note Payable (due in 5 years) 4 (f) Goodwill

5 (g) Unearned Revenue 1 (h) Accounts Receivable 3 (i) Accumulated Depreciation— Building 4 (j) Patents 2 (k) Note Receivable (due in 3 years) 5 (l) Salaries Payable

BRIEF EXERCISE 4-10 Reuben Company Balance Sheet (Partial) December 31, 2011 Current assets Cash............................................................................... $ 19,300 Short-term investments................................................ 8,200 Accounts receivable ..................................................... 13,700 Supplies......................................................................... 5,200 Prepaid insurance......................................................... 3,900 Total current assets ................................................. $50,300

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 4-11 Working capital = Current assets − Current liabilities Big: Working capital = $1,000,000 − $900,000 = $100,000 Small: Working capital = $200,000 − $100,000 = $100,000 Current ratio = Current assets ÷ Current liabilities Big: Current ratio = $1,000,000 ÷ $900,000 = 1.11:1 Small: Current ratio = $200,000 ÷ $100,000 = 2.00:1 The working capital is the same for both companies but Small Company’s current ratio is much stronger. The current ratio is more relevant.

BRIEF EXERCISE 4-12 Working capital = Current assets − Current liabilities Working capital = $175,200 − $136, 750 = $38,450 Current ratio Current ratio

= Current assets ÷ Current liabilities = $175,200 ÷ $136,750 = 1.28:1

Acid-test ratio = (Cash + Accounts Receivable + Short-term Investments) ÷ Current liabilities Acid-test ratio = ($10,500 + $27,200 + $7,600) ÷ $136,750 = $45,300 ÷ $136,750 = .33:1 Cool Delight’s short-term debt-paying ability (current ratio) and immediate short-term liquidity (acid-test ratio) are poor. The excess of the current assets over the current liabilities (working capital) is minimal. Attention must be given to rectify Cool Delight’s liquidity problems.

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Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 4-13

Totals Loss Totals

Income Statement Dr. Cr. 37,250 28,950 8,300 37,250 37,250

Balance Sheet Dr. Cr. 37,050 45,350 8,300 45,350 45,350

*BRIEF EXERCISE 4-14

Totals Profit Totals

Income Statement Dr. Cr. 33,300 45,400 12,100 45,400 45,400

Balance Sheet Dr. Cr. 71,800 59,700 12,100 71,800 71,800

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Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 4-15 (a) Nov. 1 Salaries Payable ................................... Salaries Expense.............................. To reverse Oct. 31 accrual.

1,200 1,200

6 Salaries Expense ................................. 3,000 Cash. ................................................. To record Nov. 4 payment of salary.

3,000

(b) Salaries Expense Explanation Ref. Debit

Credit Balance

Oct 31 Balance after closing entries Nov. 1 Reversing entry 6 Payment of salary 3,000

0 1,200 Cr 1,800

Date

Salaries Payable Explanation Ref. Debit

Oct. 31 Balance Nov. 1 Reversing entry

1,200

Credit Balance 1,200 0

The balances after posting the two entries are a debit of $1,800 in Salaries Expense and $0 in Salaries Payable.

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Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 4-16 (a)

Nov.

1 Interest Earned .......................... Interest Receivable ............... To record reversing entry.

5,600 5,600

Nov. 10 Cash ........................................... 6,000 Interest Earned...................... To record interest received.

6,000

(b) Interest Earned Ref. Debit

Credit Balance

Oct 31 Balance after closing entries Nov. 1 Reversing entry 5,600 10 Collection of interest

0 5,600 Dr 400

Date

Explanation

Interest Receivable Explanation Ref. Debit

Oct. 31 Balance Nov. 1 Reversing entry

6,000

Credit Balance

5,600 5,600

5,600 0

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 4-1 (a)

June 30 Service Revenue .................... Income Summary ...............

15,800

30 Income Summary ................... Salaries Expense ............... Utilities Expense ................ Rent Expense .....................

13,425

30 Income Summary ................... J. Rothwell, Capital ............

2,375

30 J. Roth, Capital ....................... J. Rothwell, Drawings ........

2,650

15,800

9,500 1,225 2,700

2,375

2,650

(b) Date

Income Summary Explanation Ref. Debit

June 30 Close Revenues 30 Close Expenses 30 Closing entry (c)

Credit Balance 15,800

13,425 2,375

15,800 2,375 0

The ending balance in J. Rothwell’s, Capital account should agree with the capital account ending balance on the Statement of Owner’s Equity and the Balance Sheet.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-2 (a) VICTOIRE ESTHETICS Statement of Owner's Equity Month Ended May 31, 2011

B. Victoire, capital, May 1, 2011...................................... Add: Investment .............................................................. Profit ....................................................................... Less: Drawings ............................................................... B. Victoire, capital, May 31, 2011....................................

$ 7,500 5,000 4,000 16,500 3,250 $13,250

b) May

31 Income Summary ................... B. Victoire, Capital .............

4,000

31 B. Victoire, Capital.................. B. Victoire, Drawings .........

3,250

4,000

3,250

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-2 (Continued) (b) (Continued)

Date

Income Summary Explanation Ref. Debit

May 31 Balance 31 Closing entry

Date

B. Victoire, Drawings Explanation Ref. Debit

Credit Balance

3,250

B. Victoire, Capital Explanation Ref. Debit

May 31 Balance 31 Closing entry 31 Closing entry

4,000 Cr 0

4,000

May 31 Balance 31 Closing entry

Date

Credit Balance

4,000 3,250

3,250 0

12,500 16,500 13,250

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-3 (a) GENERAL JOURNAL Date

Account Titles and Explanation

J15 Debit

Credit

July 31 Service Revenue................................. 71,700 Income Summary ...........................

71,700

31 Income Summary ............................... 77,350 Depreciation Expense ................... Salaries Expense ........................... Interest Expense ............................ Rent Expense ................................. Supplies Expense ..........................

2,700 36,050 1,350 16,400 20,850

31 B. Donatello, Capital .......................... Income Summary ...........................

5,650

31 B. Donatello, Capital........................... 16,500 B. Donatello, Drawings ..................

16,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-3 (Continued) (a) (Continued)

Date Explanation July 31 Balance

Cash Ref. ✓

Debit

Credit Balance 5,840

Accounts Receivable Date Explanation Ref. Debit July 31 Balance ✓

Credit Balance 11,440

Prepaid Expenses Date Explanation Ref. Debit July 31 Balance ✓

Credit Balance 1,620

Date Explanation July 31 Balance

Supplies Ref. ✓

Date Explanation July 31 Balance

Equipment Ref. Debit ✓

Debit

Credit Balance 470

Credit Balance 17,600

Accumulated Depreciation—Equipment Date Explanation Ref. Debit Credit Balance July 31 Balance ✓ 5,400 Accounts Payable Date Explanation Ref. Debit July 31 Balance ✓

Credit Balance 4,245

Interest Payable Date Explanation Ref. Debit July 31 Balance ✓

Credit Balance 525

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-3 (Continued) (a) (Continued) Unearned Service Revenue Date Explanation Ref. Debit Credit Balance July 31 Balance ✓ 2,750 Notes Payable Ref. Debit ✓

Credit Balance 15,000

B. Donatello, Capital Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15 5,650 31 Closing entry J15 16,500

Credit Balance 31,200 25,550 9,050

B. Donatello, Drawings Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry

Credit Balance 16,500 16,500 0

Date Explanation July 31 Balance

Date July 31 31 31 31

Income Summary Explanation Ref. Debit Balance ✓ Closing entry J15 Closing entry J15 77,350 Closing entry J15

Service Revenue Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15 71,700

Credit Balance 0 71,700 71,700 5,650 Dr. 5,650 0

Credit Balance 71,700 0

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-3 (Continued) (a) (Continued) Depreciation Expense Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15

Credit Balance 2,700 2,700 0

Salaries Expense Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15

Credit Balance 36,050 36,050 0

Interest Expense Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15

Credit Balance 1,350 1,350 0

Rent Expense Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15

Credit Balance 16,400 16,400 0

Supplies Expense Date Explanation Ref. Debit July 31 Balance ✓ 31 Closing entry J15

Credit Balance 20,850 20,850 0

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-3 (Continued) (b) DONATELLO COMPANY Post-Closing Trial Balance July 31, 2011

Debit Cash .................................................................... $ 5,840 Accounts receivable .......................................... 11,440 Prepaid expenses ............................................... 1,620 Supplies .............................................................. 470 Equipment........................................................... 17,600 Accumulated depreciation—equipment ........... Accounts payable............................................... Interest payable .................................................. Unearned service revenue ................................. Notes payable ..................................................... B. Donatello, capital ........................................... ______ $36,970

Credit

$ 5,400 4,245 525 2,750 15,000 9,050 $36,970

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-4 (a)

Aug. 31 Bowling Revenues ................. Income Summary ...............

35,900

31 Income Summary ................... Depreciation Expense ....... Insurance Expense ............ Interest Expense ................

14,970

31 Income Summary ................... T. Williams, Capital ............

20,930

31 T. Williams, Capital................. T. Williams, Drawings ........

16,000

35,900

9,300 870 4,800

20,930

16,000

(b)

Clos. Clos. Bal.

Income Summary 14,970 Clos. 35,900 Bal. 20,930 20,930 0

T. Williams, Capital Bal. 125,000 Clos. 16,000 Clos. 20,930 Bal. 129,930

T. Williams, Drawings Bal. 16,000 Clos. 16,000 Bal. 0

Bowling Revenues Clos. 35,900 Bal. 35,900 Bal. 0

Depreciation Expense Bal. 9,300 Clos. 9,300 Bal. 0

Insurance Expense 870 Clos. 0

Interest Expense Bal. 4,800 Clos. 4,800 Bal. 0

Bal. Bal.

870

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-4 (Continued) (c) ALPINE BOWLING LANES Post-Closing Trial Balance August 31, 2011

Debit Credit Cash ................................................................. $ 17,940 Accounts receivable ....................................... 10,780 Prepaid insurance ........................................... 4,590 Supplies ........................................................... 740 Investments in bonds ..................................... 10,000 Land ................................................................. 64,000 Building ............................................................ 128,800 Accumulated depreciation—building ............ $ 30,900 Equipment........................................................ 62,400 Accumulated depreciation—equipment ........ 24,960 Accounts payable............................................ 12,300 Unearned bowling revenue............................. 980 Interest payable ............................................... 400 Mortgage payable ............................................ 99,780 T. Williams, capital .......................................... _______ 129,930 $299,250 $299,250

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-5 (a)

Apr.

2 Cash ................................................ 4,000 Tim Sasse, Capital .....................

4,000

6 Supplies .......................................... 1,500 Cash ............................................

1,500

15 Cash ................................................ Service Revenue ........................

600

25 Cash ................................................ 1,200 Unearned Service Revenue .......

600

1,200

(b) (c) and (e) Cash Apr. 2 4,000 Apr. 6 Apr. 15 600 Apr. 25 1,200 Bal.

1,500

Apr. 6 Apr.30

Supplies 1,500 Apr. 30 1,100

400

4,300

Unearned Service Revenue Apr.30 400 Apr. 25 1,200 Bal. 800

Service Revenue Apr. 15 600 Apr. 30 400 Apr.30 500 Clos. 1,500 Bal. 1,500 Bal. 0

Accounts Receivable Apr. 30 500

Supplies Expense Apr. 30 400 Clos. 400 Bal. 0

Income Summary Clos. 400 Clos. 1,500 Clos. 1,100 Bal. 0

Tim Sasse, Capital Apr. 2 4,000 Clos. 1,100 Bal. 5,100

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-5 (Continued)

(c)

(Continued) Apr. 30 Supplies Expense........................... Supplies......................................

400

30 Unearned Service Revenue ........... Service Revenue .......................

400

30 Accounts Receivable ..................... Service Revenue ........................

500

400

500

(d) SASSE ROOF REPAIRS Adjusted Trial Balance April 30, 2011

Cash ................................................................. Accounts receivable ....................................... Supplies ........................................................... Unearned service revenue .............................. Service revenue ............................................... Supplies expense ............................................ Tim Sasse, capital ...........................................

(e)

Apr.

Debit $ 4,300 500 1,100

Credit

$ 800 1,500 400 _____ $6,300

30 Service Revenues................... Income Summary ...............

1,500

30 Income Summary ................... Supplies Expense ..............

400

30 Income Summary ................... Tim Sasse, Capital .............

1,100

4,000 $6,300

1,500

400

1,100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 4-6 (a) 1.

Accounts Payable ($920 − $290) ................ Cash .........................................................

630

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

560

L. Choi, Drawings ........................................ Salaries Expense ....................................

400

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

700

Unearned Service Revenue ........................ Service Revenue .....................................

175

630

56 504

400

700

175

(b)

1. 2. 3. 4. 5.

Balance Sheet Income Statement Owner's Assets Liabilities Equity Revenue Expenses Profit O O NE NE NE NE U U NE NE NE NE NE NE NE NE O U O NE O O NE O NE O U U NE U

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 4-7 (a) 1.

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

625

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

625

Short-Term Investments ................... Cash ............................................

2,000

Cash ................................................... T. D’Addario, Capital ..................

2,000

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

870

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

780

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

440

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

440

Accounts Payable ............................. Equipment Expense ...................

3,500

Equipment ......................................... Notes Payable.............................

3,500

625

2,000

870

780

440

3,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-7 (Continued) (b) 1.

Salaries Expense............................... Supplies ......................................

625

Short-Term Investments ................... T. D’Addario, Capital ..................

2,000

Accounts Receivable ($870 − $780) . Cash ............................................

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

440

Accounts Payable ............................. Equipment ......................................... Equipment Expense ................... Notes Payable.............................

3,500 3,500

625

2,000

440

3,500 3,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-8

Account Accounts payable and accrued liabilities Accounts receivables Accumulated other comprehensive loss Capital assets Capital stock Cash and cash equivalents Contributed surplus Current portion of long-term debt Employee future benefit obligation Financing expenses General and operating expenses Goodwill Income tax expense Income taxes payable Income taxes receivable Inventories Investments Long-term debt Long-term debt due within one year Long-term lease obligation Mortgages and loans receivable Other revenues Prepaid expenses Retained earnings

(a) (b) B/S or Balance Sheet I/S classification B/S Current Liabilities B/S Current Assets B/S Shareholder’s Equity B/S B/S B/S B/S B/S B/S I/S I/S B/S I/S B/S B/S B/S B/S B/S B/S B/S B/S I/S B/S B/S

Property, Plant, and Equipment Shareholder’s Equity Current Assets Shareholder’s Equity Current Liabilities Long-term Liabilities

Intangible Assets Current Liabilities Current Assets Current Assets Long-term Assets Long-term Liabilities Current Liabilities Long-term Liabilities Long-term Assets Current Assets Shareholder’s Equity

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-9 (a) DONATELLO COMPANY Income Statement Year Ended July 31, 2011

Service revenue .................................................. Expenses Depreciation expense .................................... $ 2,700 Salaries expense............................................ 36,050 Interest expense ............................................ 1,350 Rent expense ................................................. 16,400 Supplies expense .......................................... 20,850 Total expenses .......................................... Loss ....................................................................

$71,700

77,350 $ 5,650

DONATELLO COMPANY Statement of Owner's Equity Year Ended July 31, 2011 B. Donatello, capital, August 1, 2010 ($31,200 – $5,000) Add: Investment .............................................................

$26,200 5,000 31,200

Less: Loss ......................................................... $ 5,650 Drawings.................................................. 16,500 0 22,150 B. Donatello, capital, July 31, 2011 ................................ $ 9,050

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-9 (Continued) (b) DONATELLO COMPANY Balance Sheet July 31, 2011

Assets Current assets Cash............................................................................. $ 5,840 Accounts receivable ................................................... 11,440 Supplies....................................................................... 470 Prepaid expenses ....................................................... 1,620 Total current assets ............................................... 19,370 Property, plant, and equipment Equipment ...................................................... $17,600 Less: Accumulated depreciation .................. 5,400 12,200 Total assets ............................................................ $31,570 Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... Interest payable .......................................................... Unearned service revenue ......................................... Total current liabilities ........................................... Long-term liability Notes payable ............................................................. Total liabilities ........................................................ Owner's equity B. Donatello, capital ................................................... Total liabilities and owner's equity .......................

$ 4,245 525 2,750 7,520 15,000 22,520 9,050 $31,570

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-10 (a) ALPINE BOWLING LANES Income Statement Year Ended August 31, 2011

Bowling revenue .............................................................

$35,900

Expenses Depreciation expense .................................... $9,300 Insurance expense ........................................ 870 Interest expense ............................................ 4,800 Total expenses ....................................................... 14,970 Profit................................................................................. $ 20,930

ALPINE BOWLING LANES Statement of Owner's Equity Year Ended August 31, 2011 ______________________________________________________ T. Williams, capital, September 1, 2010 ......................... $125,000 Add: Profit........................................................................ 20,930 135,930 Less: Drawings ................................................................ 16,000 T. Williams, capital, August 31, 2011 ............................. $129,930

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-10 (Continued) (a) (Continued) ALPINE BOWLING LANES Balance Sheet August 31, 2011 Assets Current assets Cash............................................................................. $ 17,940 Accounts receivable ................................................... 10,780 Supplies....................................................................... 740 Prepaid insurance....................................................... 4,590 Total current assets ............................................... 34,050 Long-term investment in bonds ..................................... 10,000 Property, plant, and equipment Land ................................................. $64,000 Building ........................................... $128,800 Less: Accumulated depreciation .. 30,900 97,900 Equipment ....................................... 62,400 Less: Accumulated depreciation .. 24,960 37,440 199,340 Total assets ..................................................................... $243,390 Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... $012,300 Interest payable .......................................................... 400 Unearned bowling revenue ........................................ 980 Current portion of mortgage payable ...................... 0 12,750 Total current liabilities ........................................... 26,430 Long-term liabilities Mortgage payable ....................................................... 87,030 Total liabilities ........................................................ 113,460 Owner's equity T. Williams, capital ...................................................... 129,930 Total liabilities and owner's equity ....................... $243,390

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-10 (Continued) (b) Working capital = Current Assets – Current Liabilities $34,050 − $26,430 = $7,620 Current Ratio = Current Assets ÷ Current Liabilities $34,050 ÷ $26,430 = 1.29:1 Acid-test ratio

= (Cash + Accounts receivable + Shortterm investments) ÷ Current liabilities = ($17,940 + $10,780) ÷ $26,430 = $28,720 ÷ $26,430 = 1.09:1

(c)

Almost 50% of current assets are in the form of cash. The company's liquidity appears to be reasonably good.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 4-11 (a)

Working Capital = Current Assets − Current Liabilities Fiscal years: 2008: $2,384,464 − $1,843,860 = $540,604 2007: $2,172,199 − $2,159,045 = $13,154 2006: $1,821,423 − $1,577,784 = $243,639 Current Ratio = Current Assets ÷ Current Liabilities 2008: $2,384,464 ÷ $1,843,860 = 1.29:1 2007: $2,172,199 ÷ $2,159,045 = 1.01:1 2006: $1,821,423 ÷ $1,577,784 = 1.15:1 Acid-test ratio = (Cash + Accounts receivable) ÷ Current Liabilities 2008: ($36,567 + $448,476) ÷ $1,843,860 = 0.26:1 2007: ($27,588 + $372,206) ÷ $2,159,045 = 0.19:1 2006: ($62,865 + $307,779) ÷ $1,577,784 = 0.23:1

(b) Shoppers Drug Mart’s short-term debt-paying ability (current ratio) and immediate short-term liquidity (acid-test ratio) have improved substantially in the 2008 fiscal year ending January 3, 2009. This trend is after a severe decline experienced in 2007 compared to 2006. The excess of the current assets over the current liabilities (working capital) is not high in 2008 but is adequate compared to 2007 when it was extremely low.

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 4-12 GARDENS DESIGNS Work Sheet Month Ended April 30, 2011 Unadjusted Trial Balance Account Titles

Dr.

Cash Accounts receivable Prepaid rent Equipment Accum. deprec.–equip. Accounts payable Notes payable Interest payable T. Hibbiscus, capital T. Hibbiscus, drawings Service revenue Salaries expense Rent expense Depreciation expense Interest expense Totals Profit Totals

14,840 8,780 4,875 18,900

Solutions Manual

Cr.

Adjustments

Adjusted Trial Balance

Dr.

Cr.

(1) 720 (2) 975 4,725 5,670 11,600

Cr.

(4) 58

(1) 720

9,840 (2) 975 (3) 197 (4) 58 60,885 1,950

1,950

Dr.

4,922 5,670 11,600 58 25,960 3,650

13,650 9,840 975 197 58 61,860

Cr.

14,840 9,500 3,900 18,900

3,650 12,930

Balance Sheet

4,922 5,670 11,600 58 25,960

25,960

60,885

Dr.

14,840 9,500 3,900 18,900

(3) 197

3,650

Cr.

Income Statement

61,860

13,650 9,840 975 197 0 58 11,070 2,580 13,650

13,650

50,790

13,650

50,790

48,210 2,580 50,790

Chapter 4

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 4-13 (a) (1) Dec.31 Accounts Receivable .................... Commission Revenue ..............

4,400

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

1,500

4,400

1,500

(2) Dec.31 Commission Revenue ................... 96,400 Income Summary....................

96,400

31 Income Summary .......................... Interest Expense .......................

9,300

31 Income Summary .......................... 87,100 I. Masterson, Capital ................. (b) Jan. 1 Commission Revenue ................... Accounts Receivable ................

4,400

1 Interest Payable ............................. Interest Expense .......................

1,500

6,200

31 Interest Expense............................ Cash ...........................................

2,235

87,100

4,400

1,500

6,200

2,235

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 4-13 (Continued) (a), (b) and (c)

Date

Explanation

Cash Ref.

Dec. 31 Unadjusted balance Jan. 10 31

Date

6,200

7,600 13,800 11,565

2,235

Credit Balance

4,400 4,400

Interest Payable Explanation Ref. Debit

Dec. 31 Unadjusted balance 31 Adjusting entry Jan. 1 Reversing entry

Date

Credit Balance

Accounts Receivable Explanation Ref. Debit

Dec. 31 Unadjusted balance 31 Adjusting entry Jan. 1 Reversing entry

Date

Debit

24,000 28,400 24,000

Credit Balance

1,500

0 1,500 0

I. Masterson, Capital Explanation Ref. Debit

Credit Balance

Dec. 31 Unadjusted balance 31 Closing entry

1,500

87,100

48,000 135,100

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 4-13 (Continued) (a), (b), and (c) (Continued)

Date

Income Summary Explanation Ref. Debit

Dec. 31 Closing entry 31 Closing entry 31 Closing entry

Date Dec. 31 31 31 Jan. 1 10

Date Dec. 31 31 31 Jan. 1 31

Credit Balance

9,300 87,100

96,400 87,100 0

Commission Revenue Explanation Ref. Debit

Credit Balance

Unadjusted balance Adjusting entry Closing entry Reversing entry

96,400

4,400 96,400 4,400 6,200

Interest Expense Explanation Ref. Debit Unadjusted balance Adjusting entry Closing entry Reversing entry

Credit Balance

1,500 9,300 1,500 2,235

92,000 96,400 0 4,400 Dr. 1,800

7,800 9,300 0 1,500 Cr. 735

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 4-14 (a)

It would be useful to prepare reversing entries for adjustment 1, 4, and 6.

(b) (1) May

(4)

(6)

(c)

May

1 Property Management Revenue.. Accounts Receivable ..............

600

1 Interest Payable ........................... Interest Expense......................

545

600

1 Property Tax Payable .................. 1,304 Property Tax Expense ............. ($3,912 ÷ 12 × 4)

545

1,304

Reversing entries are useful for these adjustments because it simplifies the recording of future transactions. The entire later payment can be debited to the expense account and credited to the revenue account. You will not have to remember what has gone before. The use of reversing entries does not change the amounts reported in the financial statements. It simply makes it easier to record future transactions.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 4-1A (a)

Professional Fees Earned ....................... 275,000 Other Revenue ......................................... 20,000 Income Summary ................................

295,000

Income Summary ..................................... 165,000 Operating Expenses ............................ Other Expenses ...................................

145,000 20,000

Income Summary ..................................... 130,000 J. Lecoure, Capital ..............................

130,000

J. Lecoure, Capital ................................... 125,000 J. Lecoure, Drawings ..........................

125,000

(b) Income Summary 295,000 165,000 Bal. 130,000 Clos. 130,000 Bal. 0

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-1A (Continued) (c) LECOURE CONSULTING Post-Closing Trial Balance September 30, 2011

Debit Credit Cash .................................................................. $ 20,000 Equipment ........................................................ 60,000 Accumulated depreciation .............................. $ 10,000 Accounts payable ............................................ 5,000 J. Lecoure, capital ........................................... _______ 65,000 $80,000 $80,000 (d)

The total debits on the post-closing trial balance will do not equal the total assets at September 30, 2011 because of the contra asset account accumulated depreciation which has a credit balance.

Taking It Further: Closing entries are made at the end of an accounting period after preparation of the financial statements to: a. transfer revenue, expense, and drawings account balances to the owner’s capital account and b. reset these temporary accounts to zero. The temporary accounts have done the job of accumulating accounting information that has been reported on the income statement and the statement of owner’s equity. Permanent accounts are not closed as they continue on reporting balances at each of the reporting periods in the future.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (a) TORONTO TENNIS PARK Income Statement Year Ended December 31, 2011

Service revenue ............................................................... $139,800 Expenses Advertising expense ................................... $ 2,400 Depreciation expense ................................. 10,300 Utilities expense .......................................... 2,175 Interest expense .......................................... 4,155 Insurance expense ...................................... 3,500 Salaries expense ......................................... 32,100 Supplies expense ........................................ 2,170 Total expenses ........................................................ 56,800 Profit ................................................................................. $ 83,000

TORONTO TENNIS PARK Statement of Owner's Equity Year Ended December 31, 2011 ______________________________________________________ T. Fichman, capital, January 1, 2011 ($165,000 − $2,500) .............................................. $ 162,500 Add: Investment ........................................... $ 2,500 Profit..................................................... 83,000 85,500 248,000 Less: Drawings .............................................................. 59,200 T. Fichman, capital, December 31, 2011 ......................... $ 188,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (Continued) (a) (Continued) TORONTO TENNIS PARK Balance Sheet December 31, 2011 ______________________________________________________ Assets Current assets Cash ............................................................................... $ 6,185 Accounts receivable ..................................................... 13,500 Prepaid insurance ......................................................... 888,400 Supplies ......................................................................... 1,140 Total current assets .................................................. 29,225 Long-term investments ..................................................... 25,000 Property, plant, and equipment Land ................................................. $46,800 Building ......................................... $187,580 Less: Accumulated depreciation .. 37,520 150,060 Equipment........................................ 26,000 Less: Accumulated depreciation . 5,600 20,400 217,260 Total assets ...................................................................... $271,485 Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ $ 313,220 Salaries payable .......................................................... 3,000 Interest payable ........................................................... 350 Unearned revenue ....................................................... 2,190 Current portion of notes payable ............................... 7,500 Total current liabilities............................................ 26,260 Long-term liabilities Notes payable .............................................................. 56,425 Total liabilities ......................................................... 82,685 Owner's equity T. Fichman, capital ...................................................... 188,800 Total liabilities and owner's equity ........................ $271,485

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (Continued) (b) GENERAL JOURNAL Date Jan

Account Titles and Explanation

Debit

Credit

31 Service Revenue ............................... 139,800 Income Summary .........................

139,800

31 Income Summary .............................. 56,800 Advertising Expense ..................... Depreciation Expense ................... Utilities Expense ........................... Interest Expense ........................... Insurance Expense ....................... Salaries Expense ........................... Supplies Expense .........................

2,400 10,300 2,175 4,155 3,500 32,100 2,170

31 Income Summary .............................. 83,000 T. Fichman, Capital ......................

83,000

31 T. Fichman, Capital ........................... 59,200 T. Fichman, Drawings ..................

59,200

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (Continued) (c) Clos. Clos. Bal.

Income Summary 56,800 Clos. 139,800 Bal. 83,000 83,000 0

T. Fichman, Capital Bal. 165,000 Clos. 59,200 Clos. 83,000 Bal. 188,800

T. Fichman, Drawings Bal. 59,200 Clos. 59,200 Bal. 0

Service Revenue 139,800 Bal. 139,800 Bal. 0

Advertising Expense Bal. 2,400 Clos. 2,400 Bal. 0

Depreciation Expense Bal. 10,300 Clos. 10,300 Bal. 0

Utilities Expense Bal. 2,175 Clos. 2,175 Bal. 0

Interest Expense 4,155 Bal. Bal.

4,155 0

Insurance Expense Bal. 3,500 Clos. 3,500 Bal. 0

Salaries Expense 32,100 Clos. 32,100 0

Supplies Expense Bal. 2,170 Clos. 2,170 Bal. 0

Clos.

Bal. Bal.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (Continued) (d) TORONTO TENNIS PARK Post-Closing Trial Balance December 31, 2011 Debit Credit Cash ................................................................... $ 6,185 Accounts receivable .......................................... 13,500 Prepaid insurance .............................................. 8,400 Supplies.............................................................. 1,140 Investments ........................................................ 25,000 Land .................................................................... 46,800 Building .............................................................. 187,580 Accumulated depreciation—building .............. $ 37,520 Equipment ......................................................... 26,000 Accumulated depreciation—equipment .......... 5,600 Accounts payable ............................................. 13,220 Salaries payable................................................. 3,000 Interest payable ................................................. 350 Unearned revenue ............................................. 2,190 Notes payable .................................................... 63,925 T. Fichman, capital ............................................ 188,800 $314,605 $314,605

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2A (Continued) Taking It Further: If the classified balance sheet for Toronto Tennis Park had been prepared following the International Financial Reporting Standards it would have the title of Statement of Financial Position. The content of the balance sheets is the same as to amounts and key sub-totals as in part (a) above but the sequence of the major categories of the elements in the balance sheet would have changed. For the IFRS format, the presentation follows the following sequence: long-term assets, including properly plant and equipment and then intangible assets, current assets (in increasing liquidity order), shareholders’ equity, non-current liabilities and current liabilities.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3A (a) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Jan. 31 Accounts Receivable ........................ Service Revenue ...........................

1,550

31 Insurance Expense ($6,420 x 10/12) . Prepaid Insurance ........................

5,350

31 Supplies Expense ($5,240 − $580) .... Supplies ........................................

4,660

31 Depreciation Expense ....................... Accumulated Depreciation— Building ($90,000 ÷ 45) .................. Accumulated Depreciation— Equipment ($27,000 ÷ 15) ..............

3,800

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

1,520

Credit

1,550

5,350

4,660

2,000 1,800

1,520

31 Interest Expense ($102,000 x 6% x 1/12) 510 Interest Payable ............................

510

31 Unearned Revenue ........................... Service Revenue ...........................

850

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3A (Continued) (b) ELBOW CYCLE REPAIR SHOP Adjusted Trial Balance January 31, 2011

Debit Credit Cash ................................................................... $ 3,200 Accounts receivable ($6,630 + $1,550) ............. 8,180 Prepaid insurance ($6,420 − $5,350) ................. 1,070 Supplies ($5,240 − $4,660)................................. 580 Land .................................................................... 50,000 Building .............................................................. 90,000 Accumulated depreciation—building ($11,000 + $2,000) ........................................... $ 13,000 Equipment ......................................................... 27,000 Accumulated depreciation—equipment ($4,500 + $1,800) ............................................. 6,300 Accounts payable ............................................. 6,400 Salaries payable................................................. 1,520 Interest payable ................................................. 510 Unearned revenue ($1,950 − $850) ................... 1,100 Mortgage payable .............................................. 102,000 H. Dude, capital ................................................. 61,000 H. Dude, drawings ............................................. 101,100 Service revenue ($235,550 + $1,550 + $850) .... 237,950 Salaries expense ($115,200 + $1,520) ............... 116,720 Utilities expense ................................................ 12,000 Interest expense ($5,610 + $510) ...................... 6,120 Insurance expense ............................................ 5,350 Supplies expense .............................................. 4,660 Depreciation expense ........................................ 3,800 _______ $429,780 $429,780

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3A (Continued) (c) ELBOW CYCLE REPAIR SHOP Income Statement Year Ended January 31, 2011

Service revenue ............................................................... $237,950 Expenses Salaries expense ......................................... $116,720 Utilities expense .......................................... 12,000 Interest expense .......................................... 6,120 Insurance expense ...................................... 5,350 Supplies expense ........................................ 4,660 Depreciation expense ................................. 3,800 Total expenses ........................................................ 148,650 Profit ................................................................................. $ 89,300

ELBOW CYCLE REPAIR SHOP Statement of Owner's Equity Year Ended January 31, 2011 ______________________________________________________ H. Dude, capital, February 1, 2010 ($61,000 − $5,000) ... $ 56,000 Add: Investment ............................................ $ 5,000 Profit..................................................... 89,300 94,300 150,300 Less: Drawings .............................................................. 101,100 H. Dude, capital, January 31, 2011.................................. $ 49,200

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3A (Continued) (c) (Continued) ELBOW CYCLE REPAIR SHOP Balance Sheet January 31, 2011 Assets Current assets Cash ............................................................................... $ 3,200 Accounts receivable ..................................................... 8,180 Prepaid insurance ......................................................... 1,070 Supplies ......................................................................... 580 Total current assets .................................................. 13,030 Property, plant, and equipment Land ................................................. $50,000 Building ............................................ $90,000 Less: Accumulated depreciation ... 13,000 77,000 Equipment........................................ $27,000 Less: Accumulated depreciation .. 6,300 20,700 147,700 Total assets ........................................................................ $160,730 Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ $ 06,400 Salaries payable .......................................................... 1,520 Interest payable ........................................................... 510 Unearned revenue ....................................................... 1,100 Current portion of mortgage payable ........................ 4,500 Total current liabilities............................................ 14,030 Long-term liabilities Mortgage payable ........................................................ 97,500 Total liabilities ......................................................... 111,530 Owner's equity H. Dude, capital ........................................................... 48,665 Total liabilities and owner's equity ........................ $160,195

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3A (Continued) (d) GENERAL JOURNAL Date Jan

Account Titles and Explanation

Debit

Credit

31 Service Revenue ............................... 237,950 Income Summary .........................

237,950

31 Income Summary .............................. 148,650 Salaries Expense .......................... Utilities Expense ........................... Interest Expense ........................... Insurance Expense ....................... Supplies Expense ......................... Depreciation Expense ...................

116,720 12,000 6,120 5,350 4,660 3,800

31 Income Summary .............................. 89,300 H. Dude, Capital ............................

89,300

31 H. Dude, Capital ................................ 101,100 H. Dude, Drawings ........................

101,100

Taking It Further: Likely the reason that Henry had to invest $5,000 cash into the business in November of 2010 is because during the year he withdrew $101,100 cash when the business’ profit was only $89,300. This means he was withdrawing more cash than then business could generate. Henry should be concerned that his capital balance is diminishing and he should try to reduce his drawings in the coming year.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (a) GENERAL JOURNAL Date July

Account Titles and Explanation

J1 Debit

Credit

1 Cash ................................................... 20,000 L. Chang, Capital ..........................

20,000

1 Equipment ......................................... 25,000 Cash .............................................. Note Payable .................................

5,000 20,000

3 Cleaning Supplies ............................. Accounts Payable ........................

2,100 2,100

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

1,800

12 Accounts Receivable ........................ Cleaning Revenue ........................

4,500

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

1,400

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

2,000

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

3,400

25 Accounts Receivable ........................ Cleaning Revenue .........................

9,000

1,800

4,500

1,400

2,000

3,400

9,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a) (Continued) July 31 Gas & Oil Expense ............................ Cash ...............................................

550

31 L. Chang, Drawings .......................... Cash ..............................................

1,600

550

1,600

(a), (c), and (f) Cash Date July

Explanation

1 1 5 18 20 21 31 31

Ref.

Debit

J1 J1 J1 J1 J1 J1 J1 J1

20,000

Credit

Balance

550 1,600

20,000 15,000 13,200 11,800 9,800 13,200 12,650 11,050

Credit

Balance

5,000 1,800 1,400 2,000 3,400

Accounts Receivable Date July 12 21 25 31

Explanation

Ref.

Debit 4,500

Adjusting

J1 J1 J1 J2

3,400 9,000 1,500

4,500 1,100 10,100 11,600

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a), (c) and (f) (Continued) Cleaning Supplies Date July 3 31

Explanation

Ref.

Debit 2,100

Adjusting

J1 J2

Credit

Balance

1,400

2,100 700

Credit

Balance

150

1,800 1,650

Prepaid Insurance Date July 5 31

Date July

Explanation

Ref.

Debit 1,800

Adjusting

J1 J2

Explanation 1

Equipment Ref. J1

Debit

Credit Balance

25,000

Accumulated Depreciation—Equipment Date

Explanation

Ref.

July 31

Adjusting

Debit

Credit

Balance

521

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a), (c) and (f) (Continued) Accounts Payable Date July

Explanation

Ref.

3 18

J1 J1

Debit

Credit

Balance

2,100

2,100 700

Credit

Balance

800

Credit

Balance

1,400

Salaries Payable Date

Explanation

Ref.

July 31

Adjusting

Debit

Interest Payable Date

Explanation

Ref.

July 31

Adjusting

Debit

Note Payable Date July

Explanation 1

Ref. J1

Debit

Credit

Balance

20,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a), (c) and (f) (Continued) L. Chang, Capital Date July

1 31 31

Explanation

Ref.

Closing Closing

J1 J3 J3

Debit

Credit 20,000 9,487

1,600

Balance 20,000 29,487 27,887

L. Chang, Drawings Date July 31 31

Explanation

Ref.

Debit 1,600

Closing

J1 J3

Credit

1,600

Balance 1,600 0

Income Summary Date

Explanation

Ref.

July 31 31 31

Closing Closing Closing

J3 J3 J3

Debit

Credit 15,000

5,513 9,487

Balance 15,000 9,487 0

Cleaning Revenue Date July 12 25 31 31

Explanation

Ref.

Adjusting Closing

J1 J1 J2 J3

Debit

15,000

Credit

Balance

4,500 4,500 9,000 13,500 1,500 15,000 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a), (c) and (f) (Continued) Gas & Oil Expense Date July 31 31

Explanation

Ref.

Debit 550

Closing

J1 J3

Credit

Balance

550

550 0

Credit

Balance

2,800

2,000 2,800 0

Credit

Balance

1,400

1,400 0

Credit

Balance

521

521 0

Salaries Expense Date July 20 31 31

Explanation

Ref.

Debit

Adjusting Closing

J1 J2 J3

2,000 800

Cleaning Supplies Expense Date

Explanation

Ref.

Debit

July 31 31

Adjusting Closing

J2 J3

1,400

Depreciation Expense Date

Explanation

Ref.

Debit

July 31 31

Adjusting Closing

J2 J3

521

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (a), (c) and (f) (Continued) Insurance Expense Date

Explanation

Ref.

Debit

July 31 31

Adjusting Closing

J2 J3

150

Credit

Balance

150

150 0

Credit

Balance

Interest Expense Date

Explanation

Ref.

Debit

July 31 31

Adjusting Closing

J2 J3

92 92

(b) LEE’S WINDOW WASHING Trial Balance July 31, 2011 Debit Cash ................................................................... $11,050 Accounts receivable .......................................... 10,100 Cleaning supplies ............................................. 2,100 Prepaid insurance ............................................. 1,800 Equipment ......................................................... 25,000 Accounts payable ............................................. Note payable ...................................................... L. Chang, capital ............................................... L. Chang, drawings ........................................... 1,600 Cleaning revenue .............................................. Gas & oil expense .............................................. 550 Salaries expense ............................................... 2,000 Totals ............................................................ $54,200

Credit

$ 700 20,000 20,000 13,500

$54,200

92 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (c) GENERAL JOURNAL Date

Account Titles and Explanation

J2 Debit

July 31 Accounts Receivable ........................ Cleaning Revenue ........................

1,500

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

521

31 Insurance Expense ............................ Prepaid Insurance ........................ ($1,800 ÷ 12)

150

31 Cleaning Supplies Expense ............. Cleaning Supplies ........................ ($2,100 − $700)

1,400

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

800

31 Interest Expense ............................... Interest Payable ............................ ($20,000 × 5.5% × 1/12)

Credit

1,500

521

150

1,400

800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (d) LEE’S WINDOW WASHING Adjusted Trial Balance July 31, 2011

Debit Cash ................................................................... $11,050 Accounts receivable .......................................... 11,600 Cleaning supplies ............................................. 700 Prepaid insurance ............................................. 1,650 Equipment ......................................................... 25,000 Accumulated depreciation—equipment .......... Accounts payable ............................................. Salaries payable................................................. Interest payable ................................................. Note payable ...................................................... L. Chang, capital ............................................... L. Chang, drawings ........................................... 1,600 Cleaning revenue .............................................. Gas & oil expense .............................................. 550 Salaries expense ............................................... 2,800 Cleaning supplies expense ............................... 1,400 Depreciation expense ....................................... 521 Insurance expense ............................................ 150 Interest expense ................................................ 92 Totals ............................................................ $57,113

Credit

521 700 800 92 20,000 20,000 15,000

______ $57,113

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (e) LEE’S WINDOW WASHING Income Statement Month Ended July 31, 2011 Revenues Cleaning revenue ........................................................ Expenses Gas & oil expense ......................................... $ 550 Salaries expense ........................................... 2,800 Cleaning supplies expense .......................... 1,400 Depreciation expense ................................... 521 Insurance expense ........................................ 0,150 Interest expense ............................................ 92 Total expenses ........................................................ Profit .................................................................................

$15,000

5,513 $9,487

LEE’S WINDOW WASHING Statement of Owner's Equity Month Ended July 31, 2011 L. Chang, capital, July 1 .................................................. $00,000 Add: Investments ............................................. $20,000 Profit ........................................................ 9,487 0 29,487 29,487 Less: Drawings ............................................................... 0, 1,600 L. Chang, capital, July 31 ................................................ $27,887

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (e) (Continued) LEE’S WINDOW WASHING Balance Sheet July 31, 2011 Assets Current assets Cash ............................................................................. Accounts receivable ................................................... Cleaning supplies........................................................ Prepaid insurance ....................................................... Total current assets ................................................ Property, plant, and equipment Equipment...................................................... $25,000 Less: Accumulated depreciation ................ 521 Total assets .............................................................

$11,050 11,600 700 1,650 25,000

24,479 $49,479

Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ Salaries payable .......................................................... Interest payable ........................................................... Note payable, current portion .................................... Total current liabilities............................................ Long term liabilities Note payable ................................................................ Total liabilities .................................................................. Owner's equity L. Chang, capital ......................................................... Total liabilities and owner's equity ........................

700 800 92 5,000 6,592 15,000 21,592

27,887 $49,479

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (f) GENERAL JOURNAL Date

Account Titles and Explanation

J3 Debit

Credit

July 31 Cleaning Revenue ............................. 15,000 Income Summary .........................

15,000

31 Income Summary .............................. Gas & Oil Expense ....................... Salaries Expense .......................... Cleaning Supplies Expense ......... Depreciation Expense .................. Insurance Expense ....................... Interest Expense ...........................

5,513 550 2,800 1,400 521 150 92

31 Income Summary .............................. L. Chang, Capital ..........................

9,487

31 L. Chang, Capital ............................... L. Chang, Drawings ......................

1,600

9,487

1,600

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4A (Continued) (g) LEE’S WINDOW WASHING Post-Closing Trial Balance July 31, 2011 Debit Cash ................................................................... $ 11,050 Accounts receivable .......................................... 11,600 Cleaning supplies ............................................. 700 Prepaid insurance ............................................. 1,650 Equipment ......................................................... 25,000 Accumulated depreciation—equipment .......... Accounts payable ............................................. Salaries payable................................................. Interest payable ................................................. Note payable ...................................................... L. Chang, capital ............................................... $50,000

Credit

$ 521 700 800 92 20,000 27,887 $50,000

Taking It Further: Lee’s Window Washing will need to record adjusting journal entries every month if it wishes to prepare financial statement each month. Closing entries, on the other hand, are done only at the end of the fiscal year.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5A (a) (1)

INCORRECT ENTRY

(2)

CORRECT ENTRY

1. Salaries Expense 1,900 Salaries Expense Cash 1,900 Salaries Payable Cash

(3)

Salaries Payable Salaries Expense

500

2. Salaries Expense 2,200 S. Morris, Drawings 2,200 S. Morris, Drawings Cash 2,200 Cash 2,200 Salaries Expense

2,200

3. No entry

Rent Expense Cash

1,400 500

CORRECTING ENTRY

500

1,900

950

Rent Expense 950 Cash

2,200 950

4. Cash 690 Accounts Receivable

Cash 960 Cash 270 690 Accounts Receivable 960 Accounts Receivable

5. Advertising Expense 45 Cash

Misc. Expense 45 Cash

145

Miscellaneous Expense 145 145 Advertising Expense Cash

950

270

45 100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5A (Continued) (a) Continued (1) INCORRECT ENTRY

6. Equipment Cash

(2) CORRECT ENTRY

220 220

Repair Expense Cash

(3) CORRECTING ENTRY

220

Repair Expense 220 Equipment

7. Supplies 3,400 Equipment 3,400 Equipment Accounts Payable 3,400 Accounts Payable 3,400 Supplies 8. Depr. Expense 187 Depr. Expense 240 Accum. Depr–Equip 187 Accum. Depr–Equip

220 220 3,400

Depr. Expense 53 240 Accum. Depr–Equip

3,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5A (Continued) (b) EDGEMONT ENTERTAINMENT INSTALLATIONS Trial Balance April 30, 2011

Debit Cash ($4,960 − $950 + $270 − $100) ................. $ 4,180 Accounts receivable ($3,200 − $270) ............... 2,930 Supplies ($3,800 − $3,400) ................................. 400 Equipment ($11,220 − $220 + $3,400) ............... 14,400 Accumulated depreciation ($2,387 + $53) ........ Accounts payable............................................... Salaries payable ($500 − $500) ......................... Unearned revenue ............................................. S. Morris, capital ................................................ S. Morris, drawings ($0 + $2,200) ...................... 2,200 Service revenue ................................................. Salaries expense ($7,000 − $500 − $2,200) ...... 4,300 Advertising expense ($445 − $45) ..................... 400 Miscellaneous expense ($490 + $145) .............. 635 Depreciation expense ($187 + $53) .................. 240 Repair expense ($100 + $220) ........................... 320 Rent expense ($0 + $950) .................................. 950 $30,955

Credit

$ 2,440 2,275 0 590 17,700 7,950

______ $30,955

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5A (Continued) Taking It Further: Cash and the owner’s capital that will appear on the balance sheet of Edgemont Entertainment Installations will be correct, but other financial statements will be in error. The income statement will show reduced profit and this will affect the opinion of the users of the financial statements. On the other hand drawings will be too low. This gives incorrect information about the profitability of the company and how cash is being used. This will cause concern for the financial statement users, since the owner has control over the cash of the business. These are the reasons why this error is so important to correct. Error 2 would have the following effects on the financial statements: Income statement: Salary expense overstated by $2,200 Profit understated by $2,200 Statement of owner’s equity: Drawing understated by $2,200 Profit understated by $2,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-6A (a)

Item

Income Statement Revenue Expenses Profit

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

NE O $400 NE U $850 U $1,200 NE O $300 NE

U $500 NE O $90 NE NE NE NE O $530

O $500 O $400 U $90 U $850 U $1,200 NE O $300 U $530

Balance Sheet Assets Liabilities Owner’s Equity NE U $500 O $500 O $400 NE O $400 U $90 NE U $90 NE O $850 U $850 U $1,200 NE U $1,200 NE NE NE U $300 U $ 600 O $300 U $350 O $180 U $530

(b) 1.

Cash ................................................... Rent Payable...............................

500

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

500

Service Revenue ............................... Cash ............................................

400

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

400

Cash ................................................... Utilities Expense ........................

320

Utilities Expense ............................... Cash ............................................

230

500

400

320

230

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-6A (Continued) (b) Continued 4.

Unearned Service Revenue .............. Accounts Receivable .................

850

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

850

Interest Earned .................................. Interest Receivable.....................

600

Interest Receivable ........................... Interest Earned ...........................

600

850

600

No error

Service Revenue ............................... Unearned Service Revenue .......

300

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

300

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

530

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

350

300

530

350

Taking It Further: Since the work has been done, the revenue has been earned. It does not matter that the customer has not paid cash yet. Many students make the error of thinking that cash must be received in order for the revenue to be earned.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7A (a) Although not required, the closing entries would be: GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Dec. 31 Service Revenue................................. 65,000 Interest Revenue ................................ 1,100 Income Summary ..........................

66,100

31 Income Summary .............................. 16,700 Depreciation Expense ................... Insurance Expense ........................ Interest Expense ............................ Supplies Expense ..........................

10,000 1,500 2,800 2,400

31 Income Summary .............................. 49,400 F. Dunder, Capital .........................

49,400

31 F. Dunder, Capital .............................. 33,000 F. Dunder, Drawings .....................

33,000

Closing

F. Dunder, Capital Dec. 31, 2010 July 18 33,000 Bal. Closing Dec. 31, 2011

14,100 3,200 17,300 49,400 33,700

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7A (Continued) (b) DUNDER TOUR COMPANY Balance Sheet December 31, 2011 Assets Current assets Cash............................................................................. Short-term investments.............................................. Accounts receivable ................................................... Interest receivable ...................................................... Prepaid insurance....................................................... Supplies....................................................................... Total current assets ............................................... Long-term Investment Note receivable ........................................................... Property, plant, and equipment Equipment ...................................................... $50,000 Less: Accumulated depreciation ................. 15,000 Intangible asset Patent .......................................................................... Total assets ............................................................

$ 4,500 2,800 3,500 100 2,800 3,100 16,800 18,400

035,000 15,000 $85,200

Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... Interest payable .......................................................... Unearned revenue ...................................................... Current portion of note payable ................................ Total current liabilities ........................................... Long-term liabilities Notes payable ............................................................. Total liabilities ........................................................ Owner's equity F. Dunder, capital........................................................ Total liabilities and owner's equity .......................

$ 7,300 700 3,500 3,000 14,500 37,000 51,500 33,700 $85,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7A (Continued)

December 31, 2010

Working Capital

$16,800 − $14,500 = $2,300

$17,400 − $22,300 = ($4,900)

Current Ratio

$16,800 ÷ $14,500 = 1.16:1

$17,400 ÷ $22,300 = 0.78:1

December 31, 2011

December 31, 2010

$10,900* ÷ $14,500 = .75:1

$15,600 ÷ $22,300 = .70:1

(d)

Acid-test Ratio

*$10,900 = 4,500 + $2,800 + $3,500 + $100

Taking It Further: Although the acid-test ratio shows very little change, the working capital and current ratios both show a substantial improvement in 2011 over 2010. In 2010, the working capital was negative and the current ratio less than 1, indicating that the company did not have sufficient current assets to cover current liabilities. In 2011, the company had a positive working capital amount of $2,300 and a current ratio of greater than 1. Dunder Tour Company’s liquidity has improved.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-8A (a) Amounts in thousands 2009

2008

2007

Working Capital

$48,056 − $10,967 = $37,089

$49,853 − $11,205 = $38,648

$56,422 − $30,275 = $26,147

Current Ratio

$48,056 ÷ $10,967 = 4.38:1

$49,853 ÷ $11,205 = 4.45:1

$56,422 ÷ $30,275 = 1.86:1

Acid-test Ratio

$24,979 ÷ $10,967 = 2.28:1

$20,637 ÷ $11,205 = 1.84:1

$21,303 ÷ $30,275 = .70:1

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-8A (Continued) (b) (Continued) Working capital is positive for all years and the current ratios are all greater than 1, which indicates the company can meet its currently maturing obligations. There was a significant increase in all three ratios from 2007 to 2008 followed by a slight decline from 2008 to 2009 in the working capital and current ratios. The acid-test ratio increased in 2009 compared to 2008. Thus the company’s has been able to improve and sustain its liquidity over the three years. Even with the slight decrease in the working capital and current ratio in2009, these ratios still are very strong

Taking It Further: The current ratio will always be larger than the acid-test ratio if a company has inventory, supplies, and/or prepaid expenses. When a business has no inventory, or prepaid expenses and supplies, the amounts used in the ratios are the same. Since an airline would not have inventory and Danier Leather has substantial amounts of inventory, the difference between the current ratio and the acid-test ratio will be much larger for Danier Leather than for an airline. This is why a retail company can not be compared to an airline when using the acid-test ratio.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-9A ELBOW CYCLE REPAIR SHOP Work Sheet Year Ended January 31, 2011 Account Titles

Trial Balance Debit Credit 3,200

Cash Accounts receivable 6,630 Prepaid insurance 6,420 Supplies 5,240 Land 50,000 Building 90,000 Accum. deprec.— building Equipment 27,000 Accum. deprec.— equipment Accounts payable Salaries payable

Adjustments Debit Credit

(1) 1,550 (2) 5,350 (3) 4,660

11,000

Adjusted Trial Balance Debit Credit 3,200

Income Statement Debit Credit

8,180

1,070 580 50,000 90,000

(4) 2,000

13,000 27,000

4,500

Balance Sheet Debit Credit 3,200

13,000 27,000

(4) 1,800

6,300

(5) 1,520

6,400 1,520

6,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-9A (Continued) Account Titles

Trial Balance Debit Credit

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Income Statement Debit Credit

Balance Sheet Debit Credit

Interest payable (6) 510 510 510 Unearned revenue 1,950 (7) 850 1,100 1,100 Mortgage payable 102,000 102,000 102,000 H. Dude, capital 61,000 61,000 61,000 H. Dude, drawings 101,100 101,100 101,100 Service (1) 1,550 revenue 235,550 (7) 850 237,950 237,950 Salaries exp. 115,200 (5) 1,520 116,720 116,720 Utilities exp. 12,000 12,000 12,000 Interest exp. 5,610 (6) 510 6,120 6,120 (2) 5,350 5,350 5,350 Insurance exp. Supplies exp. (3) 4,660 4,660 4,660 Deprec. exp. (4) 3,800 3,800 3,800 Totals 422,400 422,400 18,240 18,240 429,780 429,780 148,650 237,950 281,130 191,830 Profit 89,300 89,300 Totals 237,950 237,950 281,130 281,130 Taking It Further: Adjusting entries must be recorded in a journal and posted to the general ledger otherwise the account balances will not agree with the financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (a) WATER WORLD PARK Work Sheet Year Ended September 30, 2011 Account Titles Cash Accounts receivable Supplies Prepaid insurance Land Building Accum. amort— building Equipment Accum. amort— equipment Accounts payable

Trial Balance Debit Credit 11,770

Adjustments Debit Credit

(1) 1,175 18,600

(2)17,250

33,000 80,000 480,000

(4)27,500

96,000

Adjusted Trial Balance Debit Credit 11,770

Balance Sheet Debit Credit 11,770

1,175 1,350

5,500 80,000 480,000

(3)16,000

120,000

Income Statement Debit Credit

112,000 120,000

48,000

(3)12,000

60,000

23,600

(8)

24,550

950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (Continued) (a) (continued) Account Titles Wages payable Int. payable Unearned adm. rev. Mort. payable M. Berge, cap. M. Berge, draw. Admission rev. Concession rev. Wages exp. Repairs exp. Advertising exp. Utilities exp. Insurance exp. Interest exp. Deprec. exp. Supplies exp. Totals Loss Totals

Trial Balance Debit Credit

Adjustments Debit Credit (5) 2,950 (6) 1,750

Adjusted Trial Income Balance Statement Debit Credit Debit Credit 2,950 1,750

3,700 (7) 3,000 350,000 175,450

700 350,000 175,450

14,000

123,000 30,500 9,660 16,900 5,500 20,605

963,535

700 350,000 175,450

14,000 250,065 16,720

(7) 3,000 (1) 1,175 (5) 2,950

(8) 950 (4)27,500 (6) 1,750 (3)28,000 (2)17,250 963,535 82,575

Balance Sheet Debit Credit 2,950 1,750

82,575

14,000 253,065 17,895

125,950 30,500 9,660 17,850 33,000 22,355 28,000 17,250 998,360

253,065 17,895

125,950 30,500 9,660 17,850 33,000 22,355 28,000 17,250 998,360 284,565 270,960 713,725 727,400 13,605 13,605 284,565 284,565 727,400 727,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (Continued) (b) WATER WORLD PARK Balance Sheet September 30, 2011 Assets Current assets Cash ............................................................................. $ 11,770 Accounts receivable ................................................... 1,175 Supplies ....................................................................... 1,350 Prepaid insurance ....................................................... 5,500 Total current assets ................................................ 19,795 Property, plant, and equipment Land .......................................................... $ 80,000 Building ...................................... $480,000 Less: Accumulated depreciation 112,000 368,000 Equipment.................................. $120,000 Less: Accumulated depreciation 60,000 60,000 508,000 Total assets ............................................................. $527,795 Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ Wages payable ............................................................ Interest payable ........................................................... Unearned admission revenue .................................... Mortgage payable—current portion ........................... Total current liabilities............................................ Long-term liabilities Mortgage payable ........................................................ Total liabilities ......................................................... Owner's equity M. Berge, capital ($175,450 − $13,605 − $14,000) ...... Total liabilities and shareholder’s equity ..............

$ 24,550 2,950 1,750 700 50,000 79,950 300,000 379,950 147,845 $527,795

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (Continued) (c) Sept. 30 Reference to worksheet: (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

30 Accounts Receivable....................... Concession Revenue ..................

1,175 1,175

30 Supplies Expense ............................ 17,250 Supplies ....................................... ($18,600 − $1,350 = $17,250)

17,250

30 Depreciation Expense ..................... 28,000 Accumulated Depreciation —Building ($480,000 ÷ 30) .......... Accumulated Depreciation —Equipment ($120,000 ÷ 10) ......

16,000

30 Insurance Expense .......................... 27,500 Prepaid Insurance ....................... ($33,000 ÷ 12 X 10 = $27,500)

27,500

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

2,950

30 Interest Expense .............................. Interest Payable .......................... ($350,000 X 6% ÷ 12 = $1,750)

1,750

30 Unearned Admission Revenue ....... Admission Revenue ....................

3,000

30 Utilities Expense .............................. Accounts Payable .......................

950

12,000

2,950

1,750

3,000

950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (Continued) (d) Sept. 30 Admission Revenue ........................ 253,065 Concession Revenue ...................... 17,895 Income Summary ........................

270,960

30 Income Summary ............................. 284,565 Wages Expense ........................... Repairs Expense ......................... Advertising Expense ................... Utilities Expense ......................... Insurance Expense ..................... Interest Expense ......................... Depreciation Expense ................. Supplies Expense .......................

125,950 30,500 9,660 17,850 33,000 22,355 28,000 17,250

30 M. Berge, Capital ............................. 13,605 Income Summary ........................

13,605

30 M. Berge, Capital ............................. 14,000 M. Berge, Drawings .....................

14,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10A (Continued) (e) WATER WORLD PARK Post-Closing Trial Balance September 30, 2011

Debit Credit Cash .................................................................. $ 11,770 Accounts receivable ........................................ 1,175 Supplies............................................................ 1,350 Prepaid Insurance ............................................ 5,500 Land ................................................................. 80,000 Building ........................................................... 480,000 Accumulated depreciation—building ............ $112,000 Equipment ........................................................ 120,000 Accumulated depreciation—equipment ........ 60,000 Accounts payable ........................................... 24,550 Wages payable ................................................. 2,950 Interest payable ............................................... 1,750 Unearned admission revenue ........................ 700 Mortgage payable ........................................... 350,000 M. Berge, capital ............................................. _______ 147,845 $699,795 $699,795 Taking It Further: The preparation of the worksheet is optional because it is not part of the company’s books but basically a tool for accountants in the preparation of financial statements. Since all of the adjustments recorded on the worksheet ultimately get recorded in the general ledger, the preparation of the worksheet is not absolutely necessary. Adjusting entries can be posted as they are recorded in the journal to arrive at the adjusted trial balance and financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11A

(a)

Assuming the company does not use reversing entries:

Cash ............................................................ Interest Revenue ................................... Interest Receivable................................

1,530 410 1,020

Wages Expense ......................................... 18,750 Wages Payable........................................... 56,250 Cash ....................................................... Insurance Expense .................................... Prepaid Insurance ................................. Alternatively, this could be treated as a year-end adjustment.

75,000

5,000 5,000

Prepaid Insurance ...................................... 15,000 Cash .......................................................

15,000

Unearned Service Revenue ....................... 15,000 Cash ............................................................ 185,000 Service Revenue....................................

200,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11A (Continued) (a) (Continued) 2. Interest Receivable Dec. 31 Bal. 1,020 Feb. 1 1,020 0

Interest Revenue Feb. 1

Wages Payable Dec. 31 56,250 Bal. 56,250 0

Wages Expense Jan. 7 18,750

Jan. 7

Prepaid Insurance Dec. 31 Bal. 5,000 5,000 15,000 15,000 Unearned Service Revenue Dec. 31 Bal. 25,000 15,000

410 410

18,750 Insurance Expense 5,000 5,000

Service Revenue 200,000

200,000 Bal.

10,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11A (Continued) (b) Assuming that reversing entries are used for accruals: 1.

Interest Revenue ........................................ Interest Receivable................................

1,020 1,020

Wages Payable........................................... 56,250 Wages Expense .....................................

56,250

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

1,530

Wages Expense ......................................... 75,000 Cash ....................................................... Insurance Expense .................................... Prepaid Insurance ................................. Alternatively, this could be treated as a year-end adjustment.

75,000

5,000 5,000

Prepaid Insurance ...................................... 15,000 Cash .......................................................

15,000

Unearned Service Revenue ....................... 15,000 Cash ............................................................ 185,000 Service Revenue....................................

200,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11A (Continued) (b) (Continued) 3. Interest Receivable Dec. 31 Bal. 1,020 Jan. 1 1,020 0

Interest Revenue Jan. 1 1,020 Feb. 1 1,530 410

Wages Payable Dec. 31 56,250 Bal. 56,250 0

Wages Expense Jan. 1 56,250 Jan. 7 75,000 18,750

Jan. 1

Prepaid Insurance Dec. 31 Bal. 5,000 5,000 15,000 15,000 Unearned Service Revenue Dec. 31 Bal. 25,000 15,000 Bal. 10,000

(c)

Insurance Expense 5,000

5,000 Service Revenue 200,000 200,000

All of the account balances in (b) are the same as they were in (a).

Taking It Further: Reversing entries can be useful because they simplify the recording of cash transactions after the fiscal year end. It is not necessary to look at the previous year’s adjusting entries to decide how to record a cash transaction after the year end.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-12A (a) May 31 Accounts Receivable .............................. Game Fee Revenue ............................

750

31 Supplies Expense ($2,950 – $875) ......... Supplies ..............................................

2,075

750

2,075

31 Depreciation Expense ($128,000 ÷ 10)... 12,800 Accumulated Depreciation ................ 12,800 31 Salaries Expense .................................... Salaries Payable .................................

1,390

31 Interest Expense ($60,000 x 6.5% x 3/12) Interest Payable ..................................

975

31 Unearned Game Fee Revenue ............... Game Fee Revenue ($1,500 − $700) ..

800

June 1 Game Fee Revenue ................................. Accounts Receivable .........................

750

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

1,390

1 Interest Payable ...................................... Interest Expense.................................

975

1,390

975

800

(b)

750

1,390

975

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-12A (Continued) (c) June 19 Cash ......................................................... Game Fee Revenue ............................

1,150

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

1,980

1 Interest Expense ($60,000 x 6.5% x 3/12) Cash ....................................................

975

June 19 Cash ......................................................... Accounts Receivable ......................... Game Fee Revenue ............................

1,150

3 Salaries Expense .................................... Salaries Payable ................................. Cash ....................................................

590 1,390

1 Interest Payable ...................................... Cash ($60,000 x 6.5% x 3/12) .............

975

1,150

1,980

975

(d)

750 400

1,980

975

Taking It Further: Reversing entries should only be used for adjusting journal entries that are accruals: accrued revenues and accrued expenses. Reversing prepayment adjusting entries would not provide the objective achieved through their use.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-1B

(a) Repair Service Revenue .......................... 180,000 Other Revenue ......................................... 35,000 Income Summary ................................

215,000

Income Summary ..................................... 155,000 Repair Service Expense ...................... Other Expenses ...................................

125,000 30,000

Income Summary ..................................... R. LaPorte, Capital ..............................

60,000 60,000

R. LaPorte, Capital ................................... R. LaPorte, Drawings ..........................

50,000 50,000

(b) Income Summary 155,000 215,000 Bal. 60,000 60,000 Bal. 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-1B (Continued) (c) LaPorte Repair Company Post-Closing Trial Balance October 31, 2011

Debit Credit Cash .................................................................. $ 30,000 Equipment ........................................................ 85,000 Accumulated depreciation .............................. $ 35,000 Accounts payable ............................................ 10,000 R. LaPorte, capital ........................................... _______ 70,000 $115,000 $115,000 (d)

The total debits on the post-closing trial balance will do not equal the total assets at October 31, 2011 because of the contra asset account accumulated depreciation which has a credit balance.

Taking It Further: Closing entries are made at the end of an accounting period after preparation of the financial statements to: a. transfer revenue, expense, and drawings account balances to the owner’s capital account and b. reset these temporary accounts to zero. The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the equality of the permanent account balances that are carried forward into the next accounting period.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (a) ARCTIC RIVER GOLF DOME Income Statement Year Ended December 31, 2011 Revenues Service revenue ........................................................... $73,500 Expenses Salaries expense ......................................... $47,040 Depreciation expense ................................. 5,800 Utilities expense .......................................... 5,280 Interest expense .......................................... 12,870 Insurance expense ...................................... 1,800 Supplies expense ........................................ 3,420 Total expenses ........................................................ 76,210 Loss ................................................................................. ($ 2,710)

ARCTIC RIVER GOLF DOME Statement of Owner's Equity Year Ended December 31, 2011 A. Putyuk, capital, January 1, 2011 ($73,500 − $3,300).. Add: Investment ............................................................ Less: Loss ....................................................... $2,710 Drawings ............................................... 7,200 A. Putyuk, capital, December 31, 2011 ...........................

$70,200 3,300 73,500 9,910 $63,590

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (Continued) (a) (Continued) ARCTIC RIVER GOLF DOME Balance Sheet December 31, 2011 Assets Current assets Cash ...................................................................................... $ 8,400 Accounts receivable ............................................................ 7,500 Prepaid insurance ................................................................ 1,200 Supplies ................................................................................ 570 Total current assets ......................................................... 17,670 Long-term investments ............................................................ 15,000 Property, plant, and equipment Land .................................................................... $102,500 Building ............................................ $150,000 Less: Accumulated depreciation ... 24,000 126,000 Equipment........................................ $ 28,000 Less: Accumulated depreciation ... 8,400 19,600 248,100 Total assets ............................................................. $280,770 Liabilities and Owner's Equity Current liabilities Accounts payable................................................................. $ 12,740 Salaries payable ................................................................... 2,850 Interest payable .................................................................... 0 01,400 Unearned revenue ................................................................ 2,190 Current portion of mortgage payable ................................. 3,000 Total current liabilities..................................................... 22,180 Long-term liabilities Mortgage payable ................................................................. 195,000 Total liabilities .................................................................. 217,180 Owner's equity A. Putyuk, capital ................................................................. 63,590 Total liabilities and owner's equity ................................. $280,770

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (Continued) (b) GENERAL JOURNAL Date

Account Titles and Explanation

J14 Debit

Credit

Dec. 31 Service Revenue ............................... 73,500 Income Summary .........................

73,500

31 Income Summary .............................. 76,210 Salaries Expense .......................... Depreciation Expense ................... Utilities Expense ........................... Interest Expense ........................... Insurance Expense ....................... Supplies Expense .........................

47,040 5,800 5,280 12,870 1,800 3,420

31 A. Putyuk, Capital ............................. Income Summary .........................

2,710 2,710

31 A. Putyuk, Capital .............................. A. Putyuk, Drawings .....................

7,200 7,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (Continued) (c) Income Summary 73,500 76,210 2,710 0 A. Putyuk, Capital 73,500 2,710 7,200 63,590

Service Revenue 73,500

A. Putyuk, Drawings 7,200 7,200 0

Supplies Expense 3,420

73,500

3,420 0

Depreciation Expense 5,800 5,800 0 Salaries Expense 47,040

0 Insurance Expense 1,800 1,800 0 Utilities Expense 5,280

47,040 0

5,280 0

Interest Expense 12,870 12,870 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (Continued) (d) ARCTIC RIVER GOLF DOME Post-Closing Trial Balance December 31, 2011

Debit Credit Cash ................................................................. $ 8,400 Accounts receivable ....................................... 7,500 Prepaid insurance ........................................... 1,200 Supplies ........................................................... 570 Investments ...................................................... 15,000 Land ................................................................. 102,500 Building ........................................................... 150,000 Accumulated depreciation—building ............ $ 24,000 Equipment ....................................................... 28,000 Accumulated depreciation—equipment ........ 8,400 Accounts payable ........................................... 12,740 Salaries payable............................................... 2,850 Interest payable .............................................. 1,400 Unearned revenue ........................................... 2,190 Mortgage payable ........................................... 198,000 A. Putyuk, capital ............................................ _______ 63,590 Totals .......................................................... $313,170 $313,170

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-2B (Continued) Taking It Further: If the classified balance sheet for Arctic River Golf Course had been prepared following the International Financial Reporting Standards it would have the title of Statement of Financial Position. The content of the balance sheets is the same as to amounts and key sub-totals as in part (a) above but the sequence of the major categories of the elements in the balance sheet would have changed. For the IFRS format, the presentation follows the following sequence: long-term assets, including properly plant and equipment and then intangible assets, current assets (in increasing liquidity order), shareholders’ equity, non-current liabilities and current liabilities.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3B (a) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Sept. 30 Accounts Receivable ........................... 1,150 Service Revenue ..............................

1,150

30 Insurance Expense ($4,140 x 10/12) ... 3,450 Prepaid Insurance ...........................

3,450

30 Supplies Expense ($3,780 – $960) ...... 2,820 Supplies ...........................................

2,820

30 Depreciation Expense .......................... 7,200 Accumulated Depreciation —Building ($98,000 ÷ 40) ................. Accumulated Depreciation —Equipment ($38,000 ÷ 8) ............... 30 Salaries Expense ................................. Salaries Payable ..............................

975

30 Interest Expense ................................. Interest Payable ............................... ($125,000 x 5.5% x 1/12)

573

2,450 4,750

975

30 Unearned Revenue ($3,300 x ¾) .......... 2,475 Service Revenue ..............................

573

2,475

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3B (Continued) (b) EDGE SPORTS REPAIR SHOP Adjusted Trial Balance September 30, 2011

Account Titles Debit Credit Cash ................................................................... $ 6,750 Accounts receivable ($11,540 + $1,150) .......... 12,690 Prepaid insurance ($4,140 – $3,450) ................ 690 Supplies ($3,780 – $2,820) ................................ 960 Land ................................................................... 55,000 Building ............................................................. 98,000 Accumulated depreciation—building ($17,150 + $2,450) ........................................... $ 19,600 Equipment .......................................................... 38,000 Accumulated depreciation—equipment ($9,500 + $4,750) ............................................. 14,250 Accounts payable ............................................. 8,550 Unearned revenue ($3,300 – $2,475) ................ 825 Salaries payable ($0 + $975) ............................ 975 Interest payable ($0 + $573) ............................. 573 Mortgage payable ............................................. 125,000 R. Brachman, capital ........................................ 60,000 R. Brachman, drawings .................................... 103,525 Service revenue ($189,550 + $1,150 + $2,475) 193,175 Salaries expense ($75,900 + $975) ................... 76,875 Utilities expense ............................................... 10,113 Interest expense ($6,302 + $573) ...................... 6,875 Insurance expense ............................................ 3,450 Supplies expense ............................................. 2,820 Depreciation expense ........................................ 7,200 _______ $422,948 $422,948

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3B (Continued) (c) EDGE SPORTS REPAIR SHOP Income Statement Year Ended September 30, 2011

Service revenue ............................................................... $193,175 Expenses Salaries expense ........................................... $76,875 Utilities expense ............................................ 10,113 Interest expense ............................................ 6,875 Insurance expense ........................................ 3,450 Supplies expense .......................................... 2,820 Depreciation expense ................................... 7,200 Total expenses ........................................................ 107,333 Profit ................................................................................. $ 85,842

EDGE SPORTS REPAIR SHOP Statement of Owner's Equity Year Ended September 30, 2011

R. Brachman, capital, October 1, 2010 ($60,000 − $4,000) ........................... Add: Investment ....................................... Profit ................................................

$56,000 $ 4,000 85,842

Less: Drawings ............................................................ 0 R. Brachman, capital, September 30, 2011 ....................

89,842 145,842 103,525 $42,317

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3B (Continued) (c) (Continued) EDGE SPORTS REPAIR SHOP Balance Sheet September 30, 2011 Assets Current assets Cash ............................................................................. $ 6,750 Accounts receivable ................................................... 12,690 Prepaid insurance ....................................................... 690 Supplies ....................................................................... 960 Total current assets ................................................ 21,090 Property, plant, and equipment Land .......................................................... $55,000 Building ....................................... $98,000 Less: Accumulated depreciation 19,600 78,400 Equipment................................... 38,000 Less: Accumulated depreciation 14,250 23,750 157,150 Total assets ............................................................. $178,240 Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ $ 8,550 Salaries payable .......................................................... 975 Interest payable ........................................................... 573 Unearned revenue ....................................................... 825 Current portion of mortgage payable ...................... 0 5,400 Total current liabilities............................................ 16,323 Long-term liabilities Mortgage payable ........................................................ 119,600 Total liabilities ......................................................... 135,923 Owner's equity R. Brachman, capital ................................................... 42,317 Total liabilities and owner's equity ........................ $178,240

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-3B (Continued) (d) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Sept. 30 Service Revenue ............................... 193,175 Income Summary .........................

193,175

30 Income Summary .............................. 107,333 Salaries Expense .......................... Utilities Expense ........................... Interest Expense ........................... Insurance Expense ....................... Supplies Expense ......................... Depreciation Expense ...................

76,875 10,113 6,875 3,450 2,820 7,200

30 Income Summary .............................. 85,842 R. Brachman, Capital ...................

85,842

30 R. Brachman, Capital ........................ 103,525 R. Brachman, Drawings ...............

103,525

Taking It Further: Likely the reason that Ralph had to invest $4,000 cash into the business in November of 2010 is because during the year he withdrew $103,525 cash when the business’ profit was only $85,842. This means he was withdrawing more cash than then business could generate. Ralph should be concerned that his capital balance is diminishing and he should try to reduce his drawings in the coming year.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (a) GENERAL JOURNAL Date Mar.

Account Titles and Explanation

J1 Debit

Credit

1 Cash ................................................... 10,000 L. Eddy, Capital ............................

10,000

1 Equipment ......................................... Cash .............................................. Note Payable .................................

6,500 1,500 5,000

3 Cleaning Supplies ............................. Accounts Payable ........................

1,200

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

1,200

12 Accounts Receivable ........................ Cleaning Revenue ........................

4,800

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

500

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

1,800

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

1,400

25 Accounts Receivable ........................ Cleaning Revenue .........................

2,500

1,200

4,800

500

1,800

1,400

2,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a) (Continued) Mar. 31 Gas & Oil Expense ............................ Cash ...............................................

375

31 L. Eddy, Drawings ............................. Cash ..............................................

900

375

900

(a), (c), and (f) Cash Date Mar.

Explanation

1 1 5 18 20 21 31 31

Ref.

Debit

J1 J1 J1 J1 J1 J1 J1 J1

10,000

1,400

Credit

Balance

10,000 1,500 8,500 1,200 7,300 500 6,800 1,800 5,000 6,400 375 6,025 900 5,125

Accounts Receivable Date Mar. 12 21 25 31

Explanation

Ref.

Adjusting

J1 J1 J1 J2

Debit

Credit

4,800 1,400 2,500 500

Balance 4,800 3,400 5,900 6,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a), (c) and (f) (Continued) Cleaning Supplies Date Mar. 3 31

Explanation

Ref.

Debit 1,200

Adjusting

J1 J2

Credit

Balance

800

1,200 400

Credit

Balance

100

1,200 1,100

Prepaid Insurance Date Mar. 5 31

Date Mar.

Explanation

Ref.

Debit 1,200

Adjusting

J1 J2

Explanation 1

Equipment Ref. J1

Debit

Credit Balance

6,500

Accumulated Depreciation—Equipment Date

Explanation

Ref.

Mar. 31

Adjusting

Debit

Credit

Balance

108

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a), (c) and (f) (Continued) Accounts Payable Date Mar.

Explanation

Ref.

3 18

J1 J1

Debit

Credit

Balance

1,200

1,200 700

Credit

Balance

500

Credit

Balance

500

Salaries Payable Date

Explanation

Ref.

Mar. 31

Adjusting

Debit

Interest Payable Date

Explanation

Ref.

Mar. 31

Adjusting

Debit

Note Payable Date Mar.

Explanation 1

Ref. J1

Debit

Credit

Balance

5,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a), (c) and (f) (Continued) L. Eddy, Capital Date Mar.

1 31 31

Explanation

Ref.

Closing Closing

J1 J3 J3

Debit

Credit 10,000 4,098

900

Balance 10,000 14,098 13,198

L. Eddy, Drawings Date Mar. 31 31

Explanation

Ref.

Debit 900

Closing

J1 J3

Credit

900

Balance 900 0

Income Summary Date

Explanation

Ref.

Mar. 31 31 31

Closing Closing Closing

J3 J3 J3

Debit

Credit 7,800

3,702 4,098

Balance 7,800 4,098 0

Cleaning Revenue Date Mar. 12 25 31 31

Explanation

Ref.

Adjusting Closing

J1 J1 J2 J3

Debit

Credit 4,800 2,500 500

7,800

Balance 4,800 7,300 7,800 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a), (c) and (f) (Continued) Gas & Oil Expense Date Mar. 31 31

Explanation

Ref.

Debit 375

Closing

J1 J3

Credit

Balance

375

375 0

Credit

Balance

2,300

1,800 2,300 0

Credit

Balance

800

800 0

Credit

Balance

108

108 0

Salaries Expense Date Mar. 20 31 31

Explanation

Ref.

Debit

Adjusting Closing

J1 J2 J3

1,800 500

Cleaning Supplies Expense Date

Explanation

Ref.

Debit

Mar. 31 31

Adjusting Closing

J2 J3

800

Depreciation Expense Date

Explanation

Ref.

Debit

Mar. 31 31

Adjusting Closing

J2 J3

108

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (a), (c) and (f) (Continued) Insurance Expense Date

Explanation

Ref.

Debit

Mar. 31 31

Adjusting Closing

J2 J3

100

Credit

Balance

100

100 0

Credit

Balance

Interest Expense Date

Explanation

Ref.

Debit

Mar. 31 31

Adjusting Closing

J2 J3

19 19

(b) EDDY’S CARPET CLEANERS Trial Balance March 30, 2011 Debit Cash ................................................................... $ 5,125 Accounts receivable .......................................... 5,900 Cleaning supplies ............................................. 1,200 Prepaid insurance ............................................. 1,200 Equipment ......................................................... 6,500 Accounts payable ............................................. Note payable ...................................................... L. Eddy, capital ................................................. L. Eddy, drawings ............................................. 900 Cleaning revenue .............................................. Gas & oil expense .............................................. 375 Salaries expense ............................................... 1,800 Totals ............................................................ $23,000

Credit

700 5,000 10,000 7,300

$23,000

19 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (c) GENERAL JOURNAL Date

Account Titles and Explanation

J2 Debit

Mar. 31 Depreciation Expense ....................... Accumulated Depreciation —Equipment ................................. ($6,500 ÷ 5 years) × 1/12

108

31 Insurance Expense ............................ Prepaid Insurance ........................ ($1,200 ÷ 12)

100

31 Cleaning Supplies Expense ............. Cleaning Supplies ........................ ($1,200 − $400)

800

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

500

31 Interest Expense ............................... Interest Payable ............................ ($5,000 × 4.5% × 1/12)

31 Accounts Receivable ....................... Cleaning Revenue ........................

500

Credit

108

100

800

500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (d) EDDY’S CARPET CLEANERS Adjusted Trial Balance March 31, 2011

Debit Cash ................................................................... $ 5,125 Accounts receivable .......................................... 6,400 Cleaning supplies ............................................. 400 Prepaid insurance ............................................. 1,100 Equipment ......................................................... 6,500 Accumulated depreciation—equipment .......... Accounts payable ............................................. Salaries payable................................................. Interest payable ................................................. Note payable ...................................................... L. Eddy, capital ................................................. L. Eddy, drawings ............................................. 900 Cleaning revenue .............................................. Gas & oil expense .............................................. 375 Salaries expense ............................................... 2,300 Cleaning supplies expense ............................... 800 Depreciation expense ....................................... 108 Insurance expense ............................................ 100 Interest expense ................................................ 19 Totals ............................................................ $24,127

Credit

108 700 500 19 5,000 10,000 7,800

______ $24,127

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (e) EDDY’S CARPET CLEANERS Income Statement Month Ended March 31, 2011 Revenues Cleaning revenue ........................................................ Expenses Gas & oil expense ......................................... $ 375 Salaries expense ........................................... 2,300 Cleaning supplies expense .......................... 800 Depreciation expense ................................... 108 Insurance expense ........................................ 0,100 Interest expense ............................................ 19 Total expenses ........................................................ Profit .................................................................................

$7,800

3,702 $4,098

EDDY’S CARPET CLEANERS Statement of Owner's Equity Month Ended March 31, 2011 L. Eddy, capital, March 1 ................................................. $0,000 Add: Investments ............................................. $10,000 Profit ........................................................ 4,098 0 14,098 14,098 Less: Drawings ............................................................... 0, 900 L. Eddy, capital, March 31 ............................................... $13,198

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (e) (Continued) EDDY’S CARPET CLEANERS Balance Sheet March 31, 2011 Assets Current assets Cash ............................................................................. Accounts receivable ................................................... Cleaning supplies........................................................ Prepaid insurance ....................................................... Total current assets ................................................ Property, plant, and equipment Equipment...................................................... $6,500 Less: Accumulated depreciation ................ 108 Total assets .............................................................

$5,125 6,400 400 1,100 13,025

6,392 $19,417

Liabilities and Owner's Equity Current liabilities Accounts payable........................................................ Salaries payable .......................................................... Interest payable ........................................................... Current portion of note payable ................................. Total current liabilities............................................ Long term liabilities Note payable ................................................................ Total liabilities ......................................................... Owner's equity L. Eddy, capital ............................................................ Total liabilities and owner's equity ........................

700 500 19 2,000 3,219 3,000 6,219

13,198 $19,417

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (f) GENERAL JOURNAL Date

Account Titles and Explanation

J3 Debit

Mar. 31 Cleaning Revenue ............................. Income Summary .........................

7,800

3,702

31 Income Summary .............................. L. Eddy, Capital ............................

4,098

31 L. Eddy, Capital ................................. L. Eddy, Drawings ........................

900

Credit

7,800

375 2,300 800 108 100 19

4,098

900

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-4B (Continued) (g) EDDY’S CARPET CLEANERS Post-Closing Trial Balance March 31, 2011 Debit Cash ................................................................... $ 5,125 Accounts receivable .......................................... 6,400 Cleaning supplies ............................................. 400 Prepaid insurance ............................................. 1,100 Equipment ......................................................... 6,500 Accumulated depreciation—equipment .......... Accounts payable ............................................. Salaries payable................................................. Interest payable ................................................. Note payable ...................................................... L. Eddy, capital ................................................. $19,525

Credit

$ 108 700 500 19 5,000 13,198 $19,525

Taking It Further: Eddy’s Carpet Cleaners will need to record adjusting journal entries every month if it wishes to prepare financial statement each month. Closing entries, on the other hand, are done at the end of the fiscal year.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5B (a) (1)

INCORRECT ENTRY

(2)

CORRECT ENTRY

(3)

CORRECTING ENTRY

1. Supplies 1,200 Equipment 2,100 Equipment 2,100 Accounts Payable 1,200 Accounts Payable 2,100 Supplies 1,200 Accounts Payable 900 2. No entry

Rent Expense Cash

1,150

Rent Expense 1,150 Cash

1,150

3. Cash 870 Cash 780 Accounts Receivable Accounts Receivable 870 Accounts Receivable 780 Cash 4. Cash 575 Accounts Payable Accounts Receivable 575 Cash

5. Salaries Expense Cash

2,000 Salaries Expense 2,000 Salaries Payable Cash

575

1,150 90 90

Accounts Receivable 575 575 Accounts Payable 575 Cash 1,150

1,250 750

Salaries Payable Salaries Expense 2,000

750 750

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5B (Continued) (a) Continued (1) INCORRECT ENTRY

(2) CORRECT ENTRY

6. Equipment 360 Repair Expense Accounts Payable 360 Cash

7. Salary Expense Cash

(3) CORRECTING ENTRY

360

Repair Expense 360 Cash Accounts Payable Equipment

1,800 M. Hubert, Drawings 1,800 1,800 Cash 1,800

360 360 360

M. Hubert, Drawings 1,800 Salary Expense 1,800

8. Depreciation exp. 191 Depreciation exp. 220 Depreciation expense 29 Accum. Depr–Equip 191 Accum. Depr–Equip 220 Accum Depr–Equip

360

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5B (Continued) (b) INTERACTIVE COMPUTER INSTALLATIONS Trial Balance March 31, 2011 Debit Cash ($7,150 − $1,150 − $90 − $1,150 − $360) .. $ 4,400 Accounts receivable ($3,850 + $90 + $575) ...... 4,515 Supplies ($3,100 − $1,200) ................................ 1,900 Equipment ($11,460 + $2,100 − $360) ............... 13,200 Accumulated depreciation ($4,631 + $29) ........ Accounts payable ($3,500 + $900 − $575 − $360) Salaries payable ($750 − $750) .......................... Unearned revenue ............................................. M. Hubert, capital .............................................. M. Hubert, drawings ($0 + $1,800) ..................... 1,800 Service revenue ................................................. Salaries expense ($6,300 − $750 − $1,800) ...... 3,750 Advertising expense ........................................ 600 Miscellaneous expense ..................................... 210 Depreciation expense ($191 + $29) ................... 220 Repair expense ($150 + $360)............................ 510 Rent expense ($0 + $1,150) ............................... 1,150 $32,255

Credit

$ 4,660 3,465 0 955 15,375 7,800

______ $32,355

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-5B (Continued) Taking It Further: Errors made that involve property, plant, and equipment or other depreciable assets cause secondary errors to be made in the depreciation of those assets. This is the reason why these types of errors are so important to correct. Error 6 would have the following effects on the financial statements: Balance sheet: Cash overstated by $360 Property, plant, and equipment overstated by $351 Equipment overstated by $360 Accumulated depreciation overstated by $6 Accounts payable overstated by $360 Owner’s equity overstated by $351 Income statement: Depreciation expense overstated by $6 Repair expense understated by $360 Profit overstated by $351

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-6B (a) Income Statement Item Revenue 1. NE 2. NE 3. O $350 4. NE 5. NE 6. NE 7. NE 8. NE 9. NE

Expenses O $700 NE NE O $270 NE NE NE O $3,200 O$950

Balance Sheet Owner’s Profit Assets Liabilities Equity U $ 700 U $700 NE U $700 NE O $1,200 O $1,200 NE O $350 U $350 U 700 O $350 U $270 U $270 NE U $270 NE U $650 U $650 NE NE U $750 U $750 NE NE NE NE NE U$3,200 U$3,200 NE U$3,200 U$950 NE NE NE

(b) 1.

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

700

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

700

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

600

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

600

Service Revenue ............................... Unearned Service Revenue .......

350

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

350

700

600

350

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-6B (Continued) (b) Continued 4.

Accumulated Depreciation ............... Depreciation Expense ................

850

Depreciation Expense ....................... Accumulated Depreciation ........

580

Service Revenue ............................... Unearned Service Revenue .......

650

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

650

Cash ................................................... Interest Expense ........................

750

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

750

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

500

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

500

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

3,200

Equipment ......................................... Cash ............................................

2,300

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

950

J. Fu, Drawings ................................. Cash ............................................ PROBLEM 4-6B (Continued)

950

850

580

650

750

500

3,200

2,300

950

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Accounting Principles, Fifth Canadian Edition

Taking It Further: The owner’s apartment rental cost is a personal expense and not a business expense. The result of charging personal expenses to the business is unethical and causes the business’ expenses to be overstated and the profit understated. Although the owner’s capital account balance remains unaffected, from a tax perspective the rent expense is not a deductible item and so there would be a violation of the reporting of the business income on the tax return for the owner.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7B (a) Although not required, the closing entries would be: GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Mar. 31 Service Revenue................................. 79,800 Interest Revenue ................................ 400 Income Summary ..........................

80,200

31 Income Summary .............................. 29,500 Advertising Expense ..................... Depreciation Expense ................... Insurance Expense ........................ Interest Expense ............................ Supplies Expense ..........................

12,000 8,000 4,000 1,800 3,700

31 Income Summary .............................. 50,700 N. Anderson, Capital .....................

50,700

31 N. Anderson, Capital ......................... 57,700 N. Anderson, Drawings ................

57,700

Closing

N. Anderson, Capital Mar. 31, 2010 Sept. 20 57,700 Bal. Closing Mar. 31, 2011

32,700 3,800 36,500 50,700 29,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7B (Continued) (b) MATRIX CONSULTING SERVICES Balance Sheet March 31, 2011 Assets Current assets Cash............................................................................. Short-term investments.............................................. Accounts receivable ................................................... Interest receivable ...................................................... Prepaid insurance....................................................... Supplies....................................................................... Total current assets ............................................... Long-term Investment Note receivable ........................................................... Property, plant, and equipment Computer equipment ................................... $48,000 Less: Accumulated depreciation ................ 20,000 Intangible asset Patent .......................................................................... Total assets .....................................................................

$ 3,900 3,000 4,700 200 4,400 2,300 18,500 10,000

28,000 16,000 $72,500

Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... Interest payable .......................................................... Unearned revenue ...................................................... Current portion of note payable ................................ Total current liabilities ........................................... Long-term liabilities Note payable ($30,000 – $10,000) .............................. Total liabilities ........................................................ Owner's equity N. Anderson, capital ................................................... Total liabilities and owner's equity .......................

$ 11,650 000, 150 1,200 10,000 23,000 20,000 43,000 29,500 $72,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-7B (Continued) (c) March 31, 2011

March 31, 2010

Working Capital

$18,500 − $23,000 = ($4,500)

$30,700 − $15,950 = $14,750

Current Ratio

$18,500 ÷ $23,000 = .80:1

$30,700 ÷ $15,950 = 1.92:1

March 31, 2011

March 31, 2010

$11,800* ÷ $23,000 = .51:1

$25,500 ÷ $15,950 = 1.60:1

(d)

Acid-test Ratio

*$11,800 = $3,900 + $3,000 + $4,700 + $200

Taking It Further: Working capital has turned negative in 2011. This means that there are insufficient current assets to pay off current liabilities. This also explains why the current ratio of 2011 is less than 1. There was a substantial decline in all ratios from 2010 to 2011; indicating a severe weakening in the company’s liquidity from 2010 to 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 4-8B (a) 2008

2007

2006

Working Capital

$6,683,416 – $4,675,236 = $2,008,180

$5,598,289 – $5,511,611 = $86,678

$11,554,028 – $4,376,683 = $7,177,345

Current Ratio

$6,683,416 ÷ $4,675,236 = 1.43:1

$5,598,289 ÷ $5,511,611 = 1.02:1

$11,554,028 ÷ $4,376,683 = 2.64:1

Acid-test Ratio

$2,634,544 ÷ $4,675,236 = .56:1

$2,440,159 ÷ $5,511,611 = .44:1

$7,570,501 ÷ $4,376,683 = 1.73:1

(b) The acid-test ratio is a measure of the company’s immediate short-term liquidity. The acid-test ratio is calculated by dividing the sum of cash, short term investments and accounts receivable by current liabilities. The current ratio is a measure of the short-term debtpaying ability that is determined by dividing all current assets by current liabilities. Finally working capital is the excess of current assets over current liabilities. If the amount is negative the term used is a working capital deficiency. After having large amounts of excess working capital is 2006 and better than average liquidity, Big Rock’s liquidity plummeted in 2007 and was restored to normal liquidity levels in 2008. The company can now meet its currently maturing obligations. PROBLEM 4-8B (Continued)

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Accounting Principles, Fifth Canadian Edition

Taking It Further: It is possible (but not very likely) for the acid-test ratio and the current ratio to be identical (or within rounding). When a business has no inventory, or prepaid expenses and supplies, the amounts used in the ratios are essentially the same. Since an airline would not have inventory and Big Rock has substantial amounts of inventory, the difference between the current ratio and the acid-test ratio will be much larger for Big Rock than for an airline. This is why a company like Big Rock can not be compared to an airline when using the acid-test ratio.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-9B

Account Titles Cash Accounts receivable Prepaid insurance Supplies Land Building Accum. deprec.– bldg Equipment Accum.deprec.– equip. Accounts payable Unearned revenue Salaries payable

Trial Balance Debit Credit 6,750

Edge Sports Repair Shop Worksheet Year Ended September 30, 2011 Adjusted Trial Income Adjustments Balance Statement Debit Credit Debit Credit Debit Credit 6,750

Balance Sheet Debit Credit 6,750

11,540

(1) 1,150

12,690

690 960 55,000 98,000

4,140 3,780 55,000 98,000

(2) 3,450 (3) 2,820

17,150

(4) 2,450

38,000

19,600 38,000

9,500

(4) 4,750

8,550 3,300 (7) 2,475 (5)

975

19,600 38,000

14,250

8,550 825 975

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-9B (Continued)

Account Titles Interest payable

Trial Balance

Adjustments

Adjusted Trial Balance

Debit

Credit

Credit (6)

Credit

573

Income Statement Debit

Credit

Balance Sheet Debit

Credit 573

Mortgage payable 125,000 125,000 125,000 R. Brachman, capital 60,000 60,000 60,000 R. Brachman, drawings 103,525 103,525 103,525 Service (1) 1,150 revenue 189,550 (7) 2,475 193,175 193,175 Salaries expense 75,900 (5) 975 76,875 76,875 Utilities expense 10,113 10,113 10,113 Interest expense 6,302 (6) 573 6,875 6,875 Insurance expense (2) 3,450 3,450 3,450 Supplies expense (3) 2,820 2,820 2,820 Deprec. expense (4) 7,200 7,200 7,200 Totals 413,050 413,050 18,643 18,643 422,948 422,948 107,333 193,175 315,615 229,773 Profit 85,842 85,842 Totals 193,175 193,175 315,615 315,615 Taking It Further: Adjusting entries must be recorded in a journal posted to the general ledger otherwise the account balances will not agree with the financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (a) KUMAR MANAGEMENT SERVICES Work Sheet Year Ended December 31, 2011 Adjusted Trial Income Account Titles Trial Balance Adjustments Balance Statement Debit Credit Debit Credit Debit Credit Debit Credit Cash 11,800 11,800 Accts. rec. 23,600 (1) 1,750 25,350 Supplies 3,150 (2) 2,505 645 Prepaid insur. 3,100 (4) 2,325 775 Land 58,000 58,000 Building 112,500 112,500 Accum. deprec. —building 22,500 (3) 2,500 25,000 Equipment 51,000 51,000 Accum. deprec. — equipment 17,000 (3) 4,250 21,250 Accts payable 10,750 (5) 725 11,475 Sal. payable (6) 950 950 Int. payable (7) 500 500 Unearned rent revenue 5,000 (8) 1,900 3,100 Mort. payable 100,000 100,000

Balance Sheet Debit Credit 11,800 25,350 645 775 58,000 112,500

25,000 51,000

21,250 11,475 950 500 3,100 100,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (Continued) (a) (Continued) Account Titles

Trial Balance Adjustments Debit Credit Debit Credit 112,150

Adjusted Trial Income Balance Statement Debit Credit Debit Credit 112,150

M. Kumar, cap. M. Kumar, draw. 28,500 28,500 Service rev. 66,100 (1) 1,750 67,850 Rent rev. 24,000 (8) 1,900 25,900 Salaries exp. 38,675 (6) 950 39,625 39,625 Utilities exp. 15,800 (5) 725 16,525 16,525 Prop. tax exp 5,375 5,375 5,375 Insurance exp. 775 (4) 2,325 3,100 3,100 Interest exp. 5,225 (7) 500 5,725 5,725 Deprec. exp. (3) 6,750 6,750 6,750 Supplies exp. (2) 2,505 2,505 2,505 Totals 357,500 357,500 17,405 17,405 368,175 368,175 79,605 Profit 14,145 Totals 93,750

Balance Sheet Debit Credit 112,150 28,500

67,850 25,900

93,750 288,570 274,425 14,145 93,750 288,570 288,570

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (Continued) (b) KUMAR MANAGEMENT SERVICES Balance Sheet December 31, 2011 Assets Current assets Cash............................................................................. $ 11,800 Accounts receivable ................................................... 25,350 Supplies....................................................................... 645 Prepaid insurance....................................................... 775 Total current assets ............................................... 38,570 Property, plant, and equipment Land .............................................................. $58,000 Building ....................................... $112,500 Less: Accumulated depreciation 25,000 87,500 Equipment ................................... $ 51,000 Less: Accumulated depreciation 21,250 29,750 175,250 Total assets ............................................................ $213,820 Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... $ 11,475 Salaries payable.......................................................... 950 Interest payable .......................................................... 500 Unearned rent revenue ............................................... 3,100 Current maturity of long-term debt ........................... 10,000 Total current liabilities ........................................... 26,025 Long-term liabilities Mortgage payable ....................................................... 90,000 Total liabilities ........................................................ 116,025 Owner's equity M. Kumar, capital ($112,150 + $14,145 – $28,500) .... 97,795 Total liabilities and shareholder’s equity ............. $213,820

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (Continued) (c) Dec. 31 Reference to worksheet: (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

31 Accounts Receivable ...................... Service Revenue .........................

1,750

31 Supplies Expense............................ Supplies....................................... ($3,150 − $645 = $2,505)

2,505

31 Depreciation Expense ..................... Accumulated Depreciation —Building ($112,500 ÷ 45) ...... Accumulated Depreciation —Equipment ($22,500 ÷ 12) ....

6,750

31 Insurance Expense .......................... Prepaid Insurance ....................... ($3,100 ÷ 12 X 9 = $2,325)

2,325

31 Utilities Expense.............................. Accounts Payable .......................

725

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

950

31 Interest Expense.............................. Interest Payable .......................... ($100,000 X 6% ÷ 12 = $500)

500

31 Unearned Rent Revenue ................. Rent Revenue ..............................

1,900

1,750

2,505

2,500 4,250

2,325

725

950

500

1,900

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (Continued) (d) Dec. 31 Service Revenue.............................. Rent Revenue .................................. Income Summary ........................

67,850 25,900

31 Income Summary ............................ Salaries Expense ........................ Utilities Expense ......................... Property tax Expense ................. Insurance Expense ..................... Interest Expense ......................... Depreciation Expense ................ Supplies Expense .......................

79,605

31 Income Summary ............................ M. Kumar, Capital .......................

14,145

31 M. Kumar, Capital ............................ M. Kumar, Drawings ...................

28,500

93,750

39,625 16,525 5,375 3,100 5,725 6,750 2,505

14,145

28,500

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-10B (Continued) (e) KUMAR MANAGEMENT SERVICES Post-Closing Trial Balance December 31, 2011

Debit Credit Cash ...................................................................$ 11,800 Accounts receivable ......................................... 25,350 Supplies ............................................................. 645 Prepaid insurance ............................................. 775 Land ................................................................... 58,000 Building .............................................................. 112,500 Accumulated depreciation—building .............. $ 25,000 Equipment .......................................................... 51,000 Accumulated depreciation—equipment .......... 21,250 Accounts payable............................................... 11,475 Salaries payable ................................................. 950 Interest payable ................................................. 500 Unearned rent revenue ..................................... 3,100 Mortgage payable .............................................. 100,000 M. Kumar, capital ..............................................._______ 97,795 $260,070 $260,070 Taking It Further: The preparation of the worksheet is optional because it is not part of the company’s books but basically a tool for accountants in the preparation of financial statements. Since all of the adjustments recorded on the worksheet ultimately get recorded in the general ledger, the preparation of the worksheet is not absolutely necessary. Adjusting entries can be posted as they are recorded in the journal to arrive at the adjusted trial balance and financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11B (a)

Assuming the company does not use reversing entries:

Cash ............................................................ Rent Revenue ......................................... Rent Receivable .....................................

6,540

Property Tax Expense ................................ Property Taxes Payable ............................. Cash ........................................................

5,600 4,000

Insurance Expense..................................... Prepaid Insurance.................................. Alternatively, this could be treated as a year-end adjustment.

8,250

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

9,000

2,180 4,360

9,600

8,250

Unearned Service Revenue ....................... 20,000 Cash ............................................................ 380,000 Service Revenue ....................................

9,000

400,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11B (Continued) (a) (Continued) 2. Rent Receivable Nov. 30 Bal.

Prepaid Insurance Nov. 30 Bal. 8,250

4,360 Dec. 4

4,360

9,000 9,000

Property Taxes Payable Nov. 30 Jun. 30 4,000 Bal. 4,000 0 Rent Revenue Dec. 4

8,250

2,180

Service Revenue 400,000

Unearned Service Revenue Nov. 30 20,000 Bal. 20,000 0 Property Tax Expense Jun. 30 5,600 Insurance Expense 8,250

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11B (Continued) (b) Assuming that reversing entries are used for accruals: 1.

Rent Revenue ............................................. Rent Receivable ..................................... Property Taxes Payable ............................. Property Tax Expense ...........................

4,360

Cash ............................................................ Rent Revenue ......................................... Property Tax Expense ................................ Cash ........................................................

6,540

Insurance Expense..................................... Prepaid Insurance.................................. Alternatively, this could be treated as a year-end adjustment.

8,250

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

9,000

4,000 4,000 4,000

6,540 9,600 9,600

8,250

Unearned Service Revenue ....................... 20,000 Cash ............................................................ 380,000 Service Revenue ....................................

9,000

400,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-11B (Continued) (b) (Continued) 3. Rent Receivable Nov. 30 Bal.

4,360 Dec. 1

4,360

Prepaid Insurance Nov. 30 Bal. 8,250 8,250

9,000 9,000

Property Taxes Payable Nov. 30 Dec. 1 4,000 Bal. 4,000 0

Unearned Service Revenue Nov. 30 20,000 Bal. 20,000 0

Rent Revenue 4,360 Dec. 4

6,540 2,180

Property Tax Expense Dec. 1 4,000 Jun. 30 9,600 5,600

400,000

Insurance Expense 8,250

Dec. 1

Service Revenue

(c)

All of the account balances in (b) are the same as they were in (a).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-12B (a) Apr. 30 Accounts Receivable ............................. Game Fee Revenue ............................

250

30 Supplies Expense ($3,825 – $540) ......... Supplies..............................................

3,285

250

3,285

30 Depreciation Expense ($140,000 ÷ 10) .. 14,000 Accumulated Depreciation —Equipment....................................... 14,000 30 Salaries Expense .................................... Salaries Payable ................................

1,950

30 Interest Expense ($96,000 x 5% x 1/12). Interest Payable .................................

400

30 Unearned Game Fee Revenue .............. Game Fee Revenue ............................

1,475

1 Game Fee Revenue ............................... Accounts Receivable .........................

250

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

1,950

1 Interest Payable ...................................... Interest Expense ................................

400

1,950

400

1,475

(b) May

250

1,950

400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 4-12B (Continued) (c) May

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

2,785

21 Cash ($1,250 + $250) .............................. Game Fee Revenue ............................

1,500

June 30 Interest Expense ($96,000 x 5% x 3/12). Cash ....................................................

1,200

2,785

1,500

1,200

(d) May

July

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

1,950 835

21 Cash ........................................................ Accounts Receivable ......................... Game Fee Revenue ............................

1,500

1 Interest Expense ($96,000 x 6% x 2/12) . Interest Payable ...................................... Cash ....................................................

800 400

2,785

250 1,250

1,200

Taking It Further: Reversing entries should only be used for adjusting journal entries that are accruals: accrued revenues and accrued expenses. Reversing additional adjusting entries would not provide the objective achieved through their use.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a) COOKIE CREATIONS Income Statement Two Months Ended December 31, 2010

Revenues Teaching revenue ....................................................... Expenses Salaries expense............................................ $ 856 Telephone expense ....................................... 125 Advertising supplies expense ...................... 175 Baking supplies expense .............................. 1,025 Depreciation expense .................................... 78 Insurance expense ........................................ 100 Interest expense ............................................ 8 Total expenses ....................................................... Profit.................................................................................

$4,305

2,367 $1,938

COOKIE CREATIONS Statement of Owner's Equity Two Months Ended December 31, 2010

N. Koebel, capital, November 1 ...................................... Add: Investments .......................................................... Profit ..................................................................... Less: Drawings............................................................... N. Koebel, capital, December 31 ....................................

0 1,000 1,938 2,938 500 $2,438

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CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) COOKIE CREATIONS Balance Sheet December 31, 2010

Assets Current assets Cash............................................................................. Accounts receivable ................................................... Baking supplies .......................................................... Prepaid insurance....................................................... Total current assets ............................................... Property, plant, and equipment Baking equipment.......................................... $1,400 Less: Accumulated depreciation ................. 78 Total assets ...............................................

$1,130 875 450 1,100 3,555

1,322 $4,877

Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... Salaries payable.......................................................... Unearned revenue ...................................................... Interest payable .......................................................... Note payable ............................................................... Total current liabilities ........................................... Owner's equity N. Koebel, capital ........................................................ Total liabilities and owner's equity .......................

75 56 300 8 2,000 2,439

2,438 $4,877

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CONTINUING COOKIE CHRONICLE (Continued) (b) 1. Working Capital 2.

Current Ratio =

Acid-test ratio =

$3,555 –

$2,439

$3,555 $2,439 $1,130 + $875 $2,439

$ 1,116

1.46:1

0.82:1

Cookie Creation’s liquidity at December 31, 2010 is strong. (c) GENERAL JOURNAL Date

Account Titles and Explanation

2010 Dec. 31 Teaching Revenue ............................ Income Summary .........................

J4 Debit

Credit

4,305 4,305

31 Income Summary ............................. Salaries Expense ......................... Telephone Expense ..................... Advertising Supplies Expense ..... Baking Supplies Expense ........... Depreciation Expense .................. Insurance Expense ....................... Interest Expense ..........................

2,367

31 Income Summary ............................. N. Koebel, Capital ........................

1,938

31 N. Koebel, Capital ............................. N. Koebel, Drawings ....................

500

856 125 175 1,025 78 100 8

1,938

500

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CONTINUING COOKIE CHRONICLE (Continued) (d) COOKIE CREATIONS Post-Closing Trial Balance December 31, 2010

Account Debit Cash .................................................................... $1,130 Accounts receivable .......................................... 875 Baking supplies ................................................. 450 Prepaid insurance ............................................. 1,100 Baking equipment ............................................. 1,400 Accumulated depreciation—baking equipment Accounts payable .............................................. Salaries payable ................................................ Unearned revenue ............................................. Interest payable ................................................. Note payable ....................................................... N. Koebel, capital .............................................. _____ $4,955

Credit

78 75 56 300 8 2,000 2,438 $4,955

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CUMULATIVE COVERAGE–CHAPTERS 2 TO 4 (b) GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Credit

Sept. 1 Cash ................................................... 10,000 Note Payable ..................................

10,000

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

500 500

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

1,050

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

1,500

15 Cash .................................................... Service Revenue ............................

5,700

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

1,300

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

2,300

21 Telephone Expense ............................ Cash ................................................

200

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

1,050

27 Accounts Receivable ........................ Service Revenue ...........................

900

1,050

1,500

5,700

1,300

2,300

200

1,050

900

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (b) (Continued) Sept. 29 Cash ................................................... Unearned Service Revenue ...........

550

30 J. Alou, Drawings .............................. Cash ...............................................

800

550

800

(a), (c), (e) and (h)

Aug. 31 Sept. 1

Sept. 12 Sept. 15

Sept. 29 Bal.

Aug. 31 Sept. 27 Bal. Aug. 31 Sept. 17 Bal. Bal.

Cash 2,790 10,000 Sept. 2 Sept. 8 1,500 5,700 Sept. 20 Sept. 21 Sept. 22 550 Sept. 30 14,640 Accounts Receivable 7,910 Sept. 12 900 7,310 Supplies 8,500 1,300 9,800 Sept. 30 1,000

500 1,050

2,300 200 1,050 800

1,500

8,800

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (a), (c), (e) and (h) (Continued)

Aug. 31

Equipment 9,000

Accumulated Depreciation—Equipment Aug. 31 1,800 Sept. 30 1,800 Bal. 3,600

Sept. 20

Accounts Payable Aug. 31 Sept. 17 2,300 Bal.

Unearned Service Revenue Aug. 31 Sept. 29 Bal. Sept. 30 500 Bal.

3,100 1,300 2,100

400 550 950 450

Salaries Payable Sept. 30

630

Interest Payable Sept. 30

Note Payable Sept. 1

10,000

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (a), (c), (e) and (h) (Continued)

Sept. 30

J. Alou, Capital Aug. 31 Sept. 30 16,400 Bal.

Aug. 31 Sept. 30 Bal. Bal.

J. Alou, Drawings 15,600 800 16,400 Sept. 30 0

Sept. 30 Sept. 30 Bal.

Income Summary 46,372 Sept. 30 10,328 0

Sept. 30

Aug. 31 Sept. 2 Bal. Bal.

Service Revenue Aug. 31 Sept. 15 Sept. 27 Bal. Sept. 30 56,700 Bal. Bal. Rent Expense 5,500 500 6,000 Sept. 30 0

21,200 10,328 15,128

16,400

56,700

49,600 5,700 900 56,200 500 56,700 0

6,000

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (a), (c), (e) and (h) (Continued) Aug. 31 Sept. 8 Sept. 22 Bal. Sept. 30 Bal. Bal.

Salaries Expense 24,570 1,050 1,050 26,670 630 27,300 Sept. 30 0

Aug. 31 Sept. 21 Bal. Bal.

Telephone Expense 2,230 200 2,430 Sept. 30 0

Sept. 30 Bal.

Supplies Expense 8,800 Sept. 30 0

8,800

Sept. 30 Bal.

Depreciation Expense 1,800 Sept. 30 0

1,800

Sept. 30 Bal.

Interest Expense 42 Sept. 30 0

27,300

2,430

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (d) ALOU EQUIPMENT REPAIR Unadjusted Trial Balance September 30, 2011

Debit Cash ...................................................................$ 14,640 Accounts receivable .......................................... 7,310 Supplies ............................................................. 9,800 Equipment .......................................................... 9,000 Accumulated depreciation—equipment ........... Accounts payable .............................................. Unearned service revenue ................................. Note payable ....................................................... J. Alou, capital ................................................... J. Alou, drawings ............................................... 16,400 Service revenue ................................................. Rent expense ...................................................... 6,000 Salaries expense ............................................... 26,670 Telephone expense ............................................ 2,430 Totals ............................................................. $92,250

Credit

$ 1,800 2,100 950 10,000 21,200 56,200

__ __ $92,250

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (e) GENERAL JOURNAL Date

Account Titles and Explanation

J2 Debit

Sept. 30 Supplies Expense .............................. Supplies ......................................... ($9,800 – $1,000)

8,800

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

630

30 Depreciation Expense ........................ Accumulated Depreciation —Equipment .................................. ($9,000 ÷ 5 years)

1,800

30 Unearned Service Revenue .............. Service Revenue ........................... ($950 – $450)

500

30 Interest Expense ................................ Interest Payable ............................ ($10,000 × 5% × 1/12)

Credit

8,800

630

1,800

500

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (f) ALOU EQUIPMENT REPAIR Adjusted Trial Balance September 30, 2011

Debit Cash ................................................................... $14,640 Accounts receivable .......................................... 7,310 Supplies ............................................................. 1,000 Equipment .......................................................... 9,000 Accumulated depreciation—equipment ........... Accounts payable .............................................. Unearned service revenue ................................. Salaries payable ................................................. Interest payable .................................................. Note payable ....................................................... J. Alou, capital ................................................... J. Alou, drawings ............................................... 16,400 Service revenue ................................................. Rent expense ...................................................... 6,000 Salaries expense ............................................... 27,300 Telephone expense ............................................ 2,430 Supplies expense ............................................... 8,800 Depreciation expense ....................................... 1,800 Interest expense ................................................. 42 Totals ............................................................. $94,722

Credit

$ 3,600 2,100 450 630 42 10,000 21,200 56,700

______ $94,722

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (g) ALOU EQUIPMENT REPAIR Income Statement Month Ended September 30, 2011 Revenues Service revenue .......................................................... Expenses Rent expense ................................................. $ 6,000 Salaries expense............................................ 27,300 Telephone expense ....................................... 2,430 Supplies expense .......................................... 8,800 Depreciation expense .................................... 1,800 Interest expense ............................................ 42 Total expenses ....................................................... Profit.................................................................................

$56,700

46,372 $10,328

ALOU EQUIPMENT REPAIR Statement of Owner's Equity Month Ended September 30, 2011 J. Alou, capital, Oct. 1, 2010 ........................................ Add: Profit................................................................... Less: Drawings ............................................................ J. Alou, capital, Sept. 30, 2011 ....................................

$21,200 10,328 31,528 0, 16,400 $15,128

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (g) (Continued) ALOU EQUIPMENT REPAIR Balance Sheet September 30, 2011 Assets Current assets Cash............................................................................. Accounts receivable ................................................... Supplies....................................................................... Total current assets ............................................... Property, plant, and equipment Equipment ...................................................... $9,000 Less: Accumulated depreciation ................. 3,600 Total assets ............................................................

$14,640 7,310 1,000 22,950

5,400 $28,350

Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... Salaries payable.......................................................... Interest payable .......................................................... Unearned service revenue ......................................... Total current liabilities ........................................... Long-term liabilities Note payable ............................................................... Total liabilities ................................................................. Owner's equity J. Alou, capital ............................................................ Total liabilities and owner's equity .......................

$ 2,100 630 42 450 3,222 10,000 13,222 15,128 $28,350

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CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (h) GENERAL JOURNAL Date

Account Titles and Explanation

J3 Debit

Credit

Sept. 30 Service Revenue ................................ 56,700 Income Summary ..........................

56,700

30 Income Summary .............................. 46,372 Rent Expense ................................ Salaries Expense .......................... Telephone Expense ...................... Depreciation Expense .................. Supplies Expense ......................... Interest Expense ...........................

6,000 27,300 2,430 1,800 8,800 42

30 Income Summary .............................. 10,328 J. Alou, Capital ..............................

10,328

30 J. Alou, Capital .................................. 16,400 J. Alou, Drawings ..........................

16,400

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Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE—CHAPTERS 2 TO 4 (Continued) (i) ALOU EQUIPMENT REPAIR Post-Closing Trial Balance September 30, 2011 Debit Cash ................................................................... $14,640 Accounts receivable .......................................... 7,310 Supplies ............................................................. 1,000 Equipment .......................................................... 9,000 Accumulated depreciation—equipment ........... Accounts payable .............................................. Unearned service revenue ................................. Salaries payable ................................................. Interest payable .................................................. Note payable ....................................................... J. Alou, capital ................................................... $31,950

Credit

$ 3,600 2,100 450 630 42 10,000 15,128 $31,950

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BYP 4-1 FINANCIAL REPORTING PROBLEM

(a)

Forzani’s balance sheet is classified based on the liquidity of the assets and liabilities. Classifications include current and non-current assets, current and non-current liabilities and shareholders’ equity.

(b) The current assets are listed in the order of liquidity. Within the non-current assets, capital assets are shown before intangible assets such as goodwill and other assets. Current liabilities appear to be listed in order of liquidity and non-current liabilities are listed before deferred items. (c)

When Forzani adopts the International Financial Reporting Standards in 2011, the company will have the choice of presenting the non-current assets first, followed by the current assets, then equity, non-current liabilities, and finally the current liabilities on its balance sheet. In addition, it could change the ordering within each of these categories. For example, within current assets, it may present items in order of reverse liquidity rather than in order of liquidity as they currently do.

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BYP4-1 (Continued) (d) (Amounts in thousands) Working Capital Current ratio

Acid-test ratio

Working Capital Current ratio

Acid-test ratio

2009 $382,253 –

$302,451

$382,253 $302,451 $3,474 + $84,455 $ 302,451

2008 $456,936 – $331,773 $456,936 $331,773 $47,484 + $75,506 $331,773

$79,802

1.26 : 1

0.29 : 1

$125,163

1.38 : 1

0.37 : 1

Working capital, current ratio and acid-test ratio weakened in 2009.

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BYP 4-2 INTERPRETING FINANCIAL STATEMENTS (a)

($ in US millions)

Total assets

2009

2008

2007

2006

2005

75%

78%

85%

88%

100%

(b) Gap’s liquidity continues to deteriorate year over year, with the exception of 2009. Working capital and current ratio both provide a good indication of liquidity. Working capital provides more information in that it provides the dollar value. The change in the liquidity during the period could be explained by general economic conditions or by opening or closing of stores. (c)

Creditors lend money to companies with the expectation that they will be repaid at a specified point in time in the future. In 2005 to 2007, the current ratio is more than 2 to 1, which is very strong. The drop in the current ratio in 2008 is partially reversed in 2009. The 2009 ratio presents a liquidity position that remains not quite as strong as the earlier years, but nevertheless excellent. Accordingly, the Gap’s creditors will not likely be concerned about its liquidity.

(d) As a creditor in this situation, I would look at other relevant ratios (which we will learn about it in later chapters). I would request information on the company’s plans for the upcoming year – such as a cash forecast. I would also look at the amount of debt repayment that is coming due in the next few years. The management’s comments about how they deal with financing and liquidity would provide further insight into the liquidity position that is expected in the future.

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BYP 4-3 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 4-4 COMMUNICATION ACTIVITY MEMO To:

Friend

From:

A. Student

Re:

Steps in the Accounting Cycle

The required steps in the accounting cycle, in the order in which they should be completed, are: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Analyze business transactions. Journalize the transactions. Post to the ledger accounts. Prepare a trial balance. Journalize and post the adjusting entries. Prepare an adjusted trial balance. Prepare the financial statements. Journalize and post the closing entries. Prepare a post-closing trial balance.

The optional steps in the accounting cycle include preparing a work sheet and preparing reversing entries. If a work sheet is prepared, it is done after step 3 above, and it includes steps 4 and 6. The work sheet is a form used to make it easier to prepare the adjusting entries and financial statements. If reversing entries are prepared, they are journalized and posted after step 9, at the beginning of the next accounting period. A reversing entry is the exact opposite of a previously recorded adjusting entry, and simplifies the recording of subsequent transactions.

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BYP 4-5 ETHICS CASE (a)

The stakeholders in this case are: You, as controller. Eddy Lieman, president. Users of the company's financial statements (particularly the owners, the banks and other creditors to whom the statements were issued).

(b) The main ethical issue is the continued circulation of significantly misstated financial statements. As controller, you have just issued misleading financial statements. You have acted ethically by telling the company's president. The president has reacted unethically by allowing the misleading financial statements to continue to circulate. A second issue is the proposal to compensate for the original misstatement by “adjusting” (misstating) the current year’s financial statement. (c)

As controller, you should impress upon the president the consequences of having those misleading financial statements detected by some user or the regulatory body (especially if you are a public company). Also stress upon him that you have a professional obligation to correct the statements or to resign.

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BYP 4-6 “ALL ABOUT YOU” ACTIVITY (a) Student Personal Balance Sheet Date Assets Current assets Cash.............................................................................

$ 1,200

Long-term assets Automobile ............................................. Computer and accessories ................... Clothes and furniture ............................

$8,000 1,200 4,000

13,200

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

$14,400

Liabilities and Personal Equity (Deficit) Current liabilities Automobile loan.......................................................... Credit cards balance .................................................. Total current liabilities ........................................... Long-term liabilities Student loan ........................................... $10,000 Automobile loan..................................... 3,600 Total liabilities ................................................................. Personal equity (deficit) .................................................. Total liabilities and personal deficit ......................

$ 2,400 1,000 3,400

13,600 17,000 (2,600) $14,400

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BYP4-6 (Continued) (b) If the tuition fees are considered an asset, an additional student loan will add to the liabilities and will add an equivalent amount to assets with no effect on the Personal Equity (Deficit). On the other hand, if the tuition fees are considered an expense, then the Personal Equity (Deficit) will be reduced by the amount of the expense. (c)

By earning income during the summer, and avoiding having to borrow an additional student loan, you will have succeeded in increasing your assets (cash in chequing account) by $2,000 while not increasing liabilities, and so the Personal Equity will be increased or (Deficit) will be reduced by $2,000.

(d) Paying liabilities (automobile loan) with assets (cash in chequing account) does not affect your Personal Equity (Deficit).

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Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

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Accounting Principles, Fifth Canadian Edition

CHAPTER 5 Accounting for Merchandising Operations ASSIGNMENT CLASSIFICATION TABLE

*7.

Brief Exercises 1

Exercises 1

Problems Set A 1

Problems Set B 1

7, 8, 9, 10, 12, 13

2, 3, 4, 5, 6

1, 2, 3, 4, 5, 6, *13

2, 3, 4, 5

11, 12, 13, 14, 15

7, 8, 9

1, 2, 3, 4, 5, 6, *13

2, 3, 4, 5

16, 17, 18

10, 11

1, 5, 6, 8

6, 7

19, 20, 21,

12, 13

1, 7, 8, 9, 10

5, 6, 7

22, 23

1, 10, 11

7, 8

*24, *25, *26

*15, *16, *17

*12, *13, *14, *15, *16

*9, *10, *11, *12

Study Objectives Describe the differences between service and merchandising companies. Prepare entries for purchases under a perpetual inventory system. Prepare entries for sales under a perpetual inventory system. Perform the steps in the accounting cycle for a merchandising company. Prepare single-step and multiple-step income statements. Calculate the gross profit margin and profit margin.

Questions 1, 2, 3, 4, 5, 6

Prepare the entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A)

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendices to each chapter.

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Identify problems and recommend inventory system.

Moderate

20-30

Record and post inventory transactions – perpetual system. Calculate net sales and gross profit.

Moderate

30-40

Record inventory transactions and post to inventory account – perpetual system.

Moderate

30-40

Record inventory transactions – perpetual system.

Moderate

30-40

Record and post inventory transactions – perpetual system. Prepare partial income statement.

Moderate

60-70

Prepare adjusting and closing entries and single-step and multiple-step income statements – perpetual system.

Moderate

50-60

Prepare adjusting and closing entries and financial statements – perpetual system. Calculate ratios.

Moderate

50-60

Calculate ratios and comment.

Moderate

20-25

*9A

Record inventory transactions – periodic system.

Moderate

30-40

*10A

Record inventory transactions – periodic system.

Moderate

30-40

*11A

Record and post inventory transactions – periodic system. Prepare partial income statement.

Moderate

60-70

*12A

Prepare financial statements and closing entries – periodic system.

Moderate

60-70

Identify problems and recommend inventory system.

Moderate

20-30

Record and post inventory transactions – perpetual system. Calculate net sales and gross profit

Moderate

30-40

Record inventory transactions and post to inventory account – perpetual system.

Moderate

30-40

Record inventory transactions – perpetual system.

Moderate

30-40

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record and post inventory transactions – perpetual system. Prepare partial income statement.

Moderate

60-70

Prepare adjusting and closing entries and single-step and multiple-step income statements – perpetual system.

Moderate

50-60

Prepare adjusting and closing entries and financial statements – perpetual system. Calculate ratios.

Moderate

50-60

Calculate ratios and comment.

Moderate

20-25

*9B

Record inventory transactions – periodic system.

Moderate

30-40

*10B

Record inventory transactions – periodic system.

Moderate

30-40

*11B

Record and post inventory transactions – periodic system. Prepare partial income statement.

Moderate

60-70

*12B

Prepare financial statements and closing entries – periodic system.

Moderate

60-70

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objective Describe the differences between service and merchandising companies.

Knowledge E5-1

Prepare entries for purchases under a perpetual inventory system.

E5-1

Prepare entries for sales under a perpetual inventory system.

E5-1

Q5-11 Q5-12 Q5-13 Q5-14 Q5-15 BE5-7 E5-2

Perform the steps in the accounting cycle for a merchandising company.

E5-1

Q5-16 Q5-17 Q5-18

Comprehension Q5-1 Q5-2 Q5-3 Q5-4 Q5-5 Q5-6 P5-1A P5-1B Q5-7 Q5-8 Q5-9 Q5-10 Q5-12 Q5-13 BE5-4 E5-2

Application BE5-1

Analysis

Synthesis

Evaluation

BE5-2 BE5-3 BE5-5 BE5-6 E5-3 E5-4 E5-5 E5-6 *E5-13 P5-2A P5-3A P5-4A P5-5A P5-2B P5-3B P5-4B P5-5B BE5-8 BE5-9 E5-3 E5-4 E5-5 E5-6 *E5-13 P5-2A P5-3A P5-4A P5-5A P5-2B P5-3B P5-4B P5-5B BE5-10 BE5-11 E5-5 E5-6 E5-8 P5-6A P5-7A P5-6B P5-7B

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE (Continued)

Study Objective Prepare single-step and multiple-step income statements.

Knowledge Q5-19 E5-1 E5-9

Comprehension Q5-20 Q5-21

Calculate the gross profit margin and profit margin.

E5-1

Q5-22 Q5-23

*7.

Prepare the entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A)

*Q5-24 *Q5-25

*Q5-26

Broadening Your Perspective

Application BE5-12 BE5-13 E5-7 E5-8 E5-10 P5-5A P5-6A P5-7A P5-5B P5-6B P5-7B BE5-14 E5-10 P5-7A P5-7B *BE5-15 *BE5-16 *BE5-17 *E5-12 *E5-13 *E5-14 *E5-15 *E5-16 *P5-9A *P5-10A *P5-11A *P5-12A *P5-9B *P5-10B *P5-11B *P5-12B Continuing Cookie Chronicles Cumulative Coverage Chapters 2-5 BYP5-3

Analysis

Synthesis

Evaluation

E5-11 P5-8A P5-8B

BYP5-1 BYP5-2

BYP5-4 BYP5-5 BYP5-6

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 1.

Service companies will have service revenue or service fees earned as their primary source of revenue. Merchandising companies will have sales revenue as their primary source of revenue. Merchandising companies will have cost of goods sold as one of their major expenses. Service companies do not have a comparable expense. Both types of companies will have operating expenses such as advertising expense, depreciation expense, insurance expense, rent expense, salaries expense, etc.

An operating cycle is the average amount of time it takes to go from cash to cash in producing revenues. The normal operating cycle for a merchandising company is likely to be longer than for a service company because inventory must first be purchased and sold, and then the receivables must be collected. Service companies do not purchase inventory so this step is eliminated and the cycle is often shorter.

A “perpetual” inventory system reflects changes for inventory purchases and sales on a “perpetual” or continuous basis. The company keeps detailed records of quantity and cost of inventory on hand for every item. When inventory is sold, the cost of goods sold is recorded as part of the sale transaction and the Merchandise Inventory account is decreased. A “periodic” inventory system does not keep detailed records of inventory on hand throughout the period. Cost of goods sold and ending inventory are determined at the end of the “period”, usually by an inventory count. When inventory is sold, the cost of goods sold is not recorded and the Merchandise Inventory account is not decreased.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 4.

The company needs to compare the cost of the detailed record keeping required in a perpetual inventory system to the benefits of having the additional information about the inventory. One of the benefits of a perpetual inventory system is the ability to answer questions from customers about merchandise availability. In a used clothing business, this may not be of much benefit each inventory item is unique. Another benefit is the monitoring of inventory quantities in order to avoid running out of stock. Again, this may not be of benefit since the company does not order recurring or similar merchandise, and may not have a supplier to order from. But if the company is selling used clothing on consignment it will need to track each item in order to determine which consignor to pay when an item is sold. The company should carefully determine the cost of the detailed record keeping required, in particular for a new company. A perpetual inventory system requires more record keeping and therefore is more expensive to use. For example, a perpetual inventory system usually requires an investment in a point of sale system that is integrated with the inventory system.

A physical count is an important control feature. Using a perpetual inventory system a company knows what should be on hand. Performing a physical count and checking it to the perpetual inventory records is necessary to detect any errors in record keeping and/or shortages in stock.

The benefits of the perpetual inventory system are that it continuously— perpetually—shows the quantity and cost of the inventory purchased, sold, and on hand. Under a perpetual inventory system, the cost of goods sold and reduction in inventory are recorded each time a sale occurs. A perpetual inventory system gives strong internal control over inventories compared to a periodic system. Another benefit of a perpetual inventory system is that it makes it easier to answer questions from customers about merchandise availability. Management can also maintain optimum inventory levels and avoid running out of stock. In a periodic system the number of items on hand cannot be determined without physically examining the inventory. A perpetual inventory system requires more record keeping and therefore is more expensive to use than a periodic system. For example, a perpetual inventory system usually requires an investment in a point of sale system that is integrated with the inventory system. In a periodic system this not required.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 7.

An inventory subsidiary ledger is used to organize and track individual inventory items. It is used in addition to the inventory account in the general ledger. Using a subsidiary ledger means that the general ledger is not as detailed and it allows the company to determine the balance of individual inventory categories.

The inventory subsidiary ledger provides the details of the Merchandise Inventory account in the general ledger. The total of the inventory subsidiary ledger must equal the total of the general ledger account.

The letters FOB mean free on board. FOB shipping point means that the goods are placed free on board the carrier by the seller, and the buyer pays the freight costs. FOB destination means that the goods are placed free on board to the buyer’s place of business, and the seller pays the freight. Freight costs on inventory purchases are added to the cost of the inventory. Freight costs on sales are recorded as an expense such as Freight Out or Delivery Expense.

10. It should take advantage of the discount offered. The bank rate of 7.25% is an annual rate which is equivalent to 0.4% for 20 days (7.25% × 20/365). Since 0.4% cost of borrowing is less than 1% saved by paying 10 days after the purchase—20 days before the final due date—it is advantageous to borrow and pay within the discount period. Another way to explain the advantage is to convert the 1% savings from paying 10 days after the purchase is to convert the 1% discount to any annual rate. In order to obtain the 1% discount the company must pay 20 days ahead of the final due date (30 days – 10 days = 20 days). The effective annual interest rate of doing this is 18.25% (1% × 365/20). Since the 18.25% savings is greater than the 7.25% rate on the bank loan, the company should borrow from the bank and take advantage of the discount.. 11. The company needs to record a credit to Sales for $75 and to debit Cost of Goods Sold for $50 instead of the $25 credit to Gross Profit. Recording the sales and cost of goods sold in separate accounts allows the company and users of financial information to do ratio analysis to measure the company’s profitability and it allows management to analyze trends and variances in both revenues and expenses separately.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 12. A quantity discount gives a reduction in price according to the volume of the purchase—in other words, the larger the number of items purchased, the better the discount. Quantity discounts are not the same as purchase discounts, which are offered to customers for early payment of the balance due. Purchase discounts are noted on the invoice by the use of credit terms that specify the amount and time period for the purchase discount. Quantity discounts are not recorded or accounted for separately whereas, purchase discounts are recorded separately. When an invoice is paid within the discount period, the Merchandise Inventory account will be reduced by the amount of the discount because inventory is recorded at cost. By paying within the discount period, a company reduces the cost of its inventory. A sales discount is the counterpart of the purchase discount. A purchase discount is a discount taken by the purchaser, and a sales discount is the discount offered by the seller. When the invoice is paid within the discount period, the discount is recorded in a separate Sales Discount account. 13.

The inventory should be recorded as Cost of Goods Sold (an expense) in June when it is sold. Revenue should be recorded in June, when it has been earned. The transaction in June represents the transfer of ownership of the goods from the seller to the buyer.

14.

Sales returns are not debited directly to the Sales account because this would not provide information on the amount of sales returns and allowances. This information is important to management as it may suggest inferior merchandise, errors in billing, or incorrect sales techniques. Debiting returns directly to sales may also cause problems in comparing sales for different periods.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 15.

A sales allowance occurs when the buyer keeps the merchandise, but the sales price is adjusted. This may happen because the purchaser is dissatisfied because the goods are damaged, of inferior quality or do not meet the purchaser’s specifications. Since the goods are not returned, the Merchandise Inventory account cannot be debited. The transaction is recorded as a reduction to Accounts Receivable or Cash and a debit to Sales Returns and Allowances. When goods are returned and are in saleable condition, they are available to be resold to another customer. A journal entry will debit Merchandise Inventory and credit Cost of Goods Sold for the same amount as the original cost of the inventory. If the goods are damaged and cannot be resold, the transaction is recorded in the same way as a sales allowance; there is no entry to Merchandise Inventory or Cost of Goods Sold. Since the items are damaged they do not represent assets to the company and cannot be returned to the Merchandise Inventory account.

16.

Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service enterprise. The types of transactions are different, but the steps in the accounting cycle are the same.

17.

The perpetual inventory system records each purchase and sale of merchandise in the Merchandise Inventory account. An adjustment at the end of the period will be necessary if the actual inventory on hand is not the same as the account balance. This difference could be the result of errors in the perpetual inventory records, or because of lost, stolen, or damaged inventory. These differences are usually identified by performing an inventory count.

18.

The additional accounts that must be closed for a merchandising company using a perpetual inventory system are Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold and Freight Out. The Sales account is debited to close it to the Income Summary account. The remaining accounts have normal debit balances and are credited when closed to Income Summary.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 19.

The single-step income statement differs from the multiple-step income statement in that (1) all data are classified into two categories: revenues and expenses; and (2) only one step, subtracting total expenses from total revenues, is required in determining profit (or loss). A multiple step income statement includes three main steps (1) cost of goods sold is subtracted from sales to determine gross profit (2) operating expenses are subtracted from gross profit to determine profit from operations and (3) non-operating expenses are subtracted from (and nonoperating revenues are added to ) profit from operations to determine profit.

20.

Net sales is calculated by deducting the contra revenue accounts, Sales Returns and Allowances and Sales Discounts, from Sales in the income statement. Gross profit is calculated by subtracting cost of goods sold from net sales. Profit from operations is calculated by subtracting operating expenses from gross profit. Profit is calculated by subtracting non-operating expenses from (or adding non-operating revenues to) profit from operations. Only merchandising companies show net sales and gross profit; service companies would show service revenues. Profit from operations is used by both merchandising and service companies as both of these types of companies may have non-operating revenues or expenses.

21.

Interest expense is a non-operating expense because it relates to how a company’s operations are financed. This is not always within the company’s control and is usually not a decision of the general manager, but rather of the chief financial officer.

22.

Gross profit is calculated as the difference between net sales revenue and cost of goods sold and is expressed in dollars. Gross profit margin represents gross profit expressed as a percentage of net sales. The gross profit margin allows the company to compare its results with past periods, competitors and industry averages. It shows the relative relationship between net sales and gross profit.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 23.

The gross profit margin measures the percentage of net sales that is available after the cost of goods sold has been deducted to cover operating expenses and to contribute to profit. For example, a gross profit margin of 45% indicates that out of every sales dollar there is 45 cents available to cover operating expenses and to contribute to profit. The profit margin measures the percentage of net sales that is left after covering all of the expenses (including the cost of goods sold). A profit margin of 5% indicates that out of every sales dollar there is 5 cents left after all expenses are covered, or there is 5 cents of profit from every sales dollar.

*24. In a periodic inventory system, purchases are recorded to the Purchases account. Purchase returns and allowances, purchase discounts and freight in are also recorded in separate accounts. In a perpetual inventory system, purchases, purchase returns and allowances, purchase discounts and freight in are recorded directly to the Merchandise Inventory account. In a perpetual system, cost of goods sold and inventory are updated when a sale occurs. This does not happen in a periodic system. *25. Renata would record revenues from the sale of merchandise when sales are made, in the same way as in a perpetual inventory system, but on the date of sale the cost of the merchandise sold is not recorded. Instead, the cost of goods sold during the period is calculated at the end of the period by taking a physical inventory count and deducting the cost of this inventory from the cost of the merchandise available for sale during the period. The gross profit would be then be calculated by deducting the cost of goods sold from the sales revenue.

*26. The purpose of these entries is to update the Merchandise Inventory account to the correct ending balance (i.e., adjust for the change in the beginning and ending inventories).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a) & (b) Company A Gross profit = $100,000 ($250,000 – $150,000) Profit = $40,000 ($100,000 − $60,000) (c) & (d) Company B Gross profit = $48,000 ($118,000 – $70,000) Operating expenses = $22,500 ($48,000 – $25,500) (e) & (f) Company C Cost of goods sold = $42,500 ($75,000 – $32,500) Operating expenses = $21,500 ($32,500 – $11,000) (g) & (h) Company D Sales = $150,400 ($71,900 + $78,500) Profit = $39,000 ($78,500 – $39,500)

BRIEF EXERCISE 5-2 Inventory Item Jelly beans Licorice sticks Bubble gum

Quantity Cost per Package 300 $1.65 500 $2.20 275 $1.20

Total Cost $ 495 1,100 330 $1,925

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-3 Total Merchandise Inventory cost: Invoice cost $7,500 Plus: Freight in 120 Less: Purchase discount 150 Total cost $7,470 Cost per unit = Total cost ÷ 600 packages = $7,470 ÷ 600 = $12.45 per package Balance in Merchandise Inventory account: Balance from BE5-2 $1,925 Cost of Canada Mints 7,470 Total $9,395

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-4 Date Feb. 5 6

8 11

Assets Inventory + $10,000 Inventory + $125 Cash – $125 Inventory – $1,200 Inventory – $176 Cash – $8,624

Liabilities Accounts Payable + $10,000

Owner’s Equity NE

Accounts Payable – $1,200 Accounts Payable – $8,800

5-15

Revenue

Expenses

Profit NE

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-5 Jan. 2 Merchandise Inventory.................... 10,000 Accounts Payable ....................... 10,000 Jan. 4 No entry required. Jan. 6 Accounts Payable............................ Merchandise Inventory ...............

1,000

Jan. 12 Accounts Payable............................ Cash .............................................

9,000

1,000

9,000

BRIEF EXERCISE 5-6 Mar. 12 Merchandise Inventory.................... 15,000 Accounts Payable ....................... 15,000 13 Merchandise Inventory.................... Cash .............................................

155

14 Accounts Payable............................ Merchandise Inventory ...............

3,000

155

3,000

22 Accounts Payable ($15,000 − $3,000) 12,000 Merchandise Inventory ($12,000 × 2%) ............................. 240 Cash ............................................. 11,760

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-7 Date Feb. 5 5

Assets Accounts Receivable + $10,000 Inventory – $5,500

6 No entry required. 8 Accounts Receivable – $1,200

Inventory + $660

Cash + $8,624

Liabilities

Owner’s Equity + $10,000

Revenue Sales + $10,000

– $5,500

– $1,200 Sales Returns and Allowances + $1,200 + $660 – $176

Sales Discounts + $176

Expenses

Profit + $10,000

Cost of Goods Sold + $5,500

– $5,500

– $1,200

Cost of Goods Sold – $660

+ $660 – $176

Accounts Receivable – $8,800

5-17

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-8 Jan. 2 Accounts Receivable ...................... 10,000 Sales ............................................ 10,000 Cost of Goods Sold ......................... Merchandise Inventory ...............

6,300

4 Freight Out ....................................... Cash .............................................

155

6 Sales Returns and Allowances ....... Accounts Receivable ..................

1,000

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

840

12 Cash ($10,000 − $1,000) .................. Accounts Receivable ..................

9,000

6,300

155

1,000

840

9,000

BRIEF EXERCISE 5-9 Mar. 12 Accounts Receivable ...................... 15,000 Sales ............................................ 15,000 Cost of Goods Sold ......................... Merchandise Inventory ............... 13

8,500 8,500

No entry required.

14 Sales Returns and Allowances ....... Accounts Receivable ..................

3,000 3,000

22 Cash ($12,000 − $240) ..................... 11,760 Sales Discounts ($12,000 × 2%) ..... 240 Accounts Receivable .................. 12,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-10 Apr. 30

Cost of Goods Sold (Inventory shrinkage) ........................... Merchandise Inventory ($98,000 − $96,500) ..........................

1,500 1,500

BRIEF EXERCISE 5-11 July 31 Sales .................................................... 175,000 Income Summary ...........................

175,000

31 Income Summary ................................ 104,750 Sales Returns and Allowances ..... Sales Discounts ............................. Cost of Goods Sold........................ Freight Out......................................

2,500 750 100,000 1,500

Merchandise Inventory is a balance sheet (permanent) account and is not closed.

BRIEF EXERCISE 5-12 (a) Net sales = $490,000 ($510,000 − $15,000 − $5,000) (b) Gross profit = $140,000 ($490,000 − $350,000) (c) Profit from operations = $35,000 ($140,000 − $12,000 − $3,000 − $40,000 − $50,000) (d) Profit = $33,000 ($35,000 + $8,000 − $10,000)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-13

Depreciation expense Cost of goods sold Freight out Insurance expense Interest expense Interest revenue Rent revenue Sales discounts Sales returns and allowances

(a) (b) Single-step income Multi-step income statement statement Expenses Operating expenses Expenses Gross profit Expenses Operating expenses Expenses Operating expenses Expenses Other expenses Revenues Other revenues Revenues Other revenues Revenues Net Sales (Net Sales) Revenues Net Sales (Net Sales)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 5-14 2010 Gross profit margin = 41.67% [($600,000 − $350,000) ÷ $600,000] Profit margin = 4.17% [($600,000 − $350,000 − $225,000) ÷ $600,000] 2011 Gross profit margin = 45.45% [($550,000 − $300,000) ÷ $550,000] Profit margin = 9.09% [($550,000 − $300,000 − $200,000) ÷ $550,000] Red River’s profitability has improved since both its gross profit margin and its profit margin have increased from the previous year.

*BRIEF EXERCISE 5-15 Feb. 5

Purchases .......................................10,000 Accounts Payable ......................

6 Freight In ......................................... Cash ............................................

10,000

135 135

8 Accounts Payable........................... 1,200 Purchase Returns and Allowances

1,200

11 Accounts Payable .......................... 8,800 Purchases Discounts................. Cash ............................................

176 8,624

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 5-16 Feb. 5 Accounts Receivable .....................10,000 Sales ...........................................

10,000

6 No entry required. 8 Sales Returns and Allowances ...... 1,200 Accounts Receivable .................

1,200

11 Cash ................................................ 8,624 Sales Discounts .............................. 176 Accounts Receivable .................

8,800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*BRIEF EXERCISE 5-17 (a) Purchases ........................................................................ $400,000 Less: Purchase returns and allowances ...... $11,000 Purchase discounts............................. 8,000 19,000 Net purchases ................................................................. $381,000 (b) Net purchases (above) .................................................... $381,000 Add: Freight in ................................................................. 16,000 Cost of goods purchased ............................................... $397,000 (c) Beginning inventory....................................... Add: Cost of goods purchased (above) ........ Cost of goods available for sale....................

$ 60,000 397,000 $457,000

(d) Cost of goods available for sale (above) ...... Less: Ending inventory .................................. Cost of goods sold .........................................

$457,000 00 80,000 $377,000

(e) Net sales ......................................................... Less: Cost of goods sold (above) ................. Gross profit.....................................................

$625,000 377,000 $248,000

Note: Freight-out is not included; it is an operating expense.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 5-1 (a)

Cost of goods sold

(b)

Subsidiary ledger

(c)

Contra revenue account

(d)

Purchase returns

(e)

FOB destination

(f)

Periodic inventory system

(g)

Sales allowance

(h)

Gross profit

(i)

Non-operating activities

(j)

FOB shipping point

(k)

Perpetual inventory system

(l)

Merchandise inventory

(m)

Profit margin

(n)

Sales discount

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-2 Balance Sheet Inventory TransType of Account action Account Name 1. Asset Inventory Liability Accounts Payable 2. Asset Inventory Asset Cash 3. Asset Inventory Liability Accounts Payable 4. Asset Inventory Asset Cash Liability Accounts Payable 5. Asset Accounts Receivable Asset Inventory 6. 7.

Asset Asset Asset

Cash Accounts Receivable Inventory

Income Statement Impact on Owner’s Equity NE

Type of Account NE

Increase Decrease Decrease Decrease

Decrease Decrease Decrease

Increase

*Increase

Revenue

Sales

Increase

Expense

Cost of Goods Sold Freight Out Sales Ret. and Allow. Cost of Goods Sold Sales Discount

Increase

Increase or Decrease Increase Increase

Decrease Decrease Decrease

Decrease Decrease

Increase

Expense Revenue Expense

Asset Asset

Account Name

Increase or Decrease

Increase Increase

Impact on Profit NE

*Increase

Decrease Decrease

Decrease

Cash Increase Decrease Revenue Increase Decrease Accounts Decrease Receivable * Assuming that the sales price is greater than the cost, owner’s equity and profit will increase by the net amount.

5-25

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-3 (a) Apr. 5 Merchandise Inventory................ 15,000 Accounts Payable ...................

15,000

6 No entry required. 8 Accounts Payable........................ Merchandise Inventory ...........

2,500 2,500

May 2 Accounts Payable ($15,000 − $2,500) ........................ 12,500 Cash .........................................

12,500

(b) Apr. 5 Accounts Receivable .................. 15,000 Sales ............................................

15,000

Cost of Goods Sold ..................... 10,500 Merchandise Inventory ...........

10,500

6 Freight Out ................................... Cash .........................................

500

8 Sales Returns and Allowances ... Accounts Receivable ..............

2,500

500

May 2 Cash ($15,000 − $2,500) .............. 12,500 Accounts Receivable ..............

2,500

12,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-4 (a) Dec. 3 Accounts Receivable .................. 48,000 Sales ........................................

48,000

Cost of Goods Sold ..................... 32,000 Merchandise Inventory. ..........

32,000

4 No entry required. 8 Sales Returns and Allowances ... Accounts Receivable ..............

2,400

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

1,600

2,400

1,600

13 Cash ($45,600 × 98%) .................. 44,688 Sales Discount ($45,600 × 2%) ... 912 Accounts Receivable ..............

45,600

(b) Dec. 3 Merchandise Inventory................ 48,000 Accounts Payable ...................

48,000

4 Merchandise Inventory................ Cash .........................................

750 750

8 Accounts Payable........................ Merchandise Inventory ...........

2,400

13 Accounts Payable........................ 45,600 Merchandise Inventory ($45,600 × 2%) ......................... Cash .........................................

2,400

912 44,688

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-5 (a) June 10 Merchandise Inventory................. Accounts Payable ....................

5,000

11 Merchandise Inventory................. Cash ..........................................

275

12 Accounts Payable......................... Merchandise Inventory ............

500

5,000

275

500

20 Accounts Payable ($5,000 − $500) 4,500 Merchandise Inventory ($4,500 × 2%) ............................ Cash ($4,500 × 98%)................. July 15 Cash .............................................. Sales ......................................... 15 Cost of Goods Sold ($5,000 + $275 − $500 − $90) ........ Merchandise Inventory ............

90 4,410

9,500 9,500

4,685 4,685

15 Freight Out .................................... Cash ..........................................

250

17 Sales Returns and Allowances .... Cash ..........................................

300

(b) July 31 Sales .............................................. Income Summary .....................

9,500

250

300

9,500

31 Income Summary.......................... 5,235 Cost of Goods Sold.................. Freight Out ............................... Sales Returns and Allowances

4,685 250 300

31 Income Summary ($9,500 − $5,235) 4,265 Pele, Capital .............................

4,265

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-6 (a) Beginning inventory Inventory purchase Freight in Cost of goods available for sale Number of chairs available for sale Average cost per chair

0 8,300 300 $8,600 100 $86.00

(b) Sales (30 chairs × $165) Less: Sales return (5 chairs × $165) Less: Sales discount (2% × [$4,950 − $825]) Net sales

$4,950.00 825.00 82.50 $4,042.50

Cost of goods available for sale (above) Less: Ending inventory (74 chairs × $86) Cost of goods sold

$8,600 6,364 $2,236

Net sales (above) Less: Cost of goods sold (above) Gross profit

$4,042.50 2,236.00 $1,806.50

(c) Oct. 1: Beginning balance $ 0 Oct. 3: Purchase of merchandise 8,300 Freight in 300 Oct. 9: Sale of merchandise (30 chairs × $86) (2,580) Oct. 11: Return of merchandise (5 chairs × $86) 430 Oct. 31: Balance before adjustment 6,450 Oct. 31: Adjustment for missing chair* (1 chair × $86) (86) Oct. 31: Balance $6364 * 100 chairs – 30 chairs sold + 5 chairs returned = 75 chairs per inventory records – 74 chairs per inventory count = 1 missing chair.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-7

Sales Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses Profit from operations Other expenses Profit

Natural Mattar Cosmetics Grocery $195,000 (e) $110,000

SE Footwear $158,000

(a) 16,000 179,000 87,000 (b) 92,000 45,000

5,000 105,000 (f) 67,000 38,000 (g) 22,000

14,000 (i) 144,000 (j) 120,000 24,000 18,000

(h)16,000 6,000 $10,000

(k) 6,000 (l) 2,000 $4,000

(a) Sales ......................................................................... $195,000 Less: *Sales returns and allowances ............................. (16,000) Net sales ................................................................... $179,000 (b) Net sales ................................................................... $179,000 Less: cost of goods sold......................................... (87,000) *Gross profit............................................................. $92,000 (c) Gross profit .............................................................. Less: Operating expenses ...................................... *Profit from operations ............................................

$92,000 (45,000) $47,000

(d) Profit from operations ............................................. $47,000 Less: Other expenses ............................................. (4,000) *Profit........................................................................ $ 43,000 (e) *Sales........................................................................ $110,000 Less: Sales returns and allowances ...................... (5,000) Net sales ................................................................... $105,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 5-7 (Continued) (f)

Net sales ................................................................... $105,000 *Cost of goods sold ................................................. (67,000) Gross profit .............................................................. $38,000

(g) Gross profit .............................................................. *Operating expenses ............................................... Profit from operations (from (h)) ............................

$38,000 (22,000) $16,000

(h) *Profit from operations ............................................ Less: Other expenses ............................................. Profit .........................................................................

$16,000 (6,000) $10,000

(i)

Sales ......................................................................... $158,000 Less : Sales returns................................................. (14,000) *Net sales ................................................................. $144,000

(j)

Net sales ................................................................... $144,000 Less: *Cost of goods sold ....................................... (120,000) Gross profit .............................................................. $ 24,000

(k) Gross profit .............................................................. Less: Operating expenses ...................................... *Profit from operations ............................................

$24,000 (18,000) $ 6,000

(l)

$6,000 (2,000) $4,000

Profit from operations ............................................. Less: *Other expenses ............................................ Profit .........................................................................

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-8 (a) CHEVALIER COMPANY Income Statement Year Ended December 31, 2011 Revenues Net sales ($2,400,000 − $41,000 − $8,500) $2,350,500 Interest revenue ........................................ 30,000 Rent revenue ............................................. 24,000 Total revenues ...................................... 2,404,500 Expenses Cost of goods sold ................................... $ 985,000 Salaries expense....................................... 875,000 Depreciation expense ............................... 125,000 Advertising expense ................................. 55,000 Delivery expense ...................................... 25,000 Insurance expense ................................... 15,000 Interest expense ....................................... 70,000 Total expenses ..................................... 2,150,000 Profit............................................................... $ 254,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-8 (Continued) (b) CHEVALIER COMPANY Income Statement Year Ended December 31, 2011 Sales.............................................................................. $2,400,000 Less: Sales returns and allowances ............. $41,000 Sales discounts ................................... 8,500 49,500 Net sales ....................................................................... 2,350,500 Cost of goods sold ....................................................... 985,000 Gross profit................................................................... 1,365,500 Operating expenses Salaries expense....................................... $875,000 Depreciation expense ............................... 125,000 Advertising expenses ............................... 55,000 Delivery expense ...................................... 25,000 Insurance expense ................................... 15,000 Total operating expenses ............................................ 1,095,000 Profit from operations ............................................. 270,500 Other revenues Interest revenue .......................... $30,000 Rent revenue ............................... 24,000 54,000 Other expenses Interest expense ....................................... 70,000 16,000 Profit.............................................................................. $ 254,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-8 (Continued) (c) Dec. 31 Sales ............................................ 2,400,000 Interest Revenue ......................... 30,000 Rent Revenue .............................. 24,000 Income Summary ..................... 2,454,000 31 Income Summary ........................ 2,199,500 Sales Returns and Allowances ........ Sales Discounts ................................ Cost of Goods Sold........................... Salaries Expense .............................. Depreciation Expense....................... Advertising Expenses....................... Delivery Expense .............................. Insurance Expense ........................... Interest Expense ...............................

41,000 8,500 985,000 875,000 125,000 55,000 25,000 15,000 70,000

31 Income Summary ($2,454,000 − $2,199,500) ......... 254,500 G. Chevalier, Capital ................ 254,500 31 G. Chevalier, Capital ......................... 150,000 G. Chevalier, Drawings ............ 150,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-9 Account Accounts payable Accounts receivable Accumulated depreciation –office building Advertising expense

Statement Balance Sheet Balance Sheet Balance Sheet

Income Statement Depreciation expense Income Statement B. Swirsky, capital Balance Sheet Statement of Owner’s Equity B. Swirsky, drawings Statement of Owner’s Equity Cash Balance Sheet Freight out Income Statement Insurance expense Income Statement Interest expense Income Statement Interest payable Balance Sheet Interest revenue Income Statement Land Balance Sheet Merchandise inventory Mortgage payable Note receivable Office building

Balance Sheet

Prepaid insurance Property tax payable

Balance Sheet Balance Sheet

Balance Sheet Balance Sheet Balance Sheet

Classification Current Liabilities Current Assets Property, Plant, and Equipment (Contra Account) Operating Expenses Operating Expenses Owner’s Equity

Deduction from capital Current Assets Operating Expenses Operating Expenses Other Expenses Current Liabilities Other Income Property, Plant, and Equipment Current Assets Long-Term Liability Current Assets Property, Plant, and Equipment Current Assets Current Liabilities

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-9 (Continued) Account Salaries expense Salaries payable Sales Sales discounts Sales returns and allowances Unearned sales revenue

Statement Income Statement Balance Sheet Income Statement Income Statement Income Statement

Classification Operating Expenses Current Liabilities Revenue Contra Revenue Contra Revenue

Balance Sheet

Current Liabilities

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-10 (a) RIKARD’S Income Statement Year Ended August 31, 2011 Sales................................................................................. $458,300 Less: Sales discounts ................................. $2,275 Sales returns and allowances 14,555 16,830 Net sales ...................................................................... 441,470 Cost of goods sold .......................................................... 273,360 Gross profit...................................................................... 168,110 Operating expenses Depreciation expense .................................... $ 6,110 Salaries expense............................................ 55,000 Rent expense ................................................. 24,000 Supplies expense .......................................... 5,040 Insurance expense ........................................ 2,205 Total operating expenses ...................................... 92,355 Profit from operations ..................................................... 75,755 Other expenses Interest expense ......................................................... 1,925 Profit................................................................................. $73,830 RIKARD’S Statement of Owner’s Equity Year Ended August 31, 2011 R. Smistad, capital September 1, 2010* ......................... $ 68,450 Add: Investment.............................................. $ 3,500 Profit ....................................................... 73,830 77,330 145,780 Less: Drawings ................................................................ 85,000 R. Smistad, capital, August 31, 2011 ............................. $60,780 *($71,950 − $3,500)

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-10 (Continued) (a) (Continued) RIKARD’S Balance Sheet August 31, 2011

Assets Current assets Cash............................................................................. $ 5,640 Accounts receivable ................................................... 2,570 Merchandise inventory .............................................. 70,350 Prepaid insurance....................................................... 1,575 Supplies....................................................................... 1,680 Total current assets ............................................... 81,815 Property, plant, and equipment Store equipment ........................ $32,600 Less: Accumulated depreciation 13,040 $19,560 Office furniture ........................... 28,500 Less: Accumulated depreciation 7,400 21,100 Total property, plant and equipment .................... 40,660 Total assets ............................................................ $122,475 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................... $ 18,035 Salaries payable.......................................................... 2,250 Interest payable .......................................................... 450 Unearned sales revenue............................................. 2,460 Current portion of note payable ................................ 5,000 Total current liabilities ........................................... 28,195 Long-term liabilities Note payable ($38,500 − $5,000) ................................ 33,500 Total liabilities ........................................................ 61,695 Owner’s Equity R. Smistad, capital ...................................................... 60,780 Total liabilities and owner’s equity ....................... $122,475

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-10 (Continued) (b) Gross profit margin = $168,110 ÷ $441,470 = 38.1% Profit margin = $73,830 ÷ $441,470 = 16.7%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 5-11 (a) Gross profit margin 2009 = 23.7% [($27,433 − $20,938) ÷ $27,433] 2008 = 23.9% [($40,023 − $30,477) ÷ $40,023] 2007 = 24.4% [($35,934 − $27,165) ÷ $35,934] Profit margin 2009 = 3.6% [$984 ÷ $27,433] 2008 = 3.5% [$1,407 ÷ $40,023] 2007 = 3.8% [$1,377 ÷ $35,934] (b) Profit margin (Profit from operations) 2009 = 5.3% [$1,442 ÷ $27,433] 2008 = 5.4% [$2,161 ÷ $40,023] 2007 = 5.6% [$1,999 ÷ $35,934] (c) The gross profit margin has decreased slightly from 2007 to 2009, from 24.4% to 23.7%. The profit margin has also decreased from 3.8% in 2007 to 3.5% in 2008, although it recovered slightly up to 3.6% in 2009. The profit margin based on profit from operations also weakened slightly from 5.6% to 5.3% in 2009.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-12 (a) Dec. 3 Accounts Receivable .................. 48,000 Sales ........................................

48,000

4 No entry required. 8 Sales Returns and Allowances ... Accounts Receivable ..............

2,400 2,400

13 Cash ($45,600 × 98%) .................. 44,688 Sales Discount ($45,600 × 2%) ... 912 Accounts Receivable ..............

45,600

(b) Dec. 3 Purchases .................................... 48,000 Accounts Payable ...................

48,000

4 Freight In ...................................... Cash .........................................

750 750

8 Accounts Payable........................ Purchase Returns and Allowances .......................

2,400

13 Accounts Payable........................ 45,600 Purchase Discounts ($45,600 × 2%) ......................... Cash .........................................

2,400

912 44,688

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-13 (a)

Perpetual Inventory System May

2 Merchandise Inventory................. Accounts Payable ....................

1,200

2 Merchandise Inventory................. Cash ..........................................

100

3 Accounts Payable......................... Merchandise Inventory (returns)

200

1,200

100

200

9 Accounts Payable ($1,200 − $200) 1,000 Merchandise Inventory ($1,000 × 2%) ............................ Cash ($1,000 × 98%)................. 12 Accounts Receivable ................... Sales Revenue.......................... Cost of Goods Sold [($1,200 + $100 − $200 − $20) × ¾] Merchandise Inventory ............

20 980

1,500 1,500

810 810

14 Sales Returns and Allowances .... Accounts Receivable ...............

180

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

100

22 Cash [($1,500 − $180) × 98%] ....... Sales Discounts [($1,500 − $180) × 2%]................... Accounts Receivable [$1,500 − $180] .........................

1,294

180

100

26 1,320

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-13 (Continued) (b) Periodic Inventory System May 2

Purchases ..................................... Accounts Payable ....................

1,200

Freight In ....................................... Cash ..........................................

100

1,200

100

Accounts Payable......................... 200 Purchases Returns and Allowances

200

Accounts Payable ($1,200 − $200) 1,000 Purchase Discounts ($1,000 × 2%) ............................ Cash ($1,000 × 98%).................

20 980

Accounts Receivable ................... Sales Revenue..........................

1,500

Sales Returns and Allowances .... Accounts Receivable ...............

180

1,500

Cash ($1,320 × 98%) ..................... 1,294 Sales Discounts ($1,320 × 2%) .... 26 Accounts Receivable [$1,500 − $180]

180

1,320

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-14 (a) July 2

Purchases ..................................... 20,000 Accounts Payable .................... Freight In ....................................... Cash ..........................................

500

Cash .............................................. Sales Revenue..........................

1,000

20,000

500

1,000

Accounts Payable......................... 20,000 Purchase Discounts ($20,000 × 2%) .......................... Cash ($20,000 × 98%) ...............

400 19,600

Accounts Receivable ................... Sales Revenue..........................

5,000 5,000

Cash ($5,000 × 99%) ..................... Sales Discounts ($5,000 × 1%) .... Accounts Receivable ...............

4,950 50

(b) Sales revenues Sales ............................................................................ Less: Sales discounts ............................................... Net sales ...................................................................... Cost of goods sold Merchandise inventory, July 1 .................... $ 0 Purchases ................................... $20,000 Less: Purchase discounts ......... 400 Net purchases ............................. 19,600 Add: Freight in ............................ 500 Cost of goods purchased ......................... 20,100 Cost of goods available for sale .............. 20,100 Merchandise inventory, July 31 ............... 16,500 Cost of goods sold ................................................. Gross profit......................................................................

5,000

$6,000 50 5,950

3,600 $ 2,350

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-15 Company 1: (a) $1,420 ($1,500 − $50 − $30) (b) $1,530 ($1,420 + $110) (c) $1,780 ($1,530 + $250) (d) $300 ($1,780 − $1,480) (e) $300 (from (d)) (f) $2,000 ($1,850 + $100 + $50) (g) $150 ($2,000 from (h) − $1,850) (h) $2,000 ($2,300 − $300 from (e)) (i) $1,900 ($2,300 − $400) Company 2: (j) $7,660 ($7,210 + $300 + $150) (k) $690 ($7,900 − $7,210) (l) $8,900 ($7,900 + $1,000) (m) $7,450 ($8,900 from (l) − $1,450) (n) $1,450 (from year 1 ending inventory) (o) $9,050 ($9,550 − $400 − $100) (p) $9,600 ($9,050 from (o) + $550) (q) $11,050 ($9,600 from (p)+ $1,450 from (n)) (r) $9,800 ($11,050 from (q) − $1,250)

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-16 (a) OKANAGAN COMPANY Income Statement Year Ended January 31, 2011

Sales revenues Sales ............................................................................ $315,000 Less: Sales returns and allowances ............ $13,000 Sales discounts .................................... 4,000 17,000 Net sales .......................................................................... 298,000 Cost of goods sold Inventory, beginning ................................ $ 61,000 Purchases ............................... $200,000 Less: Purchase discounts $2,000 Purchase returns and allowances........ 6,000 8,000 Net purchases ........................ 192,000 Add: Freight in ........................ 10,000 Cost of goods purchased ......................... 202,000 Cost of goods available for sale .............. 263,000 Inventory, ending ...................................... 42,000 Cost of goods sold .......................................................... 221,000 Gross profit...................................................................... 77,000 Operating expenses Salary expense ......................................... $ 61,000 Rent expense ........................................... 20,000 Insurance expense .................................. 12,000 Freight out ................................................. 7,000 Total operating expenses ...................................... 100,000 Loss from operations ...................................................... (23,000 ) Other expenses Interest expense ......................................................... 6,000 Loss ................................................................................. $ (29,000 )

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Accounting Principles, Fifth Canadian Edition

*EXERCISE 5-16 (Continued) (b) Jan. 31 Sales ................................................. 315,000 Merchandise Inventory (end of year) 42,000 Purchase Returns and Allowances. 6,000 Purchase Discounts ......................... 2,000 Income Summary ....................

365,000

31 Income Summary ............................. 394,000 Merchandise Inventory (beginning of year) .................. Purchases................................ Freight In ................................. Salaries Expense .................... Rent Expense .......................... Insurance Expense ................. Freight Out .............................. Interest Expense ..................... Sales Returns and Allowances Sales Discounts ......................

61,000 200,000 10,000 61,000 20,000 12,000 7,000 6,000 13,000 4,000

31 O. G. Pogo, Capital........................... 29,000 Income Summary ....................

29,000

31 O. G. Pogo, Capital........................... 42,000 O. G. Pogo, Drawings .............

42,000

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 5-1A (a)

A company’s operating cycle is the average time it takes to go from cash to cash in producing revenues. The operating cycle for a merchandising company covers the period of time between when you purchase your inventory, to when you sell it, and to when you eventually collect the accounts receivable from a sale. You are having problems paying your bills because the period of time between your sales and your collection of accounts receivable is lengthened because many customers take more than one month to pay.

(b)

Your inventory system is contributing to the problem because you are not sure of what you have on hand at any given time and often run out of inventory.

Taking It Further: You should consider switching to a perpetual inventory method because it has detailed records of each inventory purchase and sale. This system continuously—perpetually—shows the quantity and cost of the inventory purchased, sold, and on hand. This will allow you to order inventory on a more timely basis.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2A (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Apr. 2 Merchandise Inventory ...................... Accounts Payable ..........................

8,500

4 Accounts Payable [5 × ($8,500 ÷ 170)] Merchandise Inventory ..................

250

5 Accounts Receivable (45 × $95) ......... Sales ...............................................

4,275

Cost of Goods Sold (45 × $50) ........... Merchandise Inventory ..................

2,250

6 Sales Returns and Allowances .......... Accounts Receivable (15 × $95) ....

1,425

Merchandise Inventory (15 × $50) ...... Cost of Goods Sold .......................

750

10 Cash (40 × $95) .................................... Sales ...............................................

3,800

Cost of Goods Sold (40 × $50) ........... Merchandise Inventory ..................

2,000

12 Sales Returns and Allowances .......... Cash (10 × $95) ...............................

950

Merchandise Inventory (10 × $50) ...... Cost of Goods Sold .......................

500

17 Sales Returns and Allowances ......... Cash (10 × $95) ...............................

950

Credit

8,500

250

4,275

2,250

1,425

750

3,800

2,000

950

500

950

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2A (Continued) (a) (Continued) Apr. 25 Accounts Receivable (60 × $95) ......... Sales ................................................

5,700

Cost of Goods Sold (60 × $50) ........... Merchandise Inventory ..................

3,000

29 Sales Returns and Allowances ......... Accounts Receivable (25 × $95) ....

2,375

Merchandise Inventory (25 × ($50) ..... Cost of Goods Sold .......................

1,250

5,700

3,000

2,375

1,250

(b) Apr. 1 2 6 12 29 Bal.

Inventory 2,750 8,500 4 5 750 10 500 25 1,250 6,250

250 2,250 2,000 3,000

Cost of Goods Sold Apr. 5 2,250 6 750 10 2,000 12 500 25 3,000 29 1,250

Bal.

Sales Apr. 5 10 25

4,275 3,800 5,700

Bal.

13,775

4,750

Sales Returns and Allowances Apr. 6 1,425 12 950 17 950 29 2,375 Bal. 5,700

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2A (Continued) (c) Sales Less: Sales returns and allowances Net sales Net sales (from above) Less: Cost of goods sold Gross profit

$13,775 5,700 $8,075 $8,075 4,750 $3,325

Taking It Further: The owner will be missing the detail of the amount of sales returns. This can convey important information about the quality of the merchandise, or sales practices. A significant amount of sales returns can negatively affect customer loyalty and satisfaction. It is also time consuming and expensive to process the sales returns to restock the returned merchandise. Therefore, the owner should know the amount of sales returns to determine if any of these problems exist.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3A (a) GENERAL JOURNAL Date

Account Titles and Explanation

July 1 Merchandise Inventory (50 × $30) ..... Accounts Payable ...........................

Debit

Credit

1,500 1,500

2 (FOB destination means the seller pays the freight, therefore no entry required here.) 4 Accounts Payable ............................... Merchandise Inventory...................

150

10 Accounts Receivable (45 × $55) ........ Sales ...............................................

2,475

Cost of Goods Sold (45 × $30) ........... Merchandise Inventory ..................

1,350

12 Sales Returns and Allowances ......... Accounts Receivable.....................

275

Merchandise Inventory (5 × $30) ........ Cost of Goods Sold .......................

150

15 Merchandise Inventory (60 × $27.50) Accounts Payable ...........................

1,650

18 Merchandise Inventory ....................... Cash ................................................

150

2,475

1,350

275

150

1,650

150

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3A (Continued) (a) (Continued) July 21 Accounts Receivable (54 × $55) ......... Sales ...............................................

2,970

Cost of Goods Sold (54 × $30) ........... Merchandise Inventory ..................

1,620

23 Sales Returns and Allowances ......... Accounts Receivable.....................

110

30 Accounts Payable ............................... Cash ($1,500 − $150) ......................

1,350

31 Cash ($2,475 – $275) ........................... Accounts Receivable .....................

2,200

2,970

1,620

110

1,350

2,200

(b) Merchandise Inventory Open 750 July 1 1,500 July 4 150 10 1,350 12 150 15 1,650 18 150 21 1,620 1,080 (c)

There are 36 suitcases on hand on July 31. The balance in the merchandise inventory account is $1,080: $30 per suitcase × 36 suitcases = $1,080.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3A (Continued) Taking It Further: Freight terms indicate when ownership of the goods transfers from the seller to the buyer and who pays for the transportation charges. In the July 1st transaction, the freight terms are FOB destination. The seller, Trunk Manufacturers, pays for the freight charges, resulting in an inventory cost of $30 per item (50 suitcases × $30 = $1,500). When the seller pays for the freight costs, this usually results in a higher unit cost to cover the shipping expense, as shown in the July 1st transaction. In the July 15th transaction, the freight terms are FOB shipping point. The buyer, Travel Warehouse, pays for the freight charges, resulting in a lower unit cost charged by the vendor. Invoice cost (60 suitcases × $27.50) $1,650 Freight 150 Total inventory cost $1,800 Cost per suitcase ($1,800 ÷ 60) $30

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4A GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Sept. 1 Merchandise Inventory.................... Accounts Payable .......................

65,000

2 Merchandise Inventory ................... Cash ............................................

2,000

5 Accounts Payable ........................... Merchandise Inventory ..............

7,000

15 Accounts Receivable ...................... Sales ...........................................

90,000

Cost of Goods Sold ($65,000 + $2,000 − $7,000) ............ Merchandise Inventory ..............

Credit

65,000

2,000

7,000

90,000

60,000 60,000

16 Freight-Out ....................................... Cash .............................................

3,000

17 Sales Returns and Allowances ...... Accounts Receivable ..................

4,000

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

2,400

25 Sales Discounts ($86,000 × 2%) ..... Cash ($86,000 − $1,720) .................. Accounts Receivable ($90,000 − $4,000) .......................

1,720 84,280

3,000

4,000

2,400

30 Accounts Payable ($65,000 − $7,000) 58,000 Cash .............................................

86,000

58,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4A (Continued) Oct.

1 Merchandise Inventory ................... Accounts Payable ......................

50,000 50,000

2 (FOB destination means the seller pays the freight, therefore no entry required here.) 3 Accounts Payable ........................... Merchandise Inventory ..............

2,000 2,000

10 Accounts Payable ($50,000 − $2,000) 48,000 Cash ($48,000 − $960) ................ Merchandise Inventory ($48,000 × 2%)

47,040 960

11 Accounts Receivable ...................... Sales ...........................................

80,000

Cost of Goods Sold ($50,000 − $2,000 − $960) ............... Merchandise Inventory ..............

80,000

47,040 47,040

12 (FOB shipping point means the buyer pays the freight, therefore no entry required here.) 17 Sales Returns and Allowances ...... Accounts Receivable .................

1,500

31 Cash ................................................ 78,500 Accounts Receivable ($80,000 − $1,500) ....................... (No discount as not received within 10 days)

1,500

78,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4A (Continued) Taking It Further: Companies should take all available discounts since not taking the discount is equivalent to paying interest for the use of the money owing to the seller. For the Sept. 1 purchase from Hillary Company, the interest rate is calculated as follows: Amount owing to Hillary Company ($65,000 − $7,000) = $58,000 Credit terms: 1/15, n/30 Discount not taken: $58,000 × 1% = $580. This equals to an annual interest rate of 24.33% (1% ÷ 15 × 365). For the Oct. 1 purchase from Kimmel Company, the interest rate is calculated as follows: Amount owing to Kimmel Company ($50,000 − $2,000) = $48,000 Credit terms: 2/10, n/30 Discount taken: $48,000 × 2% = $960. This equals to an annual interest rate of 36.50% (2% ÷ 20 × 365). In both cases, Norlan Company should be able to obtain financing from the bank at a lower rate of interest.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Apr. 2 Merchandise Inventory ...................... Accounts Payable ..........................

8,900

3 Merchandise Inventory ...................... Cash ...............................................

300

Credit

8,900

300

4 Accounts Receivable ......................... 11,600 Sales ............................................... Cost of Goods Sold ........................... Merchandise Inventory ..................

7,300

5 Freight Out .......................................... Cash ...............................................

250

6 Sales Returns and Allowances .......... Accounts Receivable .....................

700

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

425

8 Merchandise Inventory ...................... Accounts Payable ..........................

4,500

10 Accounts Payable .............................. Merchandise Inventory ..................

300

11,600

7,300

250

700

425

4,500

15 Accounts Payable ............................... 8,900 Merchandise Inventory ($8,900 × 1%) Cash ($8,900 − $89) ........................

300

89 8,811

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (Continued) (a) (Continued) Apr. 18 Accounts Payable ($4,500 − $300) ..... 4,200 Merchandise Inventory ($4,200 × 2%) Cash ($4,200 − $84) ........................ 23 Cash .................................................... Sales ...............................................

7,500

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

4,500

24 Merchandise Inventory ...................... Cash ...............................................

2,800

25 Sales Returns and Allowances ......... Cash ................................................

230

26 Cash .................................................... Merchandise Inventory ..................

500

84 4,116

7,500

4,500

2,800

230

500

28 Cash ($11,600 − $700) ........................ 10,900 Accounts Receivable .....................

10,900

30 Accounts Receivable ......................... Sales ................................................

3,800 3,800

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

2,200 2,200

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (Continued) (b) Date

Explanation

Apr. 1 3 5 15 18 23 24 25 26 28

Balance

Date Apr. 4 6 28 30

Cash Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

Credit Balance

500 10,900

14,000 13,700 13,450 4,639 523 8,023 5,223 4,993 5,493 16,393

Accounts Receivable Explanation Ref. Debit

Credit Balance

J1 J1 J1 J1

300 250 8,811 4,116 7,500 2,800 230

11,600 700 10,900 3,800

11,600 10,900 0 3,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (Continued) (b) (Continued)

Date Apr. 1 2 3 4 6 8 10 15 18 23 24 26 30

Date

Merchandise Inventory Explanation Ref. Debit Balance

✓ J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1

8,900 300 7,300 425 4,500 300 89 84 4,500 2,800 500 2,200

Accounts Payable Explanation Ref. Debit

Apr. 2 8 10 15 18

J1 J1 J1 J1 J1

Credit Balance 3,000 11,900 12,200 4,900 5,325 9,825 9,525 9,436 9,352 4,852 7,652 7,152 4,952

Credit Balance

300 8,900 4,200

8,900 13,400 13,100 4,200 0

Date

M. Nisson, Capital Explanation Ref. Debit

Credit Balance

Apr. 1

Balance

✓

8,900 4,500

17,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (Continued) (b) (Continued)

Date

Explanation

Sales Ref.

Debit

Credit Balance

Apr. 4 23 30

J1 J1 J1

Date

Sales Returns and Allowances Explanation Ref. Debit Credit Balance

Apr. 6 25

J1 J1

Date

11,600 7,500 3,800

11,600 19,100 22,900

700 230

700 930

Cost of Goods Sold Explanation Ref. Debit

Credit Balance

Apr. 4 6 23 30

J1 J1 J1 J1

4,500 2,200

7,300 6,875 11,375 13,575

Date

Freight Out Ref. Debit

Credit Balance

Apr. 5

Explanation

7,300 425

250

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5A (Continued) (c) NISSON DISTRIBUTING COMPANY Income Statement (Partial) Month Ended April 30, 2011

$22,900 930 21,970 13,575 $ 8,395

Taking It Further: Sales returns are recorded as they occur and not based on the date of the original sale to the customer. In this case the return occurs in the month following the original sale. The timing of the sales return entry is based on the assumption that returns are not significant. If a company experiences substantial returns, it has to account for them in the same time period as the related sale in order to properly reflect the gross profit for that period’s sale. This topic is usually explored further in an intermediate accounting course.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6A

(a) July 31 Cost of Goods Sold ........................ 2,900 Merchandise Inventory ($71,800 − $68,900).....................

2,900

(b) SCARBORO WHOLESALE CENTRE Income Statement Year Ended July 31, 2011 Revenues Sales............................................................. $916,700 Less: Sales returns and allowances$18,050 Sales discounts ................... 4,625 22,675 Net sales ...................................................... 894,025 Interest revenue ......................................... 1,200 $895,225 Expenses Cost of goods sold ($712,100 + $2,900) ..... $715,000 Depreciation expense ................................. 8,350 Freight out ................................................... $5,900 Insurance expense ...................................... 3,620 Interest expense .......................................... 2,700 Rent expense ............................................... 20,000 Salaries expense ......................................... 69,800 825,370 Profit................................................................ $ 69,855

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6A (Continued) (c) SCARBORO WHOLESALE CENTRE Income Statement Year Ended July 31, 2011 Sales................................................................................. $916,700 Less: Sales returns and allowances ........ $18,050 Sales discounts ............................... 4,625 22,675 Net sales ...................................................................... 894,025 Cost of goods sold ($712,100 + $2,900) ......................... 715,000 Gross profit...................................................................... 179,025 Operating expenses Depreciation expense ................................ $ 8,350 Freight out .................................................. $5,900 Insurance expense .................................... 3,620 Rent expense ............................................. 20,000 Salaries expense........................................ 69,800 Total operating expenses ...................................... 0 107,670 Profit from operations ..................................................... 71,355 Other expenses and revenues Interest expense ....................................... $2,700 Interest revenue ......................................... 1,200 1,500 Profit................................................................................. $ 69,855

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6A (Continued) (d) July 31 Interest Revenue ............................... 1,200 Sales .................................................. 916,700 Income Summary..........................

917,900

31 Income Summary .............................. 848,045 Sales Returns and Allowances .... Sales Discounts ............................ Cost of Goods Sold ...................... Freight Out .................................. Salaries Expense ........................ Rent Expense .............................. Insurance Expense ..................... Depreciation Expense ................ Interest Expense ...........................

18,050 4,625 715,000 $ 5,900 69,800 20,000 3,620 8,350 2,700

31 Income Summary .............................. E. Martel, Capital...........................

69,855 69,855

31 E. Martel, Capital ............................... E. Martel, Drawings ......................

75,800 75,800

Income Summary 917,900 848,045 Bal.* 69,855 69,855 Bal. 0 * Check $69,855 = Profit Taking It Further: Both income statements result in the same amount of net income. The multiple-step income statement provides the user with much more information than the single-step income statement. The multiple-step income statement provides information on gross profit and profit from operations which is not included on the single-step income statement.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7A (a) Dec. 31 Supplies Expense .............................. Supplies ($2,940 − $750) ...............

2,190 2,190

31 Depreciation Expense ....................... 11,100 Accumulated Depreciation —Building ...................................... Accumulated Depreciation —Equipment .................................. 31 Interest Expense ................................ Interest Payable ............................

1,000

31 Unearned Sales Revenue .................. Sales Revenue ($4,000 − $975).....

3,025

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

2,000

31 Cost of Goods Sold [($27,050 − $2,000) − $23,800] ........... Merchandise Inventory .................

6,600 4,500

1,000

3,025

2,000

1,250 1,250

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7A (Continued) (b) WORLD ENTERPRISES Income Statement Year Ended December 31, 2011 Sales revenues Sales ($263,770 + $3,025) ........................................... $266,795 Less: Sales discounts .................................. $3,275 Sales returns and allowances ........... 2,500 5,775 Net sales ...................................................................... 261,020 Cost of goods sold ($171,225 + $2,000 + $1,250) .......... 174,475 Gross profit...................................................................... 86,545 Operating expenses Depreciation expense .................................... $11,100 Salaries expense............................................ 35,450 Supplies expense .......................................... 2,190 Utilities expense ........................................... 5,100 Total operating expenses ...................................... 53,840 Profit from operations ..................................................... 32,705 Other expenses Interest expense ......................................................... 10,975 Profit ................................................................................ $ 21,730

WORLD ENTERPRISES Statement of Owner’s Equity Year Ended December 31, 2011 S. Kim, capital, January 1, 2011 ($46,415 − $5,000) ...... Add: Investment................................................ $ 5,000 Profit ......................................................... 21,730 Less: Drawings ............................................................... S. Kim, capital, December 31, 2011 ................................

$41,415 26,730 68,145 25,170 $42,975

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7A (Continued) (b) (Continued) WORLD ENTERPRISES Balance Sheet December 31, 2011 ______________________________________________________ Assets Current assets Cash............................................................................. $ 12,000 Accounts receivable .................................................. 19,200 Merchandise inventory ($27,050 – $2,000 – $1,250) . 23,800 Supplies ($2,940 – $2,190).......................................... 750 Total current assets ............................................... 55,750 Property, plant, and equipment Land .............................................. $30,000 Building ....................................... $150,000 Less: Accumulated depreciation ($24,000 + $6,600)............. 30,600 119,400 Equipment ...................................... $45,000 Less: Accumulated depreciation ($18,000 + $4,500)............. 22,500 22,500 Total property, plant, and equipment ..................... 171,900 Total assets .......................................................... $227,650 Liabilities and Owner's Equity Current liabilities Accounts payable ......................................................... $ 35,600 Interest payable ............................................................ 1,000 Unearned sales revenue ($4,000 − $3,025).................. 975 Current portion of mortgage payable .......................... 9,800 Total current liabilities ............................................. 47,375 Long-term liabilities Mortgage payable ($147,100 − $9,800) ........................ 137,300 Total liabilities .......................................................... 184,675 Owner's equity S. Kim, capital ............................................................... 42,975 Total liabilities and owner's equity ......................... $227,650

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7A (Continued) (c) Dec. 31 Sales ........................................... 266,795 Income Summary ..................

266,795

31 Income Summary....................... 245,065 Sales Discounts .................... Sales Returns and Allowances Cost of Goods Sold............... Depreciation Expense........... Interest Expense ................... Salaries Expense .................. Supplies Expense ................. Utilities Expense ...................

3,275 2,500 174,475 11,100 10,975 35,450 2,190 5,100

31 Income Summary....................... S. Kim, Capital .......................

21,730 21,730

31 S. Kim, Capital ........................... S. Kim, Drawings...................

25,170 25,170

(d) Current ratio = $55,750 ÷ $47,375 = 1.18 to 1 Acid-test ratio = ($12,000 + $19,200) ÷ $47,375 = 0.66 to 1 Gross profit margin = $86,545 ÷ $261,020 = 33.16% Profit margin = $21,730 ÷ $261,020 = 8.33% Taking It Further: Current ratio Acid-test ratio Gross profit margin Profit margin

2011 1.18 to 1 0.66 to 1 33.16% 8.33%

2010 1.45 to 1 1.10 to 1 35% 10%

The company has seen a decrease in both the current ratio and the acid-test ratio. This decreasing trend shows a deterioration of the company’s liquidity. The gross profit margin and the profit margin have also decreased in 2011. This decreasing trend shows a deterioration of the company’s profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-8A

2008

2007

2006

Gross profit margin

11.48%

13.30%

($23,704 − $20,982) ÷ $23,704

($26,067 − ($24,180- $21,211) $22,599) ÷ $26,067 ÷ $24,180

Profit margin

0.30%

2.54%

2.18%

$71 ÷ $23,704

$663 ÷ $26,067

$528 ÷ $24,180

1.55:1

1.48:1

$8,770 ÷ $5,658

$7,060 ÷ $4,783

Current 1.45:1 ratio $7,371 ÷ $5,093

12.28%

Taking It Further Magna International’s gross profit margin and profit margin both increased in 2007. Both ratios subsequently decreased in 2008 below the 2006 levels for an overall decrease in profitability over the three year period. The current ratio increased in 2007 but subsequently decreased in 2008 below the 2006 level for an overall decrease in liquidity.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-9A GENERAL JOURNAL Date July

Account Titles and Explanation 1 Purchases (50 × $30) ........................ Accounts Payable ........................

Debit

Credit

1,500 1,500

2 (FOB destination means the seller pays the freight, therefore no entry required here.) 4 Accounts Payable .............................. Purchase Returns and Allowances

150

10 Accounts Receivable (45 × $55) ...... Sales .............................................

2,475

12 Sales Returns and Allowances ........ Accounts Receivable ...................

275

15 Purchases (60 × $27.50) .................... Accounts Payable ........................

1,650

18 Freight In ............................................ Cash ..............................................

150

21 Accounts Receivable (54 × $55) ...... Sales .............................................

2,970

23 Sales Returns and Allowances ........ Accounts Receivable ...................

110

30 Accounts Payable .............................. Cash ($1,500 − $150) .....................

1,350

31 Cash ($2,475 − $275) ......................... Accounts Receivable ....................

2,200

150

2,475

275

1,650

150

2,970

110

1,350

2,200

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-9A (Continued) Taking It Further: A perpetual inventory system provides detailed records of inventory. This would allow Travel Warehouse to track the quantity and cost of inventory purchased, sold and on hand. This would provide the benefit of being able to answer customer questions about merchandise availability and for management to maintain optimum inventory levels and avoid running out of stock. This system also allows the company to prepare financial statements more easily, since the cost of goods sold and ending inventory amounts are readily available. For a company such as Travel Warehouse, a perpetual system includes the freight in costs in the inventory cost rather than in a separate account. This would reflect the fact that the cost is the same regardless of whether Travel Warehouse or the supplier pays the freight. A perpetual inventory system is more costly to implement and maintain because of the need to enter all merchandise in the accounting system. The accounting system must also be sufficiently sophisticated to track purchases and sales of merchandise, usually through the use of scanners.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-10A GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Sept. 1 Purchases ........................................ Accounts Payable .......................

65,000

2 Freight In ......................................... Cash ............................................

2,000

Oct.

Credit

65,000

2,000

5 Accounts Payable ........................... 7,000 Purchase Returns and Allowances

7,000

15 Accounts Receivable ...................... Sales ...........................................

90,000 90,000

16 Freight-Out ....................................... Cash .............................................

3,000

17 Sales Returns and Allowances ...... Accounts Receivable ..................

4,000

25 Sales Discounts ($86,000 × 2%) ..... Cash ($86,000 − $1,720)................... Accounts Receivable ($90,000 − $4,000) .......................

1,720 84,280

3,000

4,000

86,000

30 Accounts Payable ($65,000 − $7,000) 58,000 Cash .............................................

58,000

1 Purchases ....................................... Accounts Payable ......................

50,000

2 (FOB destination means the seller pays the freight, therefore no entry required here.) *PROBLEM 5-10A (Continued) Solutions Manual 5-74 Chapter 5 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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Oct.

Accounting Principles, Fifth Canadian Edition

3 Accounts Payable ........................... 2,000 Purchase Returns and Allowances

2,000

10 Accounts Payable ($50,000 − $2,000) 48,000 Cash ($48,000 − $960) ................ Purchase Discounts ($48,000 × 2%)

47,040 960

11 Accounts Receivable ...................... Sales ...........................................

80,000

12 (FOB shipping point means the buyer pays the freight, therefore no entry required here.) 17 Sales Returns and Allowances ...... Accounts Receivable .................

1,500

31 Cash ................................................ 78,500 Accounts Receivable ($80,000 − $1,500) ....................... (No discount as not received within 10 days)

1,500

78,500

Taking It Further Norlan Company has few transactions (1 purchase and 1 sale per month). A periodic inventory system is less costly to implement and maintain than a perpetual system. If the company has relatively low inventory quantities and can maintain control over its inventory visually rather than electronically, then a periodic inventory system may be sufficient to meet their information needs.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (a)

GENERAL JOURNAL

Date

Account Titles and Explanation

J1 Debit

Apr. 2 Purchases ........................................... Accounts Payable ..........................

8,900

3 Freight In ............................................. Cash ...............................................

300

8,900

300

4 Accounts Receivable ......................... 11,600 Sales ............................................... 5 Freight Out .......................................... Cash ...............................................

250

6 Sales Returns and Allowances .......... Accounts Receivable .....................

700

8 Purchases ........................................... Accounts Payable ..........................

4,500

Credit

11,600

250

700

4,500

(FOB destination means the seller pays the freight, therefore no entry required here.)

10 Accounts Payable .............................. Purchase Returns and Allowances

300

15 Accounts Payable ............................... Purchase Discounts ($8,900 × 1%) Cash ($8,900 − $89) ........................

8,900

18 Accounts Payable ($4,500 − $300) ..... Purchase Discounts ($4,200 × 2%) Cash ($4,200 − $84) ........................

4,200

300

89 8,811

84 4,116

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (Continued) (a) (Continued) Apr. 23 Cash .................................................... Sales ...............................................

7,500

24 Purchases ........................................... Cash ...............................................

2,800

25 Sales Returns and Allowances ......... Cash ................................................

230

26 Cash .................................................... Purchase Returns and Allowances

500

7,500

2,800

230

500

28 Cash ($11,600 − $700) ........................ 10,900 Accounts Receivable .....................

10,900

30 Accounts Receivable ......................... Sales ................................................

3,800

(b) Date

Explanation

Apr. 1 3 5 15 18 23 24 25 26 28

Balance

Cash Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

Credit Balance

300 250 8,811 4,116 7,500 2,800 230 500 10,900

14,000 13,700 13,450 4,639 523 8,023 5,223 4,993 5,493 16,393

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (Continued) (b) (Continued)

Date

Accounts Receivable Explanation Ref. Debit

Apr. 4 6 28 30

J1 J1 J1 J1

Credit Balance

3,800

11,600 10,900 0 3,800

Date

Merchandise Inventory Explanation Ref. Debit

Credit Balance

Apr. 1

Balance

Date

Accounts Payable Explanation Ref. Debit

Apr. 2 8 10 15 18

11,600 700 10,900

✓

J1 J1 J1 J1 J1

3,000

Credit Balance

300 8,900 4,200

8,900 13,400 13,100 4,200 0

Date

M. Nisson, Capital Explanation Ref. Debit

Credit Balance

Apr. 1

Balance

✓

8,900 4,500

17,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (Continued) (b) (Continued)

Date

Explanation

Sales Ref.

Debit

Credit Balance

Apr. 4 23 30

J1 J1 J1

Date

Sales Returns and Allowances Explanation Ref. Debit Credit Balance

Apr. 6 25

J1 J1

700 230

700 930

Date

Purchases Ref. Debit

Credit Balance

Apr. 2 8 24

Explanation

J1 J1 J1

11,600 7,500 3,800

11,600 19,100 22,900

8,900 4,500 2,800

8,900 13,400 16,200

Date Apr. 15 18

Purchases Discounts Explanation Ref. Debit J1 J1

Credit Balance 89 89 84 173

Date Apr. 10 26

Purchases Returns and Allowances Explanation Ref. Debit Credit Balance J1 300 300 J1 500 800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (Continued) (b) (Continued) Freight In Ref.

Debit

Credit Balance

Apr. 3

300

Date

Freight Out Ref. Debit

Credit Balance

Date

Apr. 5

Explanation

250

Sales revenues Sales ............................................................................ Less: Sales returns and allowances......................... Net sales ...................................................................... Cost of goods sold Merchandise inventory, April 1 ................... $3,000 Purchases ................................... $16,200 Less: Purchase discounts ....... $ 173 Purchase returns and allowances ................. 800 973 Net purchases ............................. 15,227 Add: Freight in ............................ 300 Cost of goods purchased ......................... 15,527 Cost of goods available for sale .............. 18,527 Merchandise inventory, April 30 .............. 4,952 Cost of goods sold ................................................. Gross profit......................................................................

$22,900 930 21,970

13,575 $ 8,395

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11A (Continued) Taking It Further: The gross profit should be the same under both periodic and perpetual systems since the same transactions are recorded with the same impact on cash outflows, and the company will have the same amount of ending inventory.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12A (a) BUD’S BAKERY Income Statement Year Ended November 30, 2011 Sales................................................................................. $872,000 Less: Sales discounts ................................. $8,250 Sales returns and allowances........... 9,845 18,095 Net sales ...................................................................... 853,905 Cost of goods sold Inventory, December 1, 2010 ................... $ 34,360 Purchases .................................. $634,700 Less: Purchase discounts .. $6,300 Purchase returns and allowances........ 13,315 19,615 Net purchases ............................ $615,085 Freight in .................................... 5,060 620,145 Goods available for sale........................... 654,505 Inventory, November 30, 2011 ................. 37,350 Cost of goods sold ................................................. 617,155 Gross profit...................................................................... 236,750 Operating expenses Depreciation expense ............................... $14,000 Freight-out................................................. 8,200 Insurance expense ................................... 9,000 Property tax expense ............................... 3,500 Salaries expense....................................... 122,000 Utilities expense ....................................... 19,800 Total operating expenses ...................................... 176,500 Profit from operations ..................................................... 60,250 Other revenues and expenses Rent revenue ............................................ $2,800 Interest expense ...................................... (5,300) (2,500) Profit................................................................................. $ 57,750

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12A (Continued) (a) (Continued) BUD’S BAKERY Statement of Owner’s Equity Year Ended November 30, 2011 B. Hachey, capital, December 1, 2010 ............................ $104,480 Add: Profit........................................................................ 57,750 162,230 Less: Drawings ................................................................ 12,000 B. Hachey, capital, November 30, 2011.......................... $150,230

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12A (Continued) (a) (Continued) BUD’S BAKERY Balance Sheet November 30, 2011

Assets Current assets Cash............................................................................. $ 8,500 Accounts receivable ................................................... 13,770 Inventory ..................................................................... 37,350 Prepaid insurance....................................................... 4,500 Total current assets ............................................... 64,120 Property, plant and equipment Land ............................................................ $ 85,000 Building ...................................... $175,000 Less: Accumulated depreciation 61,200 113,800 Equipment .................................. 57,000 Less: Accumulated depreciation 19,880 37,120 Total property, plant and equipment .................... 235,920 Total assets ............................................................ $300,040 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................... $ 32,310 Salaries payable.......................................................... 8,500 Unearned sales revenue............................................. 3,000 Mortgage payable, current portion ............................ 8,500 Total current liabilities ........................................... 52,310 Long-term liabilities Mortgage payable ($106,000 − $8,500) ...................... 97,500 Total liabilities ........................................................ 149,810 Owner’s Equity B. Hachey, capital ....................................................... 150,230 Total liabilities and owner’s equity ....................... $300,040

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12A (Continued) (b) Nov. 30 Sales ............................................... 872,000 Purchase Discounts ...................... 6,300 Purchase Returns and Allowances 13,315 Rent Revenue................................. 2,800 Inventory (Nov. 30, 2011) .............. 37,350 Income Summary ...................... 30 Income Summary ........................... Purchases .................................. Freight In ................................... Sales Discounts ........................ Sales Returns and Allowances Salaries Expense ...................... Freight Out................................. Depreciation Expense............... Utilities Expense ....................... Property Tax Expense .............. Insurance Expense ................... Interest Expense ....................... Inventory (Dec. 1, 2010) ............

874,015

30 Income Summary ........................... B. Hachey, Capital .....................

57,750

30 B. Hachey, Capital ......................... B. Hachey, Drawings.................

12,000

931,765

634,700 5,060 8,250 9,845 122,000 8,200 14,000 19,800 3,500 9,000 5,300 34,360

57,750

12,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12A (Continued) (c)

Date

Explanation

Dec. 1 Nov. 30 30

Balance Closing entry Closing entry

Inventory Ref.

Debit

Credit Balance

37,350

34,360 0 37,350

Date

B. Hachey, Capital Explanation Ref. Debit

Credit Balance

Dec. 1 Nov. 30 30

Balance Closing entry Closing entry

✓ 34,360

✓ 12,000

104,480 57,750 162,230 150,230

Taking It Further: The list of accounts includes the following accounts that are used in a periodic inventory system: purchases, purchase discounts, purchase returns and allowances, and freight in. The periodic inventory system provides information about purchase returns and allowances, and purchase discounts. The purchase returns and allowances account provides management with the same information as the sales returns and allowances account. This account provides information about the volume of returns to suppliers and information about the quality of the products. The Freight In account allows management to see directly the cost of transportation for its purchased merchandise.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-1B (a) A company’s operating cycle is the average time it takes to go from cash to cash in producing revenues. The operating cycle for a merchandising company covers the period of time between when you purchase your inventory, to when you sell it, and to when you eventually collect the accounts receivable from a sale. You are having problems paying your bills because the period of time between your sales and your collection of accounts receivable is lengthened because many customers take more than one month to pay. (b) Your inventory system is contributing to the problem because you are not sure of what you have on hand at any given time and often run out of inventory. Taking It Further: You should consider switching to a perpetual inventory system where detailed records of each inventory purchase and sale are maintained. This system continuously—perpetually—shows the quantity and cost of the inventory purchased, sold, and on hand.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2B (a) GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Credit

Apr. 2 Merchandise Inventory ...................... 15,000 Accounts Payable ..........................

15,000

4 Accounts Payable [4 × ($15,000 ÷ 100)] Merchandise Inventory ..................

600 600

5 Accounts Receivable (18 × $250) ....... Sales ...............................................

4,500

Cost of Goods Sold (18 × $150) ......... Merchandise Inventory ..................

2,700

6 Sales Returns and Allowances .......... Accounts Receivable (8 × $250) ....

2,000

Merchandise Inventory (8 × $150) ...... Cost of Goods Sold .......................

1,200

10 Cash (30 × $250) .................................. Sales ...............................................

7,500

Cost of Goods Sold (30 × $150) ......... Merchandise Inventory ..................

4,500

12 Sales Returns and Allowances .......... Cash (10 × $250) .............................

2,500

Merchandise Inventory (10 × $150) .... Cost of Goods Sold .......................

1,500

4,500

2,700

2,000

1,200

7,500

4,500

2,500

1,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2B (Continued) (a) (Continued) Apr. 17 Sales Returns and Allowances ......... Cash (10 × $250) .............................

2,500 2,500

25 Accounts Receivable (40 × $250) ....... 10,000 Sales ................................................ Cost of Goods Sold (40 × $150) ......... Merchandise Inventory ..................

6,000

29 Sales Returns and Allowances ......... Accounts Receivable (25 × $250) ..

6,250

Merchandise Inventory (25 × $150) .... Cost of Goods Sold .......................

3,750

10,000

6,000

6,250

3,750

(b) Apr. 1 2 6 12 29 Bal.

Inventory 3,750 15,000 4 5 1,200 10 1,500 25 3,750 11,400

600 2,700 4,500 6,000

Cost of Goods Sold Apr. 5 2,700 6 1,200 10 4,500 12 1,500 25 6,000 29 3,750

Bal.

6,750

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-2B (Continued) (b) (Continued)

Sales Apr. 5 10 25

4,500 7,500 10,000

Bal.

22,000

Sales Returns and Allowances Apr. 6 2,000 12 2,500 17 2,500 29 6,250 Bal. 13,250

$22,000 13,250 $8,750 $8,750 6,750 $2,000

Taking It Further: The sales returns and allowances account can convey important information about inferior quality of the merchandise and the volume of returns. A significant amount of sales returns and allowances can negatively affect customer loyalty and satisfaction. They can also signify inefficiencies in filling orders, billing errors or mistakes in the delivery of goods. Dealing with sales returns also involves costs of inspecting and restocking the merchandise.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3B (a) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

June 1

Merchandise Inventory (170 × $6) ... Accounts Payable ........................

1,020

Credit

1,020

2 (FOB destination means the seller pays the freight, therefore no entry required here.) 3

Accounts Receivable (190 × $10) .... Sales .............................................

1,900

Cost of Goods Sold (190 × $6) .......... Merchandise Inventory ................

1,140

Accounts Payable ............................. Merchandise Inventory .................

Sales Returns and Allowances ......... Accounts Receivable ...................

Merchandise Inventory (140 × $5.50) Accounts Payable ........................

770

Merchandise Inventory...................... Cash ..............................................

Accounts Receivable (100 × $10) .... Sales .............................................

1,000

Cost of Goods Sold (100 × $6) .......... Merchandise Inventory ................

600

1,900

1,140

770

1,000

600

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3B (Continued) (a) (Continued) 28

Sales Returns and Allowances ......... Accounts Receivable ....................

150

Merchandise Inventory (15 × $6) ...... Cost of Goods Sold.......................

Accounts Payable ($1,020 − $60) ..... Cash ..............................................

960

150

Cash .................................................. 1,860 Accounts Receivable ($1,900 − $40)

960

1,860

(b) Merchandise Inventory Open 1,380 June 1 1,020 June 3 1,140 20 770 6 60 21 70 27 600 28 90 1,530 (c)

There are 255 books on hand on June 30. The balance in the merchandise inventory account is: $6 per book × 255 books = $1,530.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-3B (Continued) Taking It Further: Freight terms indicate when ownership of the goods transfers from the seller to the buyer and who pays for the transportation charges. In the June 1st transaction, the freight terms are FOB destination. The seller, Reader’s World Publishers, pays for the freight charges, resulting in an inventory cost of $6 per item. When the seller pays for the freight costs, this usually results in a higher invoice price to cover the shipping expense, as shown in the June 20th transaction. In the June 20th transaction, the freight terms are FOB shipping point. The buyer, Phantom Book Warehouse, pays for the freight charges. Invoice cost (140 books × $5.50) $770 Freight 70 Total inventory cost $840 Cost per book ($840 ÷ 140) $6.00

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4B GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Oct. 2

Merchandise Inventory ..................... 35,000 Accounts Payable ........................

35,000

4 No entry as FOB destination means the seller pays the freight. 5

Accounts Payable ............................. Merchandise Inventory .................

6,000 6,000

Accounts Payable ($35,000 − $6,000) 29,000 Merchandise Inventory ($29,000 × 2%) .............................. Cash ($29,000 − $580) ..................

580 28,420

Accounts Receivable ........................ 62,500 Sales .............................................

62,500

Cost of Goods Sold .......................... 28,420 Merchandise Inventory ................

28,420

No entry as FOB shipping means purchaser pays freight.

Sales Returns and Allowances ......... Accounts Receivable ...................

2,500

Sales Discounts ($60,000 × 2%) ....... 1,200 Cash ($60,000 − $1,200)..................... 58,800 Accounts Receivable ($62,500 − $2,500) .........................

2,500

60,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4B (Continued) Nov. 1

Merchandise Inventory ..................... 60,000 Accounts Payable ........................

60,000

Merchandise Inventory ..................... Cash ..............................................

4,000

Accounts Receivable ........................ 110,500 Sales .............................................

110,500

Cost of Goods Sold ($60,000 + $4,000) 64,000 Merchandise Inventory ................

64,000

Freight Out ........................................ Cash ..............................................

2,600 2,600

Sales Returns and Allowances ........ Accounts Receivable ...................

7,000

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

4,050

7,000

4,050

Cash ($110,500 − $7,000) .................. 103,500 Accounts Receivable ................... 103,500 (No discount as not received within 10 days)

Accounts Payable .............................. 60,000 Cash .............................................. (No discount as not paid within 15 days)

60,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-4B (Continued) Taking It Further: Companies should take all available discounts since not taking the discount is equivalent to paying interest for the use of the money owing to the seller. For the Oct. 2 purchase from Gregory Company, the interest rate is calculated as follows: Amount owing to Gregory: ($35,000 − $6,000) = $29,000 Credit terms: 2/10, n/30 Discount taken: $29,000 × 2% = $580. This equals to an annual interest rate of 36.50% (2% ÷ 20 × 365). For the Nov. 1 purchase from Romeo Company, the interest rate is calculated as follows: Amount owing to Romeo Company = $60,000 Credit terms: 1/15, n/30 Discount not taken: $60,000 × 1% = $600. This equals to an annual interest rate of 24.33% (1% ÷ 15 × 365). In both cases, Leeland Company should be able to obtain financing from the bank at a lower rate of interest.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (a) GENERAL JOURNAL

Date Account Titles and Explanation Debit May 1 Merchandise Inventory ..................... 5,800 Accounts Payable ........................

Credit 5,800

3 No entry as FOB destination means the seller pays the freight. 4

Accounts Receivable ........................ Sales ..............................................

3,700

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

2,250

Freight Out ......................................... Cash ..............................................

100

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

900

Merchandise Inventory ..................... Accounts Payable ........................

2,000

Merchandise Inventory ..................... Cash ...............................................

300

Accounts Payable ............................. Merchandise Inventory ................

200

Cash ($3,700 − $37) ........................... Sales Discount (1% × $3,700) ........... Accounts Receivable ....................

3,663 37

3,700

2,250

100

900

2,000

300

200

3,700

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (Continued) (a) (Continued) May 19

Accounts Payable ($2,000 − $200).... Merchandise Inventory ($1,800 × 1%) ................................ Cash ($1,800 − $18) .......................

1,800

Cash .................................................. Sales .............................................

2,600

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

1,590

Sales Returns and Allowances ........ Cash ..............................................

100

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

Cash ................................................... Merchandise Inventory .................

230

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

5,800

Accounts Receivable ........................ Sales .............................................

1,900

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

1,150

18 1,782

2,600

1,590

100

230

5,800

1,900

1,150

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (Continued) (b) Date

Explanation

May 1 5 8 10 14 19 21 28 29 31

Balance

Date May 4 14 31

Cash Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

100 900 300 3,663 1,782 2,600 100 230 5,800

Accounts Receivable Explanation Ref. Debit J1 J1 J1

Credit Balance

3,700 3,700 1,900

10,000 9,900 9,000 8,700 12,363 10,581 13,181 13,081 13,311 7,511

3,700 0 1,900

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (Continued) (b) (Continued)

Date May 1 1 4 9 10 12 19 21 28 29 31

Date

Merchandise Inventory Explanation Ref. Debit Balance

5,800 2,250 2,000 300 200 18 1,590 65 230 1,150

5,000 10,800 8,550 10,550 10,850 10,650 10,632 9,042 9,107 8,877 7,727

Supplies Ref.

Debit

Credit Balance

900

Accounts Payable Explanation Ref. Debit

Credit Balance

Explanation

May 8

Date

✓ J1 J1 J1 J1 J1 J1 J1 J1 J1 J1

Credit Balance

May 1 9 12 19 31

J1 J1 J1 J1 J1

200 1,800 5,800

5,800 7,800 7,600 5,800 0

Date

B. Copple, Capital Explanation Ref. Debit

Credit Balance

May 1

Balance

✓

5,800 2,000

15,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (Continued) (b) (Continued)

Date

Explanation

Sales Ref.

Debit

Credit Balance

May 4 21 31

J1 J1 J1

Date

Sales Returns and Allowances Explanation Ref. Debit Credit Balance

May 28

Date

3,700 6,300 8,200

100

Sales Discounts Explanation Ref. Debit

Credit Balance

May 14

Date

3,700 2,600 1,900

Cost of Goods Sold Explanation Ref. Debit

Credit Balance

May 4 21 28 31

J1 J1 J1 J1

1,150

2,250 3,840 3,775 4,925

Date

Freight Out Ref. Debit

Credit Balance

May 5

Explanation

2,250 1,590 65

100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-5B (Continued) (c) COPPLE HARDWARE STORE Income Statement (Partial) Month Ended May 31, 2011 Sales revenues Sales ............................................................................ Less: Sales returns and allowances............ $100 Sales discounts .................................. 37 Net sales .......................................................................... Cost of goods sold .......................................................... Gross profit......................................................................

$8,200 137 8,063 4,925 $3,138

Taking It Further: Sales returns are recorded as they occur and not based on the date of the original sale to the customer. In this case, the return occurs in the month following the original sale. The timing of the sales return entry is based on the assumption that returns are not significant. If a company experiences substantial returns, it has to account for them in the same time period as the related sale in order to properly reflect the gross profit for that period’s sale. This topic is usually explored further in an intermediate accounting course.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6B (a) Mar. 31 Cost of Goods Sold ($46,500 − $43,900) .............................. Merchandise Inventory...................

2,600 2,600

(b) MISSISSAUGA WHOLESALE CENTRE Income Statement Year Ended March 31, 2011 Revenues Sales .............................................................. $765,750 Less: Sales returns and allowances $12,400 Sales discounts ........................ 3,750 16,150 Net sales ......................................................... 749,600 Interest revenue ................................ $1,750 Rent revenue ....................................... 3,450 5,200 $754,800 Expenses Advertising expense ......................................$ 29,850 Cost of goods sold ($497,300 + $2,600) ........ 499,900 Depreciation expense ...................................... 6,400 Freight out expense ......................................... 16,700 Insurance expense ........................................... 3,500 Interest expense ............................................... 1,320 Rent expense .................................................... 36,000 Salaries expense .............................................. 136,630 Supplies expense ............................................. 6,500 736,800 Profit................................................................................. $ 18,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6B (Continued) (c) MISSISSAUGA WHOLESALE CENTRE Income Statement Year Ended March 31, 2011 Sales................................................................................. $765,750 Less: Sales returns and allowances ............ $12,400 Sales discounts ................................... 3,750 16,150 Net sales ...................................................................... 749,600 Cost of goods sold ($497,300 + $2,600) ......................... 499,900 Gross profit...................................................................... 249,700 Operating expenses Advertising expense ...................................... $29,850 Depreciation expense .................................... 6,400 Freight out expense ....................................... 16,700 Insurance expense ........................................ 3,500 Rent expense ................................................. 36,000 Salaries expense............................................ 136,630 Supplies expense .......................................... 6,500 Total operating expenses ...................................... 235,580 Profit from operations ..................................................... 14,120 Other revenues and expenses Interest revenue ............................ $1,750 Rent revenue ................................... 3,450 $5,200 Interest expense ............................................ 1,320 3,880 Profit................................................................................. $ 18,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6B (Continued) (d) Mar. 31 Interest Revenue ............................... 1,750 Rent Revenue .................................... 3,450 Sales .................................................. 765,750 Income Summary..........................

770,950

31 Income Summary .............................. 752,950 Sales Returns and Allowances .... Sales Discounts ............................ Cost of Goods Sold ...................... Advertising Expense .................... Freight out Expense ..................... Interest Expense ........................... Insurance Expense ....................... Salaries Expense .......................... Depreciation Expense .................. Supplies Expense ......................... Rent Expense ................................

12,400 3,750 499,900 29,850 16,700 1,320 3,500 136,630 6,400 6,500 36,000

31 Income Summary .............................. K. Martinson, Capital ....................

18,000 18,000

31 K. Martinson, Capital ........................ K. Martinson, Drawings ................

16,800 16,800

Income Summary 770,950 752,950 * 18,000 18,000 0 * Check $18,000 = Profit

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-6B (Continued) Taking It Further: Both income statements result in the same amount of profit. The multiple-step income statement provides the user with much more information than the single-step income statement. The multiple-step income provides information on gross profit and profit from operations which is not included on the singlestep income statement.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7B (a) Dec. 31 Supplies Expense .............................. Supplies ($1,650 − $950) ...............

700 700

31 Depreciation Expense ....................... Accumulated Depreciation —Furniture and Equipment ......... Accumulated Depreciation —Leasehold Improvements .........

9,560

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

1,200

31 Interest Receivable ............................ Interest Revenue ...........................

850

31 Unearned Sales Revenue ($3,000 − $1,600) ................................ Sales .............................................. 31 Cost of Goods Sold ........................... Merchandise Inventory ................. 31 Cost of Goods Sold [($37,500 − $525) − $35,675] .............. Merchandise Inventory .................

5,360 4,200

1,200

850

1,400 1,400 525 525

1,300 1,300

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7B (Continued) (b) GLOBAL ENTERPRISES Income Statement Year Ended December 31, 2011 Sales revenues Sales ($238,500 + $1,400) ........................................... $239,900 Less: Sales returns and allowances............. $4,520 Sales Discounts .................................. 4,600 9,120 Net sales ...................................................................... 230,780 Cost of goods sold ($129,200 + $525 + $1,300) ............. 131,025 Gross profit...................................................................... 99,755 Operating expenses Depreciation expense ................................ $9,560 Insurance expense .................................... 1,800 Rent expense ............................................. 6,100 Salaries expense........................................ 31,600 Supplies expense ...................................... 700 Total operating expenses ...................................... 49,760 Profit from operations ..................................................... 49,995 Other revenues and expenses Interest revenue ......................................... $ 850 Interest expense ........................................ 1,200 350 Profit................................................................................. $ 49,645

GLOBAL ENTERPRISES Statement of Owner’s Equity Year Ended December 31, 2011

I. Rochefort, capital, January 1 ($45,500 − $7,500)........ $ 38,000 Add: Investment................................................ $ 7,500 Profit ......................................................... 49,645 57,145 95,145 Less: Drawings ................................................................ 35,500 I. Rochefort, capital, December 31 ................................. $59,645

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7B (Continued) (b) (Continued) GLOBAL ENTERPRISES Balance Sheet December 31, 2011 _____________________________________________________ Assets Current assets Cash .......................................................................... $ 14,000 Short-term investments ............................................... 17,000 Accounts receivable .................................................... 15,700 Interest receivable ....................................................... 850 Merchandise inventory ($37,500 − $525 − $1,300) ...... 35,675 Supplies ($1,650 − $900) .............................................. 950 Total current assets ................................................. 84,175 Property, plant, and equipment Furniture and equipment............ $26,800 Less: Accumulated depreciation ($10,720 + $5,360) ............. 16,080 10,720 Leasehold improvements........... $42,000 Less: Accumulated depreciation ($8,400 + $4,200)............... 12,600 29,400 40,120 Total assets .............................................................. $124,295 Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... $ 26,850 Unearned sales revenue ($3,000 − $1,400)................ 1,600 Interest payable .......................................................... 1,200 Current portion of note payable ................................ 5,000 Total current liabilities ........................................... 34,650 Long-term liabilities Note payable ($35,000 − $5,000) ................................ 30,000 Total liabilities ........................................................ 64,650 Owner's equity I. Rochefort, capital .................................................... 59,645 Total liabilities and owner's equity ....................... $124,295 Solutions Manual 5-109 Chapter 5 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7B (Continued) (c) Dec. 31 Sales .................................................... 239,900 Interest Revenue ................................. 850 Income Summary............................

240,750

31 Income Summary ................................ 191,105 Sales Returns and Allowances ...... Sales Discounts .............................. Cost of Goods Sold ........................ Salaries Expense ............................ Rent Expense .................................. Insurance Expense ......................... Interest Expense ............................. Supplies Expense ........................... Depreciation Expense ....................

4,520 4,600 131,025 31,600 6,100 1,800 1,200 700 9,560

31 Income Summary ................................ 49,645 I. Rochefort, Capital .......................

49,645

31 I. Rochefort, Capital ............................ 35,500 I. Rochefort, Drawings....................

35,500

(d) Current ratio = $84,175 ÷ $34,650 = 2.43 to 1 Acid-test ratio = ($14,000 + $17,000 + $15,700 + $850) ÷ $34,650 = 1.37 to 1 Gross profit margin = $99,755 ÷ $230,780 = 43.23% Profit margin = $49,645 ÷ $230,780 = 21.51%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 5-7B (Continued) Taking It Further: Current ratio Acid-test ratio Gross profit margin Profit margin

2011 2.43 to 1 1.37 to 1 43.23% 21.51%

2010 2.1 to 1 1.1 to 1 40% 25%

The company has seen an increase in both the current ratio and the acid-test ratio. This increasing trend shows an improvement of the company’s liquidity. The gross profit margin has increased, indicating an increase in profitability and the profit margin has decreased, indicating a deterioration in profitability. There is no clear trend since the two ratios are fluctuating in opposite directions. Since the profit margin is decreasing, there is a general deterioration of the company’s profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-8B

2008

2007

2006

Gross profit margin

46.6%

49.7%

48.1%

($163,550 − $87,365) ÷ $163,550

($158,099 − $79,565) ÷ $158,099

($148,351 − $76,953) ÷ $148,351

Profit margin

7.88%

1.05%

- 3.71%

$12,895 ÷ $163,550

$1,653 ÷ $158,099

$(5,503) ÷ $148,351

4.45:1

1.86:1

3.97:1

$49,853 ÷ $11,205

$56,422 ÷ $30,275

$48,623 ÷ $12,243

Current ratio

Taking It Further: Danier Leather’s gross profit margin has increased slightly in 2007 but has decreased in 2008 below the 2006 level for an overall decrease. The profit margin has increased in both 2007 and 2008 for an overall increase in profitability. The current ratio deteriorated in 2007 but improved in 2008 above the 2006 level for an overall increase in liquidity.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-9B GENERAL JOURNAL Date

Account Titles and Explanation

Debit

June 1

Purchases (170 × $6) ........................ Accounts Payable ........................

1,020 1,020

(FOB destination means the seller pays the freight, therefore no entry required here.)

Accounts Receivable (190 × $10) .... Sales .............................................

1,900

Accounts Payable .............................. Purchase Returns and Allowances

Sales Returns and Allowances ......... Accounts Receivable ....................

Purchases (140 × $5.50) ................... Accounts Payable ........................

770

Freight In ............................................ Cash ...............................................

Accounts Receivable (100 × $10) .... Sales .............................................

1,000

Sales Returns and Allowances ......... Accounts Receivable ....................

150

Accounts Payable ($1,020 − $60) ..... Cash ..............................................

960

Cash ($1,900 − $40) .......................... Accounts Receivable ...................

1,860

Credit

1,900

770

1,000

150

960

1,860

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-9B (Continued) Taking It Further: A perpetual inventory system provides detailed records of inventory. This would allow Phantom Book Warehouse to track the quantity and cost of inventory purchased, sold and on hand. This would provide the benefit of being able to answer customer questions about merchandise availability and for management to maintain optimum inventory levels and avoid running out of stock. This system also allows the company to prepare financial statements more easily since the cost of goods sold and ending inventory amounts are readily available. For a company such as Phantom Book Warehouse, a perpetual system includes the freight in costs in the inventory cost rather than in a separate account. This would reflect the fact that the cost is the same regardless of whether Travel Warehouse or the supplier pays the freight. A perpetual inventory system is more costly to implement and maintain because of the need to enter all merchandise in the accounting system. The accounting system must also be sufficiently sophisticated to track purchases and sales of merchandise, usually through the use of scanners.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-10B GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Oct. 2

Purchases ......................................... 35,000 Accounts Payable ........................

35,000

No entry as FOB destination means the seller pays the freight.

Accounts Payable ............................. 6,000 Purchase Returns and Allowances

6,000

Accounts Payable ($35,000 − $6,000) 29,000 Purchase Discounts ($29,000 × 2%) Cash ($29,000 − $580) ..................

580 28,420

Accounts Receivable ........................ 62,500 Sales .............................................

62,500

No entry as FOB shipping means purchaser pays freight.

Sales Returns and Allowances ........ Accounts Receivable ...................

Nov. 1

2,500 2,500

Sales Discounts ($60,000 × 2%) ....... 1,200 Cash ($60,000 − $1,200)..................... 58,800 Accounts Receivable ($62,500 − $2,500) .........................

60,000

Purchases ......................................... 60,000 Accounts Payable ........................

60,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-10B (Continued) Nov. 2

Freight In ........................................... Cash ..............................................

4,000 4,000

Accounts Receivable ........................ 110,500 Sales ............................................. Freight Out ........................................ Cash ..............................................

2,600

Sales Returns and Allowances ........ Accounts Receivable ...................

7,000

110,500

2,600

7,000

Cash ($110,500 − $7,000)................... 103,500 Accounts Receivable ................... 103,500 (No discount as not received within 10 days)

Accounts Payable ............................. 60,000 Cash .............................................. (No discount as not paid within 15 days)

60,000

Taking It Further Leeland Company has few transactions (1 purchase and 1 sale per month). A periodic inventory system is less costly to implement and maintain than a perpetual system. If the company has relatively low inventory quantities and can maintain control over its inventory visually rather than electronically, then a periodic inventory system may be sufficient to meet their information needs.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11B (a) GENERAL JOURNAL

Date

Account Titles and Explanation

Debit

May 1

Purchases ......................................... Accounts Payable ........................

5,800

Credit

5,800

No entry as FOB destination means the seller pays the freight.

Accounts Receivable ........................ Sales ..............................................

3,700

Freight Out ......................................... Cash ..............................................

100

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

900

Purchases ......................................... Accounts Payable ........................

2,000

Freight In ........................................... Cash ...............................................

300

Accounts Payable ............................. Purchase Returns and Allowances

200

Cash ($3,700 − $37) .......................... Sales Discount (1% × $3,700) ........... Accounts Receivable ....................

3,663 37

3,700

100

900

2,000

300

200

3,700

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11B (Continued) (a) (Continued) May 19

Accounts Payable ($2,000 − $200).... Purchase Discounts ($1,800 × 1%) Cash ($1,800 − $18) .......................

1,800

Cash .................................................. Sales .............................................

2,600

Sales Returns and Allowances ........ Cash ..............................................

100

Cash ................................................... Purchase Returns and Allowances

230

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

5,800

Accounts Receivable ........................ Sales .............................................

1,900

18 1,782

2,600

100

230

5,800

1,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11B (Continued) (b) Date

Explanation

May 1 5 8 10 14 19 21 28 29 31

Balance

Date

Cash Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

100 900 300 3,663 1,782 2,600 100 230 5,800

Accounts Receivable Explanation Ref. Debit

May 4 14 31

10,000 9,900 9,000 8,700 12,363 10,581 13,181 13,081 13,311 7,511

Credit Balance

1,900

3,700 0 1,900

Date

Merchandise Inventory Explanation Ref. Debit

Credit Balance

May 1

Balance

Date May 8

J1 J1 J1

Credit Balance

Explanation

3,700 3,700

✓

5,000

Supplies Ref.

Debit

Credit Balance

900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11B (Continued) (b) (Continued)

Date

Accounts Payable Explanation Ref. Debit

May 1 9 12 19 31

200 1,800 5,800

5,800 7,800 7,600 5,800 0

Date

B. Copple, Capital Explanation Ref. Debit

Credit Balance

May 1

Balance

Date

J1 J1 J1 J1 J1

Credit Balance

Explanation

5,800 2,000

✓ Sales Ref.

15,000

Debit

Credit Balance

May 4 21 31

J1 J1 J1

Date

Sales Returns and Allowances Explanation Ref. Debit Credit Balance

May 28

Date May 14

3,700 2,600 1,900

3,700 6,300 8,200

100

Sales Discounts Explanation Ref. Debit

Credit Balance

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-11B (Continued) (b) (Continued)

Date May 1 9

Explanation

Purchases Ref. Debit J1 5,800 J1 2,000

Credit Balance 5,800 7,800

Date May 12 29

Purchase Returns and Allowances Explanation Ref. Debit Credit Balance J1 200 200 J1 230 430

Date May 19

Purchase Discounts Explanation Ref. Debit J1

Date May 10

Date May 5

Credit Balance 18 18

Explanation

Freight In Ref. J1

Debit 300

Credit Balance 300

Explanation

Freight Out Ref. Debit J1 100

Credit Balance 100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 5-11B (Continued) (c) COPPLE HARDWARE STORE Income Statement (Partial) Month Ended May 31, 2011 Sales revenues Sales ............................................................................... $8,200 Less: Sales returns and allowances............ $100 Sales discounts .................................. 37 137 Net sales ......................................................................... 8,063 Cost of goods sold Inventory, May 1, 2011 ...................................... $5,000 Purchases ........................................ $7,800 Less: Purchase returns and allowances............. $430 Purchase discounts ...... 18 448 Net purchases .................................. 7,352 Add: Freight in ................................. 300 Cost of goods purchased ................................. 7,652 Cost of goods available for sale ...................... 12,652 Inventory, December 31, 2008.......................... 7,727 Cost of goods sold ................................................. 4,925 Gross profit .......................................................................... $3,138 Taking It Further: The gross profit should be the same under both periodic and perpetual systems since the same transactions are recorded with the same impact on cash outflows, and the company will have the same amount of ending inventory.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12B (a) TSE’S TATOR TOTS Income Statement Year Ended December 31, 2011 Sales revenues Sales ............................................................................ $642,800 Less: Sales discounts ................................... $12,700 Sales returns and allowances ............ 11,900 24,600 Net sales ...................................................................... 618,200 Cost of goods sold Inventory, January 1 ................................. $ 40,500 Purchases ................................ $441,600 Less: Purchase discounts ... $8,830 Purchase returns and allowances ................ 20,070 28,900 Net purchases .......................... 412,700 Add: Freight in ......................... 5,600 Cost of goods purchased ......................... 418,300 Cost of goods available for sale .............. 458,800 Inventory, December 31 ........................... 34,600 Cost of goods sold ................................................. 424,200 Gross profit...................................................................... 194,000 Operating expenses Depreciation expense ............................... $23,400 Freight out ................................................. 7,500 Insurance expense ................................... 9,600 Property tax expense ............................... 4,800 Salaries expense ....................................... 127,500 Utilities expense ....................................... 18,000 Total operating expenses ...................................... 190,800 Profit from operations ..................................................... 3,200 Other revenues and expenses Interest revenue ............................................. 1,050 Interest expense ........................................... 11,345 10,295 Loss ................................................................................. $(7,095)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12B (Continued) (a) (Continued) TSE’S TATOR TOTS Statement of Owner’s Equity Year Ended December 31, 2011 _______________________________________________________ H. Tse, capital, January 1, 2011 ...................................... $ 143,600 Less: Loss ....................................................................... 7,095 136,505 Less: Drawings ................................................................ 14,450 H. Tse, capital, December 31, 2011 ............................... $122,055

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12B (Continued) (a) (Continued) TSE’S TATOR TOTS Balance Sheet December 31, 2011

Assets Current assets Cash............................................................................... $ 17,000 Accounts receivable ..................................................... 44,200 Inventory ....................................................................... 34,600 Total current assets ................................................. 95,800 Property, plant, and equipment Land ............................................................. $ 75,000 Building ....................................... $190,000 Less: Accumulated depreciation 51,800 138,200 Equipment ................................... $110,000 Less: Accumulated depreciation 42,900 67,100 280,300 Total assets .............................................................. $376,100 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................... $ 86,300 Interest payable .......................................................... 945 Salaries payable.......................................................... 3,500 Unearned service revenue ......................................... 8,300 Current portion of mortgage payable ........................ 17,000 Total current liabilities ........................................... 116,045 Long-term liabilities Mortgage payable ($155,000 − $17,000) .................... 138,000 Total liabilities ........................................................ 254,045 Owner’s Equity H. Tse, capital ............................................................. 122,055 Total liabilities and owner’s equity ....................... $376,100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12B (Continued) (b) GENERAL JOURNAL Date

Account Titles and Explanation

J2 Debit

Credit

Dec. 31 Sales ................................................. 642,800 Interest Revenue .............................. 1,050 Inventory (Dec. 31) .......................... 34,600 Purchase Returns and Allowances 20,070 Purchase Discounts ........................ 8,830 Income Summary ........................

707,350

31 Income Summary ............................. 714,445 Inventory (Jan. 1) ........................ Purchases .................................... Freight In ..................................... Salaries Expense ........................ Utilities Expense ......................... Depreciation Expense ................. Insurance Expense ..................... Property Tax Expense ................ Freight Out................................... Interest Expense ......................... Sales Returns and Allowances .. Sales Discounts ..........................

40,500 441,600 5,600 127,500 18,000 23,400 9,600 4,800 7,500 11,345 11,900 12,700

31 H. Tse, Capital .................................. Income Summary ........................

7,095

31 H. Tse, Capital .................................. H. Tse, Drawings .........................

14,450

7,095

14,450

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 5-12B (Continued) (c) Inventory Ref.

Date

Explanation

Debit

Credit Balance

Jan. 1 Dec. 31 Dec. 31

Balance Closing entry Closing entry

✓ J2 J2

34,600

40,500 75,100 34,600

Date

Explanation

H. Tse, Capital Ref. Debit

Jan. 1 Dec. 31 Dec. 31

Balance Closing entry Closing entry

✓ J2 J2

40,500

7,095 14,450

Credit Balance 143,600 136,505 122,055

Taking It Further: The list of accounts includes the following accounts that are used in a periodic inventory system: purchases, purchase discounts, purchase returns and allowances, and freight in. The periodic inventory system provides information about purchase returns and allowances, and purchase discounts. The purchase returns and allowances account provides management with the same information as the sales returns and allowances account. This account provides information about the volume of returns to suppliers and information about the quality of the products. The freight in account allows management to see directly the cost of transportation for its purchased merchandise.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a) Responses to Natalie’s questions 1. The mixers should be classified as inventory as they are for resale. 2. A perpetual inventory system will provide better control over inventory. Because you are dealing with high value items, you should use the perpetual system. 3. You still need to count inventory to ensure that your records are accurate and that the inventory that is supposed to be on hand is actually there. I suggest you should count once a month. (b) GENERAL JOURNAL

Date

Account Titles and Explanation

Debit

Jan. 4

Merchandise Inventory...................... Accounts Payable .........................

2,625

Merchandise Inventory...................... Cash ...............................................

100

Accounts Payable [($2,625 ÷ 5) + $20] Merchandise Inventory .................

545

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

875

Accounts Receivable......................... Sales .............................................

3,150

Cost of Goods Sold [($2,625 + $100) ÷ 5 x 3] ..................... Merchandise Inventory .................

Credit

2,625

100

545

875

3,150

1,635 1,635

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued) Jan. 14

Freight-Out ......................................... Cash ...............................................

Merchandise Inventory...................... Accounts Payable .........................

2,100

Cash ................................................... N. Koebel, Capital..........................

1,000

Merchandise Inventory...................... Cash ...............................................

Cash ................................................... Sales .............................................

2,100

1,000

2,100

Cost of Goods Sold .......................... 1,090 Merchandise Inventory ................. 1,090 [($2,625 + $100) ÷ 5 x 1] + [($2,100 + $80) ÷ 4 x 1]

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

160 56

Accounts Payable .............................. Telephone Expense ........................... Cash ...............................................

75 70

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

4,180

216

145

4,180

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) and (d)

Date

Explanation

Jan. 1 6 8 14 18 19 20 28 30 31

Balance

Date Jan. 1 8 12

Date Jan. 4 6 7 12 14 19 20

Cash Ref. ✓ J1 J1 J1 J1 J1 J1 J1 J1 J1

Debit

100 875 75 1,000 80 2,100 216 145 4,180

Accounts Receivable Explanation Ref. Debit Balance

✓ J1 J1

Credit Balance 1,130 1,030 1,905 1,830 2,830 2,750 4,850 4,634 4,489 309

Credit Balance

3,150

875 0 3,150

Merchandise Inventory Explanation Ref. Debit

Credit Balance

J1 J1 J1 J1 J1 J1 J1

875

2,625 100 545 1,635 2,100 80 1,090

2,625 2,725 2,180 545 2,645 2,725 1,635

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) and (d) (Continued)

Date

Baking Supplies Explanation Ref. Debit

Jan. 1

Balance

Date

Prepaid Insurance Explanation Ref. Debit

Jan. 1 31

Balance Adjusting entry

Date

Baking Equipment Explanation Ref. Debit

Jan. 1

Balance

Date

✓

450

✓ J2

Credit Balance

100

1,100 1,000

Credit Balance

✓

1,400

Accumulated Depreciation—Baking Equipment Explanation Ref. Debit Credit Balance ✓ J2

Jan. 1 31

Balance Adjusting entry

Date

Accounts Payable Explanation Ref. Debit

Jan. 1 4 7 14 29 29

Credit Balance

Balance

✓ J1 J1 J1 J1 J1

Credit Balance

2,625 545 2,100 75 4,180

78 117

75 2,700 2,155 4,255 4,180 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) and (d) (Continued)

Date Jan. 1 28

Salaries Payable Explanation Ref. Debit ✓ J1

Balance

Credit Balance

56 0

Date

Unearned Revenue Explanation Ref. Debit

Credit Balance

Jan. 1

Balance

Date

Interest Payable Explanation Ref. Debit

Jan. 1 31

Balance Adjusting entry

✓

✓ J2

Date

Explanation

Notes Payable Ref. Debit

Jan. 1

Balance

✓

Date

N. Koebel, Capital Explanation Ref. Debit

Jan. 1 18

Balance

✓ J1

300

Credit Balance

8 13

Credit Balance 2,000

Credit Balance

1,000

2,438 3,438

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) and (d) (Continued)

Date

Explanation

Jan. 12 20

Date

J1 J1

Credit Balance 3,150 2,100

Cost of Goods Sold Explanation Ref. Debit

3,150 5,250

Credit Balance

1,635 1,090

1,635 2,725

Salaries Expense Explanation Ref. Debit

Credit Balance

Jan. 28

Date

Debit

J1 J1

Jan. 12 20

Date

Sales Ref.

160

Telephone Expense Explanation Ref. Debit

Credit Balance

Jan. 29

Date

Depreciation Expense Explanation Ref. Debit

Credit Balance

Jan. 31

Adjusting entry

Date

Insurance Expense Explanation Ref. Debit

Credit Balance

Jan. 31

Adjusting entry

100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) and (d) (Continued)

Date

Explanation

Freight Out Ref. Debit

Jan. 14

Credit Balance

Date

Interest Expense Explanation Ref. Debit

Credit Balance

Jan. 31

Adjusting entry

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (c) COOKIE CREATIONS Trial Balance January 31, 2011

Debit Cash .................................................................... $ 309 Accounts receivable ......................................... 3,150 Merchandise inventory ..................................... 1,635 Baking supplies ................................................. 450 Prepaid insurance ............................................. 1,100 Baking equipment ............................................. 1,400 Accumulated depreciation—baking equipment Unearned revenue ............................................. Interest payable ................................................. Note payable ...................................................... N. Koebel, capital .............................................. Sales ................................................................... Cost of goods sold ............................................ 2,725 Salary expense .................................................. 160 Telephone expense ............................................ 70 Freight out ......................................................... 75 $11,074

Credit

78 300 8 2,000 3,438 5,250

______ $11,074

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (d) GENERAL JOURNAL Date

Account Titles and Explanation

J2 Debit

Jan. 31 Depreciation Expense ....................... Accumulated Depreciation — Baking Equipment......................... ($1,400 ÷ 36 months)

31 Interest Expense ................................ Interest Payable ............................ ($2,000 × 3% × 1/12)

31 Insurance Expense ............................ Prepaid Insurance .........................

100

Credit

100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (e) COOKIE CREATIONS Adjusted Trial Balance January 31, 2011

Debit Cash ................................................................... $ 309 Accounts receivable ......................................... 3,150 Merchandise inventory ..................................... 1,635 Baking supplies ................................................. 450 Prepaid insurance ............................................. 1,000 Baking equipment ............................................. 1,400 Accumulated depreciation—baking equipment Unearned revenue ............................................. Interest payable ................................................. Note payable ...................................................... N. Koebel, capital .............................................. Sales ................................................................... Cost of goods sold ............................................ 2,725 Salary expense .................................................. 160 Telephone expense ............................................ 70 Depreciation expense ....................................... 39 Insurance expense ............................................ 100 Freight out ......................................................... 75 Interest expense ................................................ 5 $11,118

Credit

117 300 13 2,000 3,438 5,250

_ _____ $11,118

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (f) COOKIE CREATIONS Income Statement Month ended January 31, 2011

Sales ................................................................................ Cost of goods sold ......................................................... Gross profit ..................................................................... Operating expenses Salaries expense ........................................... $160 Telephone expense ....................................... 70 Depreciation expense .................................... 39 Insurance expense ....................................... 100 Freight out ..................................................... 75 Total operating expenses ...................................... Profit from operations ..................................................... Other expenses Interest expense ........................................................ Profit ................................................................................

$5,250 2,725 2,525

444 2,081 5 $2,076

(g) Gross profit margin = 48.10% ($2,525 ÷ $5,250) Profit margin = 39.54% ($2,076 ÷ $5,250) (h) The company’s cash balance is relatively low at the end of January 2011. This is due to the payment for the purchases of inventory during the month; Cookie Creations has no outstanding payables relating to inventory purchases for the month. In addition, the company has sold merchandise on credit and has an outstanding account receivable for a sale of mixer. As cash comes in from the collection of receivables and the sale of the mixers in inventory, the company’s cash position will improve. Natalie’s cash investment has financed the purchase of inventory.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (h) (Continued) Natalie will need to carefully monitor the operations of her business. During the month of January she generated a profit margin of 39.54% selling mixers and had no time to give cooking lessons. In the two months ending December 2010, cooking lessons generated a profit margin of 45% (profit of $1,938 over revenues of $4,305). Although it would appear that giving lessons is more profitable than selling mixers, Natalie is incurring expenses in January from her lesson business even though no revenues are being generated; for example, depreciation on the baking equipment. If Natalie can combine the two sources of profit, she will increase her overall profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE – CHAPTERS 2 TO 5 (a), (b), (d) and (g)

Date Aug.

1 1 2 4 5 9 11 15 19 24 29 30 31

Balance

✓

Debit

1 10 12 19

Credit Balance

1,550 4,500 12,250 500 425 12,250 4,200 15,680 525 1,200 8,918 3,800 Accounts Receivable Explanation Ref. Debit

Date Aug.

Explanation

Cash Ref.

19,985 18,435 13,935 26,185 25,685 25,260 13,010 8,810 24,490 25,015 23,815 14,897 11,097

Credit Balance

✓ 16,750 750 16,000

0 16,750 16,000 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued)

Date Aug.

Explanation 1 4 5 5 9 10 12 21 23 30 31 31

Date Aug.

Aug.

1,572

Store Supplies Ref. Debit

Credit Balance

8,500 24,500 500 290 11,340 510 9,900 800 182 2,430

Adjusting entry Adjusting entry

✓ 345

0 345

Prepaid Insurance Explanation Ref. Debit

Credit Balance

Balance Adjusting entry

✓ 1,380

Store Equipment Explanation Ref. Debit

Date 1

Credit Balance 112,700 104,200 128,700 129,200 129,490 118,150 118,660 128,560 127,760 127,578 125,148 126,720

1 8

1 31

Debit

✓

Balance

Explanation

Date Aug.

Inventory Ref.

Balance

✓

4,140 2,760

Credit Balance 53,800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued) Accumulated Depreciation—Store Equipment Explanation Ref. Debit Credit Balance

Date Aug.

1 31

1 2 5 8 11 21 23 30

Date Aug.

1 24 31

Date Aug.

6,725

1 31

13,450 20,175

Credit Balance

✓

Balance

800 9,100

18,620 14,120 38,620 38,965 26,715 36,615 35,815 26,715

Unearned Sales Revenue Explanation Ref. Debit

Credit Balance

4,500 24,500 345 12,250 9,900

✓

Balance

3,570

4,820 5,345 1,775

Explanation

Notes Payable Ref. Debit

Credit Balance

Balance

✓

525 Adjusting entry

Interest Payable Explanation Ref. Debit

Date Aug.

✓

Accounts Payable Explanation Ref. Debit

Date Aug.

Balance Adjusting entry

36,000

Credit Balance

✓ 180

0 180

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued) A. John, Capital Explanation Ref. Debit

Date Aug.

1 31 31

Date Aug.

1 31 31

Balance Closing entry Closing entry

Credit Balance

✓ 47,100

54,650 156,977 109,877

A. John, Drawings Explanation Ref. Debit

Credit Balance

Balance

102,327

✓ 3,800

43,300 47,100 0

Closing entry

47,100

Date

Income Summary Explanation Ref. Debit

Credit Balance

Aug. 31 31 31

Closing entry Closing entry Closing entry

Date Aug.

Explanation 1 4 10 31 31

Balance

Adjusting entry Closing entry

792,270

Sales Ref.

689,943 102,327

792,270 102,327 0

Debit

Credit Balance

791,070

758,500 770,750 787,500 791,070 0

✓ 12,250 16,750 3,570

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued) Sales Returns and Allowances Explanation Ref. Debit Credit Balance

Date Aug.

1 9 12 31

Date Aug.

1 19 31

Date Aug.

1 4 9 10 12 31 31 31

11,420 11,845 12,595 0

Closing entry

12,595

Sales Discounts Explanation Ref. Debit

Credit Balance

✓

Balance

320 Closing entry

320 Rent Revenue Ref. Debit

Balance Closing entry

Balance

1,200

1,200 0

Credit Balance

✓ 8,500 290 11,340 510

Adjusting entry Adjusting entry Closing entry

0 320 0

Credit Balance

✓

Cost of Goods Sold Explanation Ref. Debit

Date Aug.

425 750

Explanation 1 31

✓

Balance

2,430 1,572 540,238

520,340 528,840 528,550 539,890 539,380 541,810 540,238 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued) Salaries Expense Explanation Ref. Debit

Date Aug.

1 15 31

Date Aug.

1 29 31

Date Aug.

1 1 31

Date Aug.

1 31 31

Aug.

✓

Balance

4,200

1 31 31

92,900 97,100 0

Closing entry

97,100

Advertising Expense Explanation Ref. Debit

Credit Balance

✓

Balance

1,200 Closing entry

10,825

Explanation

Rent Expense Ref. Debit

Balance

✓

9,625 10,825 0

Credit Balance

1,550

17,050 18,600 0

Closing entry

18,600

Interest Expense Explanation Ref. Debit

Credit Balance

Balance Adjusting entry Closing entry

✓ 180 2,160

Insurance Expense Explanation Ref. Debit

Date

Credit Balance

Balance Adjusting entry Closing entry

1,980 2,160 0

Credit Balance

✓ 1,380 1,380

0 1,380 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (a), (b), (d) and (g) (Continued) Depreciation Expense Explanation Ref. Debit

Date Aug.

1 31 31

Balance Adjusting entry Closing entry

Credit Balance

✓ 6,725 6,725

0 6,725 0

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Aug. 1

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

1,550

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

4,500

Credit

1,550

4,500

Cash .................................................. 12,250 Sales .............................................

12,250

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

8,500

Inventory ........................................... 24,500 Accounts Payable ........................ Inventory ........................................... Cash ..............................................

500

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

345

Sales Returns and Allowances ........ Cash ..............................................

425

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

290

24,500

500

345

425

290

Accounts Receivable ........................ 16,750 Sales ............................................

16,750

Cost of Goods Sold .......................... 11,340 Inventory .......................................

11,340

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CUMULATIVE COVERAGE (Continued) (b) (Continued) Aug. 11

Accounts Payable ............................. 12,250 Cash .............................................. Sales Returns and Allowances ......... Accounts Receivable ...................

750

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

510

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

4,200

12,250

750

510

4,200

Cash ($16,000 − $320) ....................... 15,680 Sales Discounts ($16,000 x 2%) ........ 320 Accounts Receivable ($16,750 − $750)

16,000

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

9,900 9,900

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

800

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

525

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

1,200

Accounts Payable ($9,900 − $800) ... Inventory ($9,100 x 2%) ................ Cash ($9,100 − $182) .....................

9,100

A. John, Drawings ............................ Cash ..............................................

3,800

800

525

1,200

182 8,918

3,800

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CUMULATIVE COVERAGE (Continued) (c) THE BOARD SHOP Trial Balance August 31, 2011

Cash ......................................................... Inventory .................................................. Store supplies ......................................... Prepaid insurance ................................... Store equipment ....................................... Accumulated depreciation—store equipment ........................................... Accounts payable..................................... Unearned sales revenue ......................... Notes payable .......................................... A. John, capital ........................................ A. John, drawings ................................... Sales ......................................................... Sales returns and allowances ................. Sales discounts ........................................ Rent revenue ........................................... Cost of goods sold ................................... Salaries expense ..................................... Advertising expense ............................... Rent expense ............................................ Interest expense ...................................... Totals ....................................................

Debit $ 11,097 127,578 345 4,140 53,800

Credit

$ 13,450 26,715 5,345 36,000 54,650 47,100 787,500 12,595 320 1,200 539,380 97,100 10,825 18,600 1,980 $924,860

__ _____ $924,860

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CUMULATIVE COVERAGE (Continued) (d) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Aug. 31

Insurance Expense ($4,140 x 4/12) .. Prepaid Insurance ........................

1,380

Depreciation Expense ($53,800 ÷ 8) Accumulated Depreciation —Store Equipment .......................

6,725

1,380

6,725

No entry required—reclassification on balance sheet only.

Unearned Sales Revenue ................. Sales ............................................

3,570

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

2,430

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

180

Inventory ($126,720 – [$127,578 − $2,430]) ...... Cost of Goods Sold.......................

Credit

3,570

2,430

180

1,572 1,572

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CUMULATIVE COVERAGE (Continued) (e) THE BOARD SHOP Adjusted Trial Balance August 31, 2011

Debit Credit Cash ................................................................. $ 11,097 Inventory .......................................................... 126,720 Store supplies .................................................. 345 Prepaid insurance ........................................... 2,760 Store equipment .............................................. 53,800 Accumulated depreciation—store equipment $ 20,175 Accounts payable ............................................ 26,715 Unearned sales revenue ................................. 1,775 Notes payable .................................................. 36,000 Interest payable ............................................... 180 A. John, capital ................................................. 54,650 A. John, drawings ............................................ 47,100 Sales ................................................................. 791,070 Sales returns and allowances ........................ 12,595 Sales discounts ................................................ 320 Rent revenue .................................................... 1,200 Cost of goods sold .......................................... 540,238 Salaries expense ............................................. 97,100 Advertising expense ....................................... 10,825 Rent expense .................................................... 18,600 Interest expense .............................................. 2,160 Insurance expense .......................................... 1,380 Depreciation expense ..................................... 6,725 ___ ____ Totals ........................................................... $931,765 $931,765

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CUMULATIVE COVERAGE (Continued) (f) THE BOARD SHOP Income Statement Year Ended August 31, 2011 Sales revenues Sales ............................................................................ $791,070 Less: Sales returns and allowances.......... $12,595 Sales discounts ................................ 320 12,915 Net sales ...................................................................... 778,155 Cost of goods sold .......................................................... 540,238 Gross profit...................................................................... 237,917 Operating expenses Salaries expense........................................ $97,100 Advertising expense .................................. 10,825 Rent expense ............................................. 18,600 Insurance expense ................................... 0001,380 Depreciation expense ................................ 6,725 Total operating expenses ...................................... 134,630 Profit from operations ..................................................... 103,287 Other revenues and expenses Rent revenue .............................................. $1,200 Interest expense ........................................ 2,160 960 Profit................................................................................. $102,327 THE BOARD SHOP Statement of Owner’s Equity Year Ended August 31, 2011 A. John, capital, September 1, 2010 ............................... $ 54,650 Add: Profit........................................................................ 102,327 156,977 Less: Drawings ................................................................ 47,100 A. John, capital, August 31, 2011 ................................... $109,877

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CUMULATIVE COVERAGE (Continued) (f) (Continued) THE BOARD SHOP Balance Sheet August 31, 2011 Assets Current assets Cash............................................................................. $ 11,097 Inventory ..................................................................... 126,720 Store supplies ............................................................. 345 Prepaid insurance....................................................... 2,760 Total current assets ............................................... 140,922 Property, plant and equipment Store equipment ........................................ $53,800 Less: Accumulated depreciation ............. 20,175 33,625 Total assets ............................................................ $174,547 Liabilities and Owner's Equity Current liabilities Accounts payable ....................................................... $ 26,715 Unearned sales revenue............................................. 1,775 Interest payable .......................................................... 180 Current portion of notes payable .............................. 6,000 Total current liabilities ........................................... 34,670 Long-term liabilities Notes payable ............................................................. 30,000 Total liabilities ........................................................ 64,670 Owner's equity A. John, capital ........................................................... 109,877 Total liabilities and owner's equity ....................... $174,547

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CUMULATIVE COVERAGE (Continued) (g) GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Aug. 31

Sales .................................................. 791,070 Rent revenue ...................................... 1,200 Income Summary .........................

792,270

Income Summary .............................. 689,943 Sales Returns and Allowances ... Sales Discounts ............................ Cost of Goods Sold ...................... Salaries Expense .......................... Advertising Expense .................... Rent Expense ............................... Interest Expense .......................... Insurance Expense ...................... Depreciation Expense ...................

12,595 320 540,238 97,100 10,825 18,600 2,160 1,380 6,725

Income Summary .............................. 102,327 A. John, Capital ............................

102,327

A. John, Capital ................................ 47,100 A. John, Drawings ........................

47,100

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CUMULATIVE COVERAGE (Continued) (h) THE BOARD SHOP Post-closing Trial Balance August 31, 2011

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BYP 5-1 FINANCIAL REPORTING PROBLEM (a) The Foranzi Group is involved in merchandising, selling at the retail level through its corporate-owned stores and at the wholesale level to its franchise operators. (b) Volume rebates and other supplier discounts are included in profit when earned. (c) They do not show the amount of sales returns. The amount may not be significant enough to show separately on the financial statements. (d) They use a multiple-step income statement format. (e)

Non-operating items reported on the income statement are: 1) loss on sale of investment, 2) interest expense and 3) amortization expense. However, normally amortization is reported as an operating expense.

(f)

1. Percentage change in revenue from 2008 to 2009 ($1,346,758 − $1,331,009) ÷ $1,331,009 = 1.2% 2. Percentage change in operating earnings before under noted items from 2008 to 2009 ($97,102 − $122,970) ÷ $122,970 = − 21.0% 3. Gross profit margin 2009: $483,519 ÷ $1,346,758 = 35.9% 2008: $478,401 ÷ $1,331,009 = 35.9% 4. Profit margin

2009: $29,325 ÷ $1,346,758 = 2.2% 2008: $47,451 ÷ $1,331,009 = 3.6%

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BYP 5-1 (Continued) (g) Based on the above, we can conclude that The Foranzi Group is less profitable in 2009 than it was in 2008. Its revenue increased 1.2% in 2009 over the previous year. Despite the increase in revenue, its operating earnings before under noted items have decreased by 21.0%. While its gross profit margin percentage is unchanged, its profit margin decreased from 3.6% to 2.2%.

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BYP 5-2 INTERPRETING FINANCIAL STATEMENTS (a) Gross profit 2008 = $22,728 [$37,633 − $14,905] 2007 = $22,243 [$36,450 − $14,207] 2006 = $24,927 [$38,700 − $13,773] Profit 2008 = $4,955 [$22,728 − $18,126 − $178 + $531] 2007 = $5,452 [$22,243 − $16,960 + $169] 2006 = $8,380 [$24,927 − $16,182 − $365] (b) Percentage change in net revenue: −2.8% [($37,633 − $38,700) ÷ $38,700] Percentage change in profit: −40.9% [($4,955 − $8,380) ÷ $8,380] (c) Gross profit margin 2008 = 60.4% [$22,728 ÷ $37,633] 2007 = 61.0% [$22,243 ÷ $36,450] 2006 = 64.4% [$24,927 ÷ $38,700] Gross profit margin decreased from 2006 to 2007 and then again in 2008.

(d) Profit margin 2008 = 13.2% [$4,955 ÷ $37,633] 2007 = 15.0% [$5,452 ÷ $36,450] 2006 = 21.7% [$8,380 ÷ $38,700] Profit margin decreased substantially from 2006 to 2007 and then decreased slightly in 2008.

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BYP 5-2 (Continued) (e) Big Rock Brewery has not managed operating expenses well, as shown by the decrease in profit margin. In particular in 2007, the operating expenses increased but revenues decreased from 2006. This increase, combined with a decrease in the gross profit margin caused a substantial decrease in the profit margin from 2006. The operating expenses have increased again in 2008, even as the gross profit margin decreased again from the 2007 level, causing a decrease in the profit margin in 2008.

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BYP 5-3 COLLABORATE 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 5-4 COMMUNICATION ACTIVITY (a) and (b) MEMORANDUM TO:

President, The Great Canadian Snowboard Company

FROM: SUBJECT: Revenue and Expense Recognition Criteria DATE:

Revenue should be recognized when there is an increase in assets or a decrease in liabilities as the result of a contract with a customer. In general, this simply means that the revenue must be recognized in the period when it is earned. Typically, sales revenues are earned when the goods are transferred from the buyer to the seller. At this point, the sales transaction is completed and the sales price is established. In this situation Dexter has made a down payment before the snowboard is complete and they should record the amount as unearned revenue. Revenue on the snowboard ordered by Dexter is earned at event No. 7, when Dexter picks up the snowboard. Whether Dexter makes a down payment with the purchase order is irrelevant in recognizing sales revenue because at this time, you have not done anything to earn the revenue. A down payment may be an indication of Dexter’s “good faith.” However, its effect on your financial statements is limited entirely to recognizing the down payment as unearned revenue.

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BYP 5-4 (Continued) Expenses, on the other hand, are recognized when there is a decrease in assets or an increase in liabilities, excluding transactions with the owner. Expense recognition is tied to revenue recognition when there is a direct association between costs incurred and the earning of revenue. Thus any costs directly associated with the snowboard should be recognized as expenses at the same time the sales revenue is recognized. If you have further questions about the accounting for this sale, please let me know.

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BYP 5-5 ETHICS CASE

(a) Rita Pelzer, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue delaying payments to creditors. Delaying payment is not an unethical practice. Companies can pay their bills late, but they do risk incurring interest charges or impairing their credit ratings. What is unethical is lying and blaming the late payment on the mail room or post office in order to avoid interest charges or affecting the company’s credit rating. Rita’s dilemma is to decide whether to (1) delay payments and place inappropriate blame for these late payments on the mail room and / or post office, or (2) risk offending her boss and possibly lose the job she just assumed. (b) The stakeholders (affected parties) are: Rita Pelzer, the assistant controller. Jamie Caterino, the controller. Liu Stores, the company. Creditors of Liu Stores (suppliers). Mail room / post office employees (those assigned the blame). (c) Rita’s alternatives: 1. Tell the controller (her boss) that she will prepare and mail creditors’ cheques to take advantage of the full credit period but will not delay mailing the cheques beyond their due dates. This may offend her boss and may jeopardize her continued employment.

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BYP 5-5 (Continued) (c) (Continued) 2. Tell the controller (her boss) that she will be happy to delay the payment four days but will not blame others for this delay when asked. This is contrary to current practice and may also offend her boss and jeopardize her continued employment. 3. Join the team and continue the practice of delaying payments and lay blame on others for the delay. 4. Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to Jamie. The company may not condone this practice. Rita definitely has a choice, but probably not without consequence. To continue the practice of lying is definitely unethical. If Rita submits to this request, she may be asked to perform other unethical tasks. If Rita stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things—if she isn’t fired. Maybe nobody has ever challenged Jamie’s unethical behaviour and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job.

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BYP 5-6 “ALL ABOUT YOU” ACTIVITY

(a) The amount of inventory shrinkage can be determined by comparing the amount of actual inventory on hand to the inventory in the accounting records. This comparison should be done on a retail price basis. The amount of shrinkage is usually expressed as a percentage of total sales. (b) Touchscreen and barcode technology are one method of reducing shrinkage. They are effective if a large proportion of the shrinkage is due to customer theft. If shrinkage is mostly due to employee theft, this technology will not necessarily reduce shrinkage. The technology is also costly. Management will need to determine if the amount of savings will outweigh the amount spent on this technology. (c) The amount is calculated by multiplying the Sales revenues by the shrinkage percentage: $400,000 x 4% = $16,000

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BYP 5-6 (Continued) (d) 1. The primary control factor is management involvement. 2. Great customer service involves staying with the customer to provide service. At the same time, this reduces the opportunity for customers to shoplift. 3. Other controls, procedures and tools: - store layout - loss prevention tools such as electronic security systems, security mirrors, video cameras and microtag systems - rewards to employees for suggestions or actions - sharing of shrinkage numbers with employees to make them aware of the cost of shrinkage and feedback of how controls are working. 4. Controls to reduce employee theft: - have an updated policies and procedures manual - prevent employees being alone in the store - limit access to store keys - limit markdown availability - control false refunds by collecting customer information and doing follow-up - use a cash register that produces an audit trail - control the back door of the store to prevent merchandise from being taken out the back. - check the garbage and employee parcels. - do new employee reference checks. - provide employee discounts on merchandise.

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Legal Notice Copyright

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CHAPTER 6 Inventory Costing ASSIGNMENT CLASSIFICATION TABLE Questions

Brief Exercises

Exercises

Problems Set A

Problems Set B

1. Describe the steps in determining inventory quantities.

1, 2, 3, 4

1, 2

1, 7

2. Calculate cost of goods sold and ending inventory in a perpetual inventory system using specific identification, FIFO, and average methods of cost determination.

5, 6, 7, 8

3, 4, 5, 6, 7, *16

3, 4, 5, 6, *13, *14

2, 3, 4, 5, 6, *12, *13

3. Determine the financial statement effects of inventory cost determination methods and of inventory errors.

9, 10, 11, 12, 13

8, 9, 10, 11

6, 7, 8

4, 5, 7, 8

4. Demonstrate the presentation and analysis of inventory.

14, 15, 16, 17, 18

12, 13, 14

9, 10

6, 8, 9, 10

*5. Calculate ending inventory and cost of goods sold in a periodic inventory system using FIFO and average inventory cost formulas (Appendix 6A).

*19, *20, *21, *22

*15, *16

*11, *12, *13, *14

*11, *12, *13

*6. Estimate ending inventory using the gross profit and retail inventory methods (Appendix 6B).

*23, *24, *25, *26

*17, *18

*15, *16, *17

*14, *15

Study Objectives

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ASSIGNMENT CHARACTERISTIC TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Identify items in inventory.

Moderate

20-25

Apply specific identification.

Simple

15-20

Apply perpetual FIFO. Record sales and inventory adjustment and calculate gross profit.

Moderate

20-25

Apply perpetual average and answer questions.

Moderate

20-25

Apply perpetual FIFO and average. Answer questions about financial statement effects.

Moderate

35-45

Record transactions using perpetual average. Apply LCNRV.

Moderate

35-45

Determine effects of inventory errors.

Complex

25-30

Determine effects of inventory errors. Calculate inventory turnover.

Complex

35-45

Apply LCNRV and prepare adjustment

Moderate

20-25

10A

Calculate ratios.

Simple

15-20

*11A

Apply periodic FIFO and average.

Simple

20-25

*12A

Apply periodic and perpetual FIFO.

Moderate

20-25

*13A

Apply periodic and perpetual average.

Moderate

20-25

*14A

Determine inventory loss using gross profit method.

Moderate

20-30

*15A

Determine ending inventory using retail method.

Moderate

20-30

Identify items in inventory.

Moderate

20-25

Apply specific identification.

Simple

15-20

Apply perpetual average. Record sales and inventory adjustment and calculate gross profit.

Moderate

20-25

Apply perpetual FIFO and answer questions.

Moderate

20-25

Apply perpetual FIFO and average. Answer questions about financial statement effects.

Moderate

35-45

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record transactions using perpetual FIFO. Apply LCNRV.

Moderate

35-45

Determine effects of inventory errors.

Complex

25-30

Determine effects of inventory errors. Calculate gross profit.

Complex

35-45

Apply LCNRV and prepare adjustment.

Moderate

20-25

10B

Calculate ratios.

Simple

15-20

*11B

Apply periodic FIFO and average.

Simple

20-25

*12B

Apply periodic and perpetual average.

Moderate

20-25

*13B

Apply periodic and perpetual FIFO.

Moderate

20-25

*14B

Determine inventory loss using gross profit method.

Moderate

20-30

*15B

Determine ending inventory using retail method.

Moderate

20-30

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material 1.

Study Objective Describe the steps in determining inventory quantities.

Knowledge BE6-1 E6-1

Comprehension Q6-1 Q6-2 Q6-3 Q6-4

Application BE6-2 E6-2 P6-1A P6-1B BE6-3 BE6-4 BE6-5 BE6-6 BE6-7 *BE6-16 E6-3 E6-4 E6-5 E6-6 *E6-13 *E6-14 P6-2A P6-3A P6-4A P6-5A P6-6A P6-2B P6-3B P6-4B P6-5B P6-6B *P6-12A *P6-13A *P6-12B *P6-13B E6-6 P6-4A P6-5A P6-4B P6-5B

Calculate cost of goods sold and ending inventory in a perpetual inventory system using the specific identification, FIFO, and average methods of cost determination.

Q6-5 Q6-6 Q6-7 Q6-8

Determine the financial statement effects of inventory cost determination methods and of inventory errors.

Q6-9 Q6-10 Q6-11 Q6-12 Q6-13 BE6-8 BE6-9

Demonstrate the presentation and analysis of inventory.

Q6-18

Q6-14 Q6-15

BE6-12 BE6-13 BE6-14 E6-9 E6-10 P6-6A P6-9A P6-6B P6-9B

Analysis P6-7A P6-7B

Synthesis

Evaluation

BE6-10 BE6-11 E6-7 E6-8 P6-7A P6-8A P6-7B P6-8B Q6-16 Q6-17 P6-8A P6-10A P6-8B P6-10B

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BLOOM’S TAXONOMY TABLE (Continued) *5

*6.

Study Objective Calculate ending inventory and cost of goods sold in a periodic inventory system using FIFO and average inventory cost formulas (Appendix 6A).

Knowledge *Q6-22

Comprehension *Q6-19 *Q6-20 *Q6-21

Estimate ending inventory using the gross profit and retail inventory methods (Appendix 6B)

*Q6-23

*Q6-24 *Q6-25 *Q6-26

Broadening Your Perspective

Application *BE6-15 *BE6-16 *E6-11 *E6-12 *E6-13 *E6-14 *P6-11A *P6-12A *P6-13A *P6-11B *P6-12B *P6-13B *BE6-17 *BE6-18 *E6-15 *E6-16 *P6-14A *P6-15A *P6-14B *P6-15B

BYP6-3 BYP6-4 BYP6-5

Analysis

Synthesis

Evaluation

*E6-17

BYP6-1 BYP6-2 BYP6-6

Continuing Cookie Chronicle

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ANSWERS TO QUESTIONS 1.

Taking a physical inventory involves counting, weighing or measuring each kind of inventory on hand. This is normally done when the store is closed. Tom will probably count items, and mark the quantity, description, location and inventory number on prenumbered inventory tags. Retailers, such as a hardware store, generally have thousands of different items to count. Later, unit costs will likely be applied to the inventory quantities using either specific identification or an assumed cost flow method.

Inventory errors can occur because quantities may be seriously miscounted if goods in transit at the statement date are ignored. The company may have purchased and taken ownership of goods that have not yet been received and this should be included in the inventory count. On the other hand it may have goods that are being delivered to a customer that are still owned by the seller. These should also be included in the inventory count and the sale should not be recorded until after the goods are delivered. The transfer of ownership is usually determined by the terms of sale and is evidenced by the free on board terms.

Consigned goods are goods held on a company’s premises (the consignee), but belong to someone else (the consignor). The consignee agrees to sell the goods for a fee but never takes ownership of the goods even though the goods are physically located on the consignee’s premises. Therefore, the consignor, not the consignee, owns the goods and should include them in inventory.

(1) include (2) do not include (3) include (it is assumed legal ownership remains with the store).

Actual physical flow may be impractical because many items are indistinguishable from one another. And, even if the items are individually identifiable, it may be too costly and too complex to track the physical flow of each inventory item. Actual physical flow may also be inappropriate because management may be able to manipulate profit through specific identification of items sold.

Specific identification is appropriate when goods are uniquely identifiable or produced for a specific purpose, for example, automobiles. GAAP does not allow companies to use specific identification when goods are interchangeable.

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QUESTIONS (Continued) 7.

Specific identification tracks the actual physical flow of goods in the system and matches the cost of a particular item of inventory against its sale price. Each good is uniquely identifiable and can be traced back to its purchase cost. This gives the specific identification method the advantage of producing financial results that are more accurate. The method however is more expensive to operate since each item must be tracked individually in the accounting system. The FIFO cost formula assumes that the first goods purchased are the first goods sold. The average cost formula determines the cost using a weighted average of the cost of the items purchased. Both the FIFO and the average cost formulas assume a flow of goods that may not exactly match the actual flow of physical goods. These cost flow assumptions can be used in both a periodic and perpetual inventory systems, whereas the specific identification method can only be used in a perpetual system. This has the advantage of making the bookkeeping simpler and less expensive.

The specific identification method is normally only used in a perpetual system. The method is based on tracking the cost of each individual item in inventory and matching its cost against the sale price on the income statement. This normally occurs throughout the period on a perpetual basis.

(a) Cash: No effect. The cash impact of the purchase and sale is the same regardless of which inventory cost flow assumption is chosen. The inventory cost flow assumption simply allocates the cost of goods available for sale between cost of goods sold and ending inventory. (b) Ending inventory: In a period of declining prices, FIFO will produce a lower ending inventory as inventory is costed using the most recent (lower) prices; Average will produce a higher ending inventory as ending inventory is costed at an average of all the inventory available for sale during the accounting period. (c) Cost of goods sold: The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of goods sold will be higher under FIFO and lower under average cost. (d) Profit: Because of the effect on the cost of goods sold, profit will be lower under FIFO and higher under average cost.

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QUESTIONS (Continued) 10.

The average cost formula results in more recent costs being reflected in cost of goods sold. This better matches current costs with current revenues and provides a better income statement valuation. The FIFO cost formula provides the better balance sheet valuation because the cost of older items are transferred to cost of goods sold. This leaves the more recently purchased items in ending inventory and better reflects replacement cost.

11. (a) Choose a method that corresponds as closely as possible to the physical flow of goods. (b) Report an inventory cost on the balance sheet that is close to the inventory’s recent costs (c) Use the same method for all inventories having a similar nature and use in the company. 12.

(a) Mila Company's 2010 profit will be understated (U) $5,000. Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

Sales - Cost of goods sold O $5,000 Gross profit/Profit U $5,000 U $5,000 O $5,000

(b) Mila’s 2011 profit will be overstated (O) $5,000 since the ending inventory of 2010 becomes the beginning inventory of 2011. Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

U $5,000

Sales - Cost of goods sold U $5,000 Gross profit/Profit O $5,000

U $5,000 0000000 U $5,000

(c) The combined profit for the two years will be correct because the errors offset each other (U $5,000 in 2010 and O $5,000 in 2011). 13.

It is necessary to correct the error because users of the financial statements look at the results for individual years and also look at any trends.

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QUESTIONS (Continued) 14.

Lucy should know the following: (a) A departure from the cost basis of accounting for inventories is justified when the utility (revenue-producing ability) of the goods is no longer as great as its cost. The write down to net realizable value should be recognized in the period in which the utility decline occurs. (b) Net realizable value means the estimated selling price less any estimated costs required to complete the sale.

15.

Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales.

16.

An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales. An inventory turnover ratio that is too low may indicate that the company has excess inventory which is not being sold and may be obsolete and as a result, the company may be spending too much to carry its inventory.

17.

An increase in the days in inventory ratio from one year to the next would usually be seen as deterioration in the company’s efficiency in managing inventory. It means that more inventory is being held relative to sales.

18.

Wabanaki Company should disclose (1) the major inventory classifications, (2) the cost flow assumption used (specific identification, FIFO, or average cost), and (3) the amount of any write-downs to net realizable value or reversals of previous write-downs, including the reason why the write-down was reversed.

*19.

No, he is not correct. The FIFO cost flow assumption assumes that the goods that were purchased the earliest are the first ones to be sold. The cost of the oldest units is used first to calculate cost of goods sold, not ending inventory.

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QUESTIONS (Continued) *20. When using FIFO, the periodic and perpetual systems produce the same results. This is because the system assigns the oldest costs to cost of goods sold in both the periodic and perpetual systems. This pattern matches the chronological order of transactions reflected in the perpetual system. The use of a perpetual inventory system allows management to better monitor inventory levels and results in better inventory control. The decision to use a periodic or perpetual inventory system is determined based on the importance that management places on being able to monitor its inventory levels throughout the year independent of the cost flow assumption used by the organization. That is, the cost of using a perpetual inventory system may outweigh the benefits of monitoring inventory or vice-versa. *21. In a period of rising prices, the periodic system will produce a higher cost of goods sold and lower ending inventory because new higher prices are included in the average cost for all sales throughout the period. In a perpetual system, these new higher costs affect only sales that occur after the purchase of the inventory. *22. In a periodic system, the average is a weighted average calculated at the end of the period based on total goods available for sale for the entire period. In a perpetual system, the average is calculated after each purchase (goods available for sale in dollars ÷ goods available for sale in units). A new average must be calculated with each purchase and thus the average becomes a moving average. *23. Inventories must be estimated when (1) a company uses the periodic inventory system and management wants interim (monthly or quarterly) financial statements but a physical inventory is only taken annually, or (2) a fire or other type of casualty makes it impossible to take a physical inventory. An estimate of the inventory can also help to test the reasonableness of the actual inventory when a physical count is done. *24. Disagree. A company’s gross profit margin does not necessarily remain constant from year to year. Gross profit can change due to changes in merchandising policies or in market conditions. The accuracy of the method is also affected by the mix of products sold during the year and whether the method is applied to a product line, a department, or the company as a whole. The year-end inventory count also serves internal control purposes. It helps management examine the presence of merchandise and its physical condition.

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QUESTIONS (Continued) *25. The gross profit method uses an average gross profit margin based on previous year’s results and applies it to net sales to estimate the cost of goods sold. The estimated cost of goods is subtracted from the goods available for sale to arrive at the estimated ending inventory. The retail inventory method calculates an average cost-to-retail percentage. This percentage is determined by dividing goods available for sale at cost, by good available for sale at retail. This ratio is then applied to the ending inventory at retail to estimate the ending inventory at cost. The retail inventory method approximates results that would have resulted had the average cost flow assumption been used. *26. The retail inventory method is an averaging technique and may produce an incorrect inventory valuation if the blend of inventory items in ending inventory is not the same as in cost of goods available for sale. It produces an estimate of ending inventory based on the average cost flow formula and would not be appropriate if the company is using a FIFO approach.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a)

Ownership of the goods belongs to the consignor (Helgeson). Thus, these goods should be included in Helgeson’s inventory.

(b)

The goods in transit should not be included in inventory as title remains with the seller until the goods reach the buyer (Helgeson).

(c)

The goods being held belong to the customer. They should not be included in Helgeson’s inventory.

(d) Ownership of these goods rests with the other company (the consignor). These goods should not be included in Helgeson’s inventory. (e)

The goods in transit to a customer should not be included in inventory as title passes to the buyer when the public carrier accepts the goods from the seller.

BRIEF EXERCISE 6-2 The correct cost of inventory is: Total cost per inventory count Less: Inventory on consignment Inventory held for alterations

$68,000 (5,000) (950)

Add: Goods shipped FOB shipping point prior to Aug. 31 4,520 Freight on inventory purchases 180 Correct inventory cost at August 31 $66,750

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BRIEF EXERCISE 6-3

Date Jan. 3 3 20

Units 3 2

PURCHASES Cost Total $1,000 $3,000 $1,200

COST OF GOODS SOLD Units Cost Total 1

$1,000

$1,200

1,200

$2,400

20 Total

Units 3 2 2 2 2 1

BALANCE Cost Total $1,000 $3,000 $1,000 2,000 $1,000 $1,200 4,400 $1,000 $1,200 3,200

$2,200

Alternatively (as the dates of the sales were not given): Cost of Goods Sold Date Jan. 3 Jan. 20 Total

Units 1 1 2

Unit Cost $1,000 $1,200

Total Cost $1,000 1,200 $2,200

Unit Cost $1,000 1,200

Total Cost $2,000 1,200 $3,200

Ending Inventory Date Jan. 3 Jan. 20 Total

Units 2 1 3

BRIEF EXERCISE 6-4 (a) (b) (c) (d) (e)

2 3 1 3 2

FIFO Average Specific identification Average FIFO

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BRIEF EXERCISE 6-5 Date

PURCHASES Units Cost Total

COST OF GOODS SOLD Units Cost Total

June 1 7

400

$7.35

$2,940.00

18 200 150 26

375

$7.90

(d) $6.00 $7.35

2,962.50

6-14

Units

BALANCE Cost Total

200

$6.00

$1,200.00

(a) 200 400

(b) $6.00 $7.35

(f) 250 (i) 250 375

(g) $7.35 (j) $7.35 $7.90

(e) 2,302.50

(h) 1,837.50 (k) 4,800.00

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BRIEF EXERCISE 6-6 Date

PURCHASES Units Cost Total

COST OF GOODS SOLD Units Cost Total

June 1 7

200 400

$7.35

$2,940.00

18 26

Units

350 375

$7.90

(d)$6.90

2,962.50

(e)2,415.00

BALANCE Cost Total $6.00

$1,200.00

(a)600 (b)$6.90

(f)250 (g)$6.90

(h)1,725.00

(i)625

(k)4,687.50

(j)$7.50

(a) 600 = 200 + 400 (b) ($1,200 + $2,940) ÷ (200 + 400) (c) $4,140 = $1,200 + $2,940 (d) see (b) above (e) $2,415 = 350 X $6.90 (f) 250 = 600 - 350 (g) see (b) above (h) $1,725 = 250 X $6.90 (i) 625 = 250 + 375 (j) $7.50 = ($1,725 + $2,962.50) ÷ (250 + 375) (k) $4,687.50 = 625 X $7.50

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BRIEF EXERCISE 6-7 (a)

FIFO

Purchases Cost of Goods Sold Date Units Cost Total Units Cost Total May 2 250 $6 $1,500 3 400 7 2,800 10 15

250 25 350

2,800

25 35 0 Total 1,000

$6 7 $1,675

35 0 $7,100

325 5 0 600

2,275 35 0 $3,950

Balance Units Cost Total 250 $6 $1,500 250 6 400 7 4,300 375 375 350 50 350 400

7 7 8 7 8

2,625 5,425 3,150 $3,150

(b) Average Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total May 2 250 $6 $1,500 250 $6.000 $1,500 3 400 7 2,800 650 6.615 4,300 10 275 $6.615 $1,819 375 6.615 2,481 15 350 8 2,800 725 7.284 5,281 25 35 0 3 50 325 7.284 2,367 400 7.284 2,914 Total 1,000 $7,100 600 $4,186 400 $2,914

Recap:

Cost of goods sold Ending inventory Goods available for sale

FIFO $3,950 3,150 $7,100

Average $4,186 2,914 $7,100

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BRIEF EXERCISE 6-8 (a) (b) (c) (d)

FIFO Average cost Average cost FIFO

BRIEF EXERCISE 6-9 (a)

Average cost gives the higher inventory valuation when prices are falling. This is because the cost of the units are a blend of older and newer items. Under the FIFO system, ending inventory is composed of newer items purchased at a lower cost.

(b) FIFO gives the higher cost of goods sold amount. This is because the cost of the units purchased earlier, at a higher cost, are assumed to have been sold first and are allocated to cost of goods sold. (c)

The selection of a cost flow assumption does not affect cash flow. The cost flow assumption is a method of allocating costs to cost of goods sold and ending inventory. It does not involve the inflow or outflow of cash.

(d) In selecting a cost determination method, the company should consider their type of inventory and its actual physical flow. While it is not essential to match the actual physical flow to the cost flow assumption, it does give the company an indication as to its flow of costs throughout the period. The company should also consider the method that will report inventory on the balance sheet that is close to the inventory’s recent costs.

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BRIEF EXERCISE 6-10

2010 2011

Assets =

Liabilities +

Owner’s Equity

No Effect No Effect

2010 Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

O $25,000

Sales - Cost of goods sold O $25,000 Gross profit/Profit U $25,000

O $25,000

Note that the beginning inventory error occurred in 2009 and that 2009 profit and owner’s equity would be overstated by $25,000. The 2010 profit is understated $25,000. This error is added to the prior year’s overstatement of $25,000, and the two errors cancel out. The Owner’s Equity at the end of the period is correct. The ending inventory is also correct at the end of 2010. 2011 Since the 2010 error reverses the impact of an error originally occurring in 2009, there would be no further impact on the 2011 financial statements. 2011 profit, owner’s equity and ending inventory would all be correctly stated (assuming no new errors have occurred).

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BRIEF EXERCISE 6-11 (a) The understatement of ending inventory caused cost of goods sold to be overstated $7,000 and profit to be understated $7,000. The correct profit for 2010 is $97,000 ($90,000 + $7,000). Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

Sales - Cost of goods sold Gross profit / Profit

O $7,000 U $7,000

U $7,000 O $7,000

(b) Total assets and owner’s equity in the balance sheet will both be understated by the amount that ending inventory is understated, $7,000. If profit is understated, then owner’s equity is also understated as profit is a component of owner’s equity. Using the accounting equation: A = L + OE U $7,000 = U $7,000 (c) The error arising in 2010, if left uncorrected, will flow through in 2011. The 2010 error will affect the 2011 beginning inventory by an understatement of $7,000. This causes cost of goods sold to be understated $7,000 and profit to be overstated $7,000. Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

U $7,000 Sales - Cost of goods sold Gross profit / Profit

U $7,000 O $7,000

U $7,000

Total assets and owner’s equity in the balance sheet will both be in the correct amount since 2011 ending inventory is correct. The 2010 error causes an understatement of 2010 profit of $7,000 and an overstatement of 2011 profit of $7,000, causing the total profit for the two-year period to be correct. This causes owner’s capital in 2011 to be correctly stated. Solutions Manual 6-19 Chapter 6 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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BRIEF EXERCISE 6-12 (a)

(b)

Inventory Categories

Cost

NRV

LCNRV

Cameras Cell phones DVD players Total

$12,000 9,000 14,000 $35,000

$11,200 9,500 10,600 $31,300

$11,200 9,000 10,600 $30,800

The entry to record the adjustment would be: Cost of goods sold ........................... 4,200 Merchandise inventory ............. 4,200 ($35,000 - $30,800)

BRIEF EXERCISE 6-13 Inventory Categories

Cost

NRV

LCNRV

Cameras Cell phones Total

$12,000 9,000 $21,000

$11,200 9,500 $20,700

$11,200 9,000 $20,200

(a)

The correct ending inventory should be $20,200. The correct cost of goods sold should be $286,200 [$285,400 + ($21,000 - $20,200)]

(b)

The notes must disclose the major inventory classifications, the cost determination method (specific identification), value of inventory reported at net realizable value ($20,200), the cost of goods sold ($286,200); and the amount of the writedown to net realizable value ($800).

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BRIEF EXERCISE 6-14 Cost of goods sold = $22,250 + $300,000 - $27,750 = $294,500 Inventory turnover = 11.8 times {$294,500 ÷ [($22,250 + $27,750) ÷ 2]} Days sales in inventory = 30.9 days (365 ÷ 11.8)

*BRIEF EXERCISE 6-15 Goods Available for Sale st

1 purchase 2nd purchase 3rd purchase Goods available for sale Ending inventory in units Number of units sold (a)

Units Unit Cost 250 $6 400 7 350 8 1,000 400 600

Total Cost $1,500 2,800 2,800 $7,100

FIFO Ending Inventory: Purchase Units rd 3 350 nd 2 50 Total 400

Unit Cost $8 7

Total Cost $2,800 350 $3,150

Cost of goods sold: $7,100 - $3,150 = $3,950 Proof of cost of goods sold: Purchase Units Unit Cost st 1 250 $6 nd 2 350 7 Total 600

Total Cost $1,500 2,450 $3,950

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*BRIEF EXERCISE 6-15 (Continued) (b) Average Average unit cost: $7,100  1,000 units = $7.10 per unit Ending Inventory: 400 units x $7.10 per unit = $2,840 Cost of Goods Sold: $7,100 - $2,840 = $4,260 Proof of cost of goods sold: 600 units x $7.10 per unit = $4,260

*BRIEF EXERCISE 6-16 (a)

FIFO Periodic

Date

Account Titles and Explanation

Debit

Jan. 3

Accounts Receivable ........................ Sales (500 x $5).............................

2,500

Purchases (1,000 x $4) ...................... Accounts Payable ........................

4,000

Cash ................................................... Sales (800 x $8).............................

6,400

Credit

2,500

4,000

6,400

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*BRIEF EXERCISE 6-16 (Continued) (b)

FIFO Perpetual

Date

Account Titles and Explanation

Debit

Jan. 3

Accounts Receivable ......................... Sales (500 x $5)..............................

2,500

Cost of Goods Sold ............................ Inventory (500 x $3) .......................

1,500

Inventory (1,000 x $4) ......................... Accounts Payable .........................

4,000

Cash .................................................... Sales (800 x $8)..............................

6,400

Cost of Goods Sold (200 x $3 + 600 x $4) ........................... Inventory ........................................

Credit

2,500

1,500

4,000

6,400

3,000 3,000

*BRIEF EXERCISE 6-17 Net sales .......................................................................... $350,000 Less: Estimated gross profit (40% x $350,000) ............ 140,000 Estimated cost of goods sold ........................................ $210,000 Cost of goods available for sale ($60,000 + $250,000) .. $310,000 Less: Estimated cost of goods sold ............................. 210,000 Estimated cost of ending inventory ............................... $100,000

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*BRIEF EXERCISE 6-18 Goods available for sale Net sales Ending inventory at retail

At Cost

At Retail

$35,000

$50,000 40,000 $10,000

Cost-to-retail ratio = $35,000 ÷ $50,000 = 70% Estimated cost of ending inventory = $10,000 x 70% = $7,000

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SOLUTIONS TO EXERCISES EXERCISE 6-1 1.

Do not include – Shippers does not own items held on consignment.

Include in inventory – Shippers still own the items as they were only shipped on consignment.

Include in inventory – Because the shipping terms are FOB destination, Shippers owns the goods until they arrive at the customer’s premises.

Do not include in inventory – Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, the customer owns the goods in transit.

Do not include in inventory – Shipping terms FOB destination means that Shippers do not own the items until they reach them.

Include in inventory – Because the shipping terms are FOB shipping point, Shippers owns the goods in transit.

Include in inventory - Because the shipping terms are FOB shipping point, ownership has transferred to Shippers.

Do not include in inventory – Because freight costs paid by the seller are freight-out or delivery expense and included in operating expenses, not as part of the cost of inventory.

Do not include in inventory - record as supplies inventory on the balance sheet.

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EXERCISE 6-2 Ending inventory—physical count................................. $281,000 Adjustments: 1. Add to inventory: Title remains with Moghul until buyer receives goods ................................................ 35,000 2. Add to inventory: Title passed to Moghul when goods were shipped .................................................. 95,000 3. Add to inventory: Title passed to Moghul when goods were shipped .................................................. 28,000 4. No effect: Title passes to purchaser upon shipment when terms are FOB shipping point ........ 0 5. No effect: Title does not transfer to Moghul until goods are received .................................................... 0 6. Add to inventory: Consignor (Moghul) own goods. 30,500 $469,500

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EXERCISE 6-3 (a)

Each item of inventory could be marked, tagged, or coded with its specific unit cost. Items that are still in inventory at the end of the year are specifically costed to determine the total cost of the ending inventory.

(b) It could choose to sell specific units purchased at specific costs if it wished to impact income selectively. If it wished to maximize income, it would choose to sell the units purchased at lower costs. In this case, the cost of goods sold would be $850 [(#1056) $400 + (#1045) $450]. The gross profit would be $650 [(2 x $750) – $850]. If it wished to minimize profit, it would choose to sell the units purchased at higher costs. In this case, the cost of goods sold would be $950 [(#1012) $500 + (#1045) $450]. The gross profit would be $550 [(2 x $750) – $950]. (c)

In this situation I recommend Discount use the specific identification instead of one of the cost flow assumptions. Specific identification is practical when a company sells a limited number of high-unit-cost items that can be clearly identified from purchase through to sale. Note to Instructor: This answer may vary depending on the cost flow assumption the student chooses.

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EXERCISE 6-4 (a)

FIFO

Date June 1

Purchases Units Cost Total

9 12

50 70 300 $205

24 Total

80 200 400

210

35 0 700

$200 225

$25,750

61,500

16 21

Cost of Goods Sold Units Cost Total

225 205

59,000

84,000

3 50 $145,500

100 250 750

205 210

6-28

73,000 $157,750

Units 50 150

Balance Cost $200 225

80 80 300

225 225 205

18,000

100 100 400

205 205 210

20,500

150 150

210

Total $43,750

79,500

104,500 31,500 $31,500

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EXERCISE 6-4 (Continued) (b) Date

Account Titles and Explanation

Debit

Credit

June 9

Accounts Receivable ......................... 38,400 Sales (120 x $320)..........................

38,400

Cost of Goods Sold ............................ 25,750 Inventory [(50 x $200) + (70 x $225)]

25,750

Inventory (300 x $205) ........................ 61,500 Accounts Payable .........................

61,500

Accounts Receivable ......................... 89,600 Sales (280 x $320)..........................

89,600

Cost of Goods Sold ............................ 59,000 Inventory [(80 x $225) + (200 x $205)]

59,000

Inventory (400 x $210) ........................ 84,000 Accounts Payable .........................

84,000

Accounts Receivable ......................... 115,500 Sales (350 x $330)..........................

115,500

Cost of Goods Sold ............................ 73,000 Inventory [(100 x $205) + (250 x $210)]

73,000

$243,500 157,750 $ 85,750

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EXERCISE 6-5 (a)

Average

Purchases Cost Total

Date Units June 1 6 1,500 $127.00 $190,500 10 14 1,200 128.00 153,600 16 26 1,100 129.00 141,900 Total 3,800 $486,000

Cost of Goods Sold Units Cost Total

1,000

126.500

126,500

1,600 5 0 2,600

127.318

203,709 3 50 $330,209

Units 500 2,000 1,000 2,200 600 1,700 1,700

Balance Cost $125.000 (1) 126.500 126.500 (2) 127.318 127.318 (3) 128.406

Total $62,500 253,000 126,500 280,100 76,391 218,291 $218,291

(1) ($62,500 + $190,500) ÷ (500 + 1,500) (2) ($126,500 + $153,600) ÷ (1,000 + 1,200) (3) ($76,391 + $141,900) ÷ (600 + 1,100)

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EXERCISE 6-5 (Continued) (b) Date

Account Titles and Explanation

Debit

Credit

June 6

Inventory (1,500 x $127) ..................... 190,500 Accounts Payable .........................

190,500

Accounts Receivable ......................... 200,000 Sales (1,000 x $200) .......................

200,000

Cost of Goods Sold ............................ 126,500 Inventory (1,000 x $126.50) ...........

126,500

Inventory (1,200 x $128) ..................... 153,600 Accounts Payable .........................

153,600

Accounts Receivable ......................... 328,000 Sales (1,600 x $205) .......................

328,000

Cost of Goods Sold ............................ 203,709 Inventory (1,600 x $127.318) .........

203,709

Inventory (1,100 x $129) ..................... 141,900 Accounts Payable .........................

141,900

$528,000 330,209 $197,791

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EXERCISE 6-6 (a)

(1) FIFO

Date July 1 July 12 July 15 July 16 July 23

July 27 Total

Purchases Cost of Goods Sold Balance Units Cost Total Units Cost Total Units Cost Total 150 $5 $ 750 230 $6 $1,380 150 5 230 6 2,130 150 $5 100 6 $1,350 130 6 780 490 7 3,430 130 6 490 7 4,210 175 8 1,400 130 6 490 7 175 8 5,610 130 6 50 7 350 35 0 440 7 3,860 175 8 1,750 895 $6,210 820 $5,210 225 $1,750

Proof: $750 + $6,210 = $5,210 + $1,750 (2) Average Purchases July 1 July 12 July 15 July 16 July 23 July 27 Total

230

Cost of Goods Sold

$6 $1,380 250 $5.605 $1,401

490 175 350 895

7 8

3,430 1,400 35 0 $6,210

570 820

6.993

3,986 $5,387

150 380 130 620 795 225 225

Balance $5.000 $ 750 5.605 2,130 5.605 729 6.708 4,159 6.993 5,559 6.993 1,573 $1,573

Proof $750 + $6,210 = $5,387 + $1,573

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EXERCISE 6-6 (Continued) (b)

FIFO—Perpetual Average—Perpetual

Cost of Goods Sold Ending Inventory 5,210 1,750 5,387

1,573

The FIFO cost flow formula will produce the higher ending inventory because costs have been rising. Under this formula, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. For Dene Company, the ending inventory under FIFO is $1,750 compared to $1,573 under average cost. (c) The average cost flow formula will produce the higher cost of goods sold for Dene Company. Under the average cost flow assumption some of the most recent costs are averaged into cost of goods sold, and the earliest costs are averaged into the ending inventory. The cost of goods sold is $5,387 compared to $5,210 under FIFO. (d) The choice of inventory cost flow formula does not affect cash flow. It is an allocation of costs between inventory and cost of goods sold.

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EXERCISE 6-7 (a) Ending inventory, incorrect Error Ending inventory, correct Cost of goods sold, incorrect Error – beginning inventory 2011 Error – ending inventory 2010 Error – ending inventory 2011 Cost of goods sold, correct

2011 $30,000 $4,000 U $34,000

2010 $30,000 $3,000 O $27,000

$170,000 $3,000 O

$175,000 $3,000 U

$4,000 O $163,000

$178,000

(b) In 2010 profit is overstated by $3,000, the amount of the error in ending inventory. This error flows through to owner’s equity in 2010 to produce an overstatement of $3,000. In 2011 both errors have an impact. The net effect is an understatement of profit by $7,000. This is a result of the $3,000 overstatement of the beginning inventory plus $4,000 understatement of ending inventory. Owner’s equity in 2011 would show only an understatement of $4,000. The $3,000 overstatement of 2010 would be offset by the $3,000 understatement in profit caused by the impact on beginning inventory in 2011. (c)

It is important that Glacier Fishing Gear correct these errors because users of the financial statements look at the results for individual years and also look at any trends.

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EXERCISE 6-8 (a) MARRAKESH COMPANY Income Statement (Partial) December 31 ______________________________________________________ 2011 2010 Sales................................................................. $530,000 $500,000 Cost of goods sold* ........................................ 430,000 390,000 Gross profit...................................................... $100,000 $110,000 * Cost of goods sold (2010) = $410,000 - $20,000 = $390,000 Cost of goods sold (2011) = $410,000 + $20,000 = $430,000 (b) The cumulative effect on total gross profit for the two years is zero, as shown below: Incorrect gross profits: $120,000 + $90,000 = Correct gross profits: $100,000 + $110,000 = Difference (c) Original Corrected

2011 $120,000 ÷ $530,000 = 23% $100,000 ÷ $530,000 = 19%

$210,000 210,000 $ 0

2010 $90,000 ÷ $500,000 = 18% $110,000 ÷ $500,000 = 22%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 6-8 (Continued) (d) Dear Mr./Ms. President: Because your ending inventory of December 31, 2010 was understated by $20,000, your profit for 2010 was understated and profit for 2011 was overstated by $20,000. The cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is understated, as it was in December 2010, the cost of goods sold is overstated and therefore profit will be understated by that amount. This understated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. Although the cumulative effect of the error over the combined two year period is nil, the effect on each individual year’s income statement is significant. For example, the gross profit margin before correction was 18% in 2010 and increased 5% to 23% in 2011. After the error is corrected, the gross profit margin for 2010 is 22% and it decreased 3% to 19% in 2011. Another problem is the company’s profit appears to be increasing over the two-year period because of the error. But when the error is corrected profit is actually decreasing over the two-year period. Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience. Sincerely,

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 6-9 (a)

Cameras Minolta Canon Total Light Meters Vivitar Kodak Total Total inventory (b)

(c)

Cost

NRV

$ 875 980 1,855

$ 800 994 1,794

$ 800 980 1,780

1,620 1,150 2,770

1,548 1,200 2,748

1,548 1,150 2,698

$4,625

$4,542

$4,478

Cost of Goods Sold ................................... Inventory ($4,625 - $4,478) .................

LCNRV

147 147

In the notes to the financial statements, the following information should be reported: (1) the major inventory classifications; (2) the cost determination method; (3) the value of inventory reported at net realizable value ($4,478); (4) the cost of goods sold; and (5) the amount of the writedown to net realizable value ($147).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 6-10 Inventory turnover

2008 3.12 times =

2007 2.61 times =

$87,365 $79,565 [($27,404 + $28,561) ÷ 2] [($28,561 + $32,348) ÷ 2] Days sales in inventory Gross profit margin

117 days = 365 ÷ 3.12

140 days = 365 ÷ 2.61

46.6% =

49.7% =

($163,550 - $87,365) $163,550

($158,099 - $79,565) $158,099

Inventory turnover has increased from 2.61 (2007) to 3.12 (2008). As well, days sales in inventory has decreased from 140 days (2007) to 117 days (2008). Both of these ratios indicate that it is taking less time to sell inventory. The gross profit margin has decreased from 49.7% to 46.6%. The decrease in this ratio indicates either a decrease in the selling price or an increase in the cost of goods sold. A decrease in the selling price would be consistent with the faster inventory turnover as customers would be willing to purchase the inventory at a lower price. It appears that the increased turnover may have been caused by reductions in inventory levels.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-11 (a) Cost of Goods Available for Sale Unit Total Date Units Cost Cost July 1 150 $5 $ 750 12 230 6 1,380 16 490 7 3,430 23 175 8 1,400 Total 1,045 $6,960 1.

FIFO Ending Inventory: Date

Units

Unit Cost

Total Cost

June 23 16

175 50 225

$8 7

$1,400 350 $1,750

Cost of Goods Sold: $6,960 - $1,750 = $5,210 Proof of Cost of Goods Sold: Date June 1 12 16

Units

150 230 440 820* * 820 = 1,045 - 225 2.

Unit Cost

Total Cost

$ 5 6 7

$ 750 1,380 3,080 $5,210

Average Average unit cost: $6,960 ÷ 1,045 units = $6.66 per unit Ending inventory: 225 units x $6.66 per unit = $1,499 Cost of goods sold: $6,960 - $1,499 = $5,461 Proof of cost of goods sold: 820 units x $6.66 per unit = $5,461

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 6-11 (Continued) (b) The average cost is not $6.50 because the average cost flow assumption uses a weighted average unit cost, not a simple average of unit costs ($5 + $6 + $7 + $8 = $26 ÷ 4 = $6.50). (c)

FIFO—Periodic FIFO—Perpetual Average—Periodic Average—Perpetual

Cost of Goods Sold $5,210 5,210

Ending Inventory $1,750 1,750

5,461 5,387

1,499 1,573

FIFO: The results are identical using either the periodic or the perpetual inventory systems. Average: Cost of goods sold is $74 lower and ending inventory $74 higher using a perpetual system. This is because in the perpetual system the higher priced purchases are only considered in the last sale; in the periodic system the weighted average is based on all of the purchases and is applied to all of the sales.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-12 FIFO Ending Inventory: Date

Units

Unit Cost

Total Cost

May 24 May 15

15 10 25

$12 11

$180 110 $290

Cost of Goods Sold: $915 - $290 = $625 Proof of Cost of Goods Sold: Date

Units

Unit Cost

Total Cost

May 1 May 15

30 35 65

$08 011 0

$240 385 $625

Average Average unit cost: $915 ÷ 90 units = $10.17 (rounded) per unit Ending Inventory: 25 units x $10.17 per unit = $254 (rounded) Cost of Goods Sold: $915 - $254 = $661 Proof of Cost of Goods Sold: 65 units x $10.17 per unit = $661 (rounded)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-13 (a) FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Nov. 1 25 $295 $7,375 Nov. 5 30 $300 $9,000 25 295 30 300 16,375 Nov. 12 25 $295 17 300 $12,475 13 300 3,900 Nov. 19 35 305 10,675 13 300 35 305 14,575 Nov. 22 13 300 32 305 13,660 3 305 915 Nov. 25 20 310 6,200 3 305 20 310 7,115 Total 85 $25,875 87 $26,135 23 $7,115 Proof $7,375 + $25,875 = $26,135 + $7,115 Average

Date Nov. 1 Nov. 5 Nov. 12 Nov. 19 Nov. 22 Nov. 25 Total

Purchases Cost of Goods Sold Units Cost Total Units Cost Total 30 $300

$ 9,000

305

10,675

20 85

310

6,200 $25,875

Units 25 55 42 $297.727 $12,505 13 48 45 303.021 13,636 3 23 87 $26,141 23

Balance Cost Total $295.00 $7,375 297.727 16,375 297.727 3,870 303.021 14,545 303.021 909 309.087 7,109 $7,109

Proof $7,375 + $25,875 = $26,141 + $7,109

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-13 (Continued) (b) Cost of Goods Available Unit Total Date Units Cost Cost Nov. 1 25 $295 $ 7,375 Nov. 5 30 300 9,000 Nov. 19 35 305 10,675 Nov. 25 20 310 6,200 Total 110 $33,250 FIFO Ending Inventory: Date

Units

Unit Cost

Total Cost

Nov. 25 19

20 3 23

$310 305

$6,200 915 $7,115

Cost of Goods Sold: $33,250 - $7,115 = $26,135 Proof of Cost of Goods Sold: Date

Units

Unit Cost

Total Cost

Nov. 1 5 19

25 30 32 87

$295 300 305

$ 7,375 9,000 9,760 $26,135

Average Average cost per unit: $33,250 ÷ 110 units = $302.272 per unit Ending inventory: 23 x $302.272 = $6,952 (rounded) Cost of goods sold: $33,250 - $6,952 = $26,298 Proof of cost of goods sold: 87 x $302.272 = $26,298 (rounded)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-14 (a)

Perpetual FIFO

Nov. 5 Inventory Accounts Payable 12 Cash Sales

Dr. 9,000

Cr. 9,000

18,900

Average Dr. Cr. 9,000 9,000 18,900

18,900

Cost of Goods Sold Inventory

12,475

19 Inventory Accounts Payable

10,675

22 Cash Sales

20,700

18,900 12,505

12,475

12,505 10,675

10,675

10,675 20,700

20,700

Cost of Goods Sold Inventory

13,660

25 Inventory Accounts Payable

6,200

20,700 13,636

13,660

13,636 6,200

6,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-14 (Continued) (b) Periodic FIFO Nov. 5 Purchases Accounts Payable

Dr. 9,000

Average Dr. Cr. 9,000 9,000

Cr. 9,000

12 Cash Sales

18,900

19 Purchases Accounts Payable

10,675

22 Cash Sales

20,700

25 Purchases Accounts Payable

6,200

18,900 18,900

18,900 10,675

10,675

10,675 20,700

20,700

20,700 6,200

6,200

*EXERCISE 6-15 Net sales ($55,000 - $1,000 - $500) ................................. Less: Estimated gross profit (40% x $53,500) .............. Estimated cost of goods sold ........................................

$53,500 021,400 $32,100

Beginning inventory........................................................ Cost of goods purchased ($31,200 - $1,400 - $300 + $1,200) .......................... Cost of goods available for sale..................................... Less: Estimated cost of goods sold ............................. Estimated cost of merchandise .....................................

$23,000 30,700 53,700 032,100 $21,600

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-16 Men’s Shoes

Women’s Shoes

Cost Retail Cost Retail Beginning inventory $ 36,000 $ 58,050 $ 45,000 $ 95,750 Goods purchased 216,000 348,400 315,000 670,200 Goods available for sale $252,000 406,450 $360,000 765,950 Net sales 365,000 635,000 Ending inventory at retail $ 41,450 $130,950 Cost to retail ratio: Estimated cost of ending inventory

$252,000 = 62% $406,450

$360,000 = 47% $765,950

$41,450 x 62% = $25,699

$130,950 x 47% = $61,547

*EXERCISE 6-17 (a) Net sales ($288,600 + $242,000) ..................................... $530,600 Less: Estimated gross profit (45% x $530,600) ............ 0238,770 Estimated cost of goods sold ........................................ $291,830 Beginning inventory ($48,000 + $35,000) ....................... Cost of goods purchased ($145,000 + $132,500) .......... Cost of goods available for sale..................................... Less: Estimated cost of goods sold ............................. Estimated cost of ending inventory ...............................

$ 83,000 0277,500 360,500 0291,830 $ 68,670

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*EXERCISE 6-17 (Continued) (b) Running Shoes

Running Clothes

Cost Retail Cost Retail Beginning inventory $ 48,000 $ 96,000 $ 35,000 $ 59,500 Goods purchased 145,000 290,000 132,500 225,250 Goods available for sale $193,000 386,000 $167,500 284,750 Net sales 288,600 242,000 Ending inventory at retail $ 97,400 $ 42,750 Cost to retail ratio: Estimated cost of ending inventory

$193,000 = 50.0% $386,000

$167,500 = 58.82% $284,750

$97,400 x 50.0% = $48,700

$42,750 x 58.82% = $25,146

Total: $48,700 + $25,146 = $73,846 (c)

The two methods do not result in the same estimate. The estimate using the gross profit rate is $68,670 and the estimate using the retail inventory method is $73,846. The difference is because the gross profit rate is based on historic gross margin rate while the retail method is based on the relationship between cost and selling prices. The difference may be a result of a change in the sales mix of the two products or in the markup on the product cost. I recommend the retail method be used in this case.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a) 1.

Include the unsold portion of $510 ($875 - $365) in Kananaskis inventory. Title passes to the buyer on sale.

Exclude the items from Kananaskis’ inventory. These goods have been sold.

Title to the goods does not transfer to the customer until March 3. Include the $950 in ending inventory.

Kananaskis owns the goods once they are shipped on February 26. Include inventory of $405 ($375 + $30).

Include $630 in inventory. These goods have not yet been sold.

Exclude the items from Kananaskis’ inventory. These goods are owned by Craft Producers.

Title of the goods does not transfer to Kananaskis until March 2. Exclude this amount from the February 28 inventory.

The sale will be recorded on February 26. The goods should be excluded from Kananaskis’ inventory at the end of February.

(b)

$65,000 +510 +950 +405 +630 $67,495

Original Feb. 28 inventory valuation 1. 3. 4. 5. Revised Feb. 28 inventory valuation

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-1A (Continued) Taking It Further The accountant would consider overlooking item 3. A sale to a customer has taken place but the legal ownership of the merchandise is transferred after year end. Recording this transaction in February will increase profit and increase the accountant’s bonus. Not correcting this error would be unethical.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-2A (a)

Oct.

(b)

Cost of goods sold Cost/ Sales price/ Model Serial # Unit Unit 8 Focus C81362 $19,000 $21,000 Mustang G62313 25,000 27,000 18 Mustang G71891 24,000 26,000 Flex X3892 26,000 28,000 F-150 F1921 24,000 26,000 Escape E21202 25,000 27,000 $143,000 $155,000

Ending inventory Model Focus Escape F-150 Mustang Flex Flex F-150 Mustang Escape

Serial # C63825 E11396 F1883 G71811 X4212 X4214 F2182 G72166 E28268

Cost/ Unit $14,000 23,000 21,000 26,000 27,000 30,000 22,000 29,000 25,000 $217,000

Gross profit = $155,000 - $143,000 = $12,000

Taking It Further: Dean’s Sales Ltd. should use the specific identification method because the vehicles are large dollar value items that are specifically identifiable.

6-50

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-3A (a) Purchases Date Units Cost Total Nov. 1 9 100 $46 $4,600 15 22

150

6,600

1,890

Total

295

$13,090

Cost of Goods Sold Balance Units Cost Total Units Cost Total 60 $50 $3,000 60 50 100 46 7,600 60 $50 60 46 $5,760 40 46 1,840 40 46 150 44 8,440 40 46 120 44 7,120 30 44 1,320 30 44 45 42 3,210 280 $12,880 75 $3,210

Proof: $3,000 + $13,090 = $12,880 + $3,210 (b) Nov. 15

Accounts Receivable ......................... Sales (120 x $66)............................

7,920

Cost of Goods Sold ............................ Inventory [(60 x $50) + (60 x $46)]

5,760

Accounts Receivable ......................... Sales (160 x $60)............................

9,600

7,920

5,760

Cost of Goods Sold ............................ 7,120 Inventory [(40 x $46) + (120 x $44)]

9,600

7,120

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-3A (Continued) (c) Sales ($7,920 + $9,600) Cost of goods sold ($5,760 + $7,120) Gross profit (d)

$17,520 12,880 $ 4,640

The entry to record the adjustment would be: Cost of Goods Sold (2 × $44) ............. Merchandise Inventory .................

88 88

Revised gross profit would be: $4,640 − $88 = $4,552

Taking It Further: The inventory shortages could be due to inventory items being damaged, stolen or misplaced. To reduce or eliminate inventory shortages, Lahti should improve internal controls to avoid theft or damage. These controls could include improved physical controls such as a locked warehouse for merchandise and improved inventory rotation to prevent spoilage or damage.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-4A (a) Purchases Date Units Cost Total Nov. 1 9 100 $46 $4,600 15 22 150 44 6,600 29 30 45 42 1,890 Total 295 $13,090

Cost of Goods Sold Balance Units Cost Total Units Cost Total 60 $50.00 $3,000 160 47.50 7,600 120 $47.50 $5,700 40 47.50 1,900 190 44.74 8,500 160 44.74 7,158 30 44.74 1,342 75 43.09 3,232 280 $12,858 75 $3,232

Proof: $3,000 + $13,090 = $12,858 + $3,232 (b)

Before making the change to the FIFO cost formula, the company must consider if the FIFO formula would result in more relevant information in the financial statements. Or has the physical flow of inventory has changed from average flow to FIFO?

(c)

Comparison FIFO Ending Cost of Inventory Goods Sold $3,210 $12,880

Average Ending Cost of Inventory Goods Sold $3,232 $12,858

If prices continue to fall, the FIFO cost formula will continue to yield lower ending inventory and higher cost of goods sold than the average cost formula.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-4A (Continued) Taking It Further: The FIFO cost flow assumption produces the more meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase price. These prices approximate replacement cost, which is the most relevant value for decision making. The average cost flow assumption produces the more meaningful profit because average costs are matched against current revenues (sales). The FIFO cost flow assumption is more likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. In selecting a cost flow assumption, management should consider their circumstances—the type of inventory and the flow of costs throughout the period. Management should also consider their financial reporting objectives. In the final determination, however, management should select the cost flow assumption that will provide the most relevant financial information for decisionmaking.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-5A (a)

(1) FIFO Purchases

Date Units Cost May 1 4 18 5 $105

Total

$525

31 June 5

110

550

12 25 Total

$1,075

Cost of Goods Balance Sold Units Cost Total Units Cost 5 $95 2 $95 $190 3 95 3 95 5 105 3 95 3 105 600 2 105 2 105 5 110 2 105 1 110 320 4 110 2 110 220 2 110 13 $1,330 2

Total $475 285 810 210 760 440 220 $220

Proof: $475 + $1,075 = $1,330 + $220 (2)

Average

Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost May 1 5 $95.00 4 2 $95.00 $190 3 95.00 18 5 $105 $ 525 8 101.25 31 6 101.25 608 2 101.25 June 5 5 110 550 7 107.43 12 3 107.43 322 4 107.43 25 2 107.43 215 2 107.43 Total 10 $1,075 13 *$1,335 2 Proof: $475 + $1,075 = *$1,335 + $215 *rounded

Total $475 285 810 202 752 430 215 $215

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-5A (Continued) (b) FIFO

Average

Sales* ............................................................... $2,975 Cost of goods sold .......................................... 1,330 Gross profit...................................................... $1,645

$2,975 1,335 $1,640

* Sales = (2 x $200) + (6 x $225) + (3 x $245) + (2 x $245) (c)

The choice of inventory cost flow assumption does not affect cash flow. It is an allocation of costs between inventory and cost of goods sold.

Taking It Further: In selecting a cost flow assumption, management should consider their circumstances—the type of inventory and the flow of costs throughout the period. In the final determination, however, management should select the cost flow assumption that best approximates the physical flow of goods or represents recent costs on the balance sheet.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-6A (a) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost July 1 25 $10.00 5 55 $9 $495 80 9.31 8 70 $9.31 $652 10 9.31 10 (15) 9.31 (140) 25 9.31 15 50 8 400 75 8.44 16 (10) 8 (80) 65 8.51 20 55 8.51 468 10 8.51 25 10 7 70 3 32320 7.75 Total 105 $885 110 $980 20 Proof: $250 + $885 = $980 + $155 GENERAL JOURNAL Date

Account Titles and Explanation

July 5

Debit

Inventory (55 x $9) ........................ Cash ..........................................

495

Cash (70 x $15).............................. Sales..........................................

1,050

Cost of Goods Sold ...................... Inventory (70 x $9.31) ...............

652

Sales Returns (15 x $15)............... Cash ..........................................

225

Inventory (15 x $9.31) ................... Cost of Goods Sold ..................

140

Credit

495

1,050

652

225

140

Total $250 745 93 233 633 553 85 155 $155

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-6A (Continued) (a) (Continued) 15

Inventory (50 x $8) ........................ Cash .........................................

400

Cash (10 x $8)................................ Inventory ..................................

Cash (55 x $12).............................. Sales ........................................

660

Cost of Goods Sold ...................... Inventory (55 x $8.51) ..............

468

Inventory (10 x $7) ........................ Cash .........................................

400

660

468

(b)

The ending inventory is 20 units x $7.75 = $155

(c)

Cost: 20 x $7.75 = $155 Net realizable value: 20 x $8 = $160

The ending inventory should be valued at $155, the lower of cost and net realizable value. (d) The cost of goods sold is $980 ($652 - $140 + $468). Since the ending inventory is valued at cost, no entry is required to adjust the amount to lower of cost and net realizable value.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-6A (Continued) Taking It Further: If Amelia had used FIFO instead of average, the cost of the ending inventory on July 31 would be calculated as follows: (10 units x $7) + (10 units x $8) = $150 The FIFO cost is lower than net realizable value, so no adjustment is required. The inventory will be presented on the balance sheet at its cost basis of $150.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-7A (a)

As reported

Year Ended December 31, 2009 Total Owner's Cost of Assets Equity goods sold $ 850,000 $ 650,000 $ 500,000

Profit $ 70,000

Impact of Dec. 31/09 Inventory understatement Correct amount

U 20,000 $ 870,000

O 20,000 $ 480,000

U 20,000 $ 90,000

As reported

Year Ended December 31, 2010 Total Owner's Cost of Assets Equity goods sold $ 900,000 $ 700,000 $ 550,000

Profit $ 80,000

U 20,000 $ 670,000

Impact of Dec. 31/09 Inventory understatement

U 20,000

O 20,000

Impact of Dec. 31/10 Inventory overstatement Correct amount

O 32,000 $ 868,000

O 32,000 $ 668,000

U 32,000 $ 602,000

O 32,000 $ 28,000

As reported

Year Ended December 31, 2011 Total Owner's Cost of Assets Equity goods sold $ 925,000 $ 750,000 $ 550,000

Profit $ 90,000

Impact of Dec. 31/10 Inventory overstatement Correct amount

NE 925,000

NE 750,000

O 32,000 $ 518,000

U 32,000 $ 122,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-7A (Continued) (b) The errors in calculating the company’s ending inventory will not have an impact on the company’s cash account. The cash balances will be correctly stated at December 31, 2009, 2010 and 2011. Taking It Further: Part (a) shows that even though inventory and owner’s equity are correct, the income statement shows the impact of the 2010 error on cost of goods sold and profit. In addition, comparative amounts for 2010 and 2009 would show incorrect amounts for inventory, owner’s equity, cost of goods sold and profit. These errors impact trend and profitability analyses.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-8A (a)

(Incorrect) ALYSSA COMPANY Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit

2011 2010 2009 $340,000 $320,000 $300,000 235,000 225,000 215,000 105,000 95,000 85,000 66,000 66,000 66,000 $ 39,000 $ 29,000 $ 19,000

(Correct) ALYSSA COMPANY Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit

2011 2010 2009 $340,000 $320,000 $300,000 260,000** 200,000* 215,000 80,000 120,000 85,000 66,000 66,000 66,000 $ 14,000 $ 54,000 $ 19,000

** $260,000 = $235,000 + $10,000 + $15,000 * $200,000 = $225,000 - $10,000 - $15,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-8A (Continued) (b) The impact of these errors on owner’s equity at July 31, 2011 is zero because the total of the profit over the three year period is the same with the incorrect statements as it is with the correct statements. However, using the incorrect numbers it appears the company’s profit is increasing over the three year period when in fact it is fluctuating. (c)

Inventory turnover = Cost of goods sold ÷ Average inventory Incorrect 2010: $225,000 ÷ [($35,000 + $25,000) ÷ 2] = 7.50 2011: $235,000 ÷ [($45,000 + $35,000) ÷ 2] = 5.88 Correct 2010: $200,000 ÷ [($45,000 + $25,000) ÷ 2] = 5.71 2011: $260,000 ÷ [($45,000 + $45,000) ÷ 2] = 5.78

Taking it Further: The incorrect annual profits show an increasing trend of profitability with profits increasing from $19,000 in 2009 to $29,000 in 2010 and then to $39,000 in 2011. The corrected profit shows no trend in profitability. Profits increased from $19,000 to $54,000 in 2010 but subsequently decreased to $14,000 in 2011. This decrease is below the 2009 level in profit. It is not possible to determine if the errors are deliberate or not. Certain factors can indicate a higher likelihood that the errors are deliberate. For example management bonuses tied to trends in profitability, or income smoothing, the magnitude of the errors unlikely not to be noticed by management (in this case the errors totalled $25,000 for inventory of $45,000 in 2010).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 6-9A (a)

(1) March 31 (2) April 30

Tonnes

Total Cost

Total NRV

LCNRV

3,000 2,500

$2,115,000 1,837,500

$2,220,000 1,800,000

$2,115,000 1,800,000

(b) (1) Mar. 31 No entry (2) Apr. 30 Cost of Goods Sold ................. Merchandise Inventory ....... (c)

37,500

An adjusting entry is required at May 31 because the inventory, on which a previous write-down had been recorded, is still on hand and the net realizable value has partly recovered. If the inventory on hand at April 30 had been sold then an adjusting entry would not be required. The adjustment is: May 31

(d)

37,500

Merchandise Inventory ........... Cost of Goods Sold............. [($730 − $720) × 2,500]

25,000 25,000

The notes should disclose the cost determination method, the value of inventory reported at net realizable value, the amount of any writedown to net realizable value (for the month of April) and reversals of previous writedowns (for the month of May), including the reason why the writedown was reversed. This type of disclosure would be required if the company prepares monthly financial statements.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-9A (Continued)

Taking It Further: Reporting inventory at the LCNRV is important in order to not overstate the value of inventory on the balance sheet. It would be misleading to record inventory, an asset, at an amount higher than what it could be sold for because inventory is held for resale purposes. If assets are overstated this would mean that expenses are understated which will cause profit and owner’s equity to be overstated.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-10A

PepsiCo. Inc Inventory turnover Days sales in inventory

2008 $20,351 ($2,522 + $2,290)  2 = 8.46 times

365 = 43.2 days 8.46 times

2007 $18,038 ($2,290 + $1,926)  2 = 8.56 times 365 = 42.7 days 8.56 times

Current ratio

$10,151 $10,806 = 1.31 : 1 = 1.23:1 $7,753 $8,787 Acid-test ($2,277 + $4,683) ($2,481 + $4,389) = 0.79 : 1 = 0.89 : 1 ratio $8,787 $7,753 Gross profit $43,251 − $20,351 $39,474 − $18,038 margin $39,474 $43,251 = 54.3% = 52.9% Profit $5,142 $5,658 = 14.3% = 11.9% margin $39,474 $43,251

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-10A (Continued)

Coca- Cola Company Inventory turnover Day sales in inventory Current ratio Acid-test ratio

Gross profit margin Profit margin

2008 $11,374 ($2,187 + $2,220)  2 = 5.16 times 365 = 70.7 days 5.16 times

2007 $10,406 ($2,220 + $1,641)  2 = 5.39 times 365 = 67.7 days 5.39 times

$12,176 $12,105 = 0.94 : 1 = 0.92 : 1 $12,988 $13,225 ($4,979 + $3,090) ($4,308 + $3,317) = 0.58 : 1 = 0.62 : 1 $13,225 $12,988

$31,944 − $11,374 $31,944 = 64.4% $5,807 = 18.2% $31,944

$28,857 − $10,406 $28,857 = 63.9% $4,847 = 22.3% $21,742

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-10A (Continued) Taking It Further: PepsiCo’s liquidity is reasonably healthy. Its current ratio is more than 1:1 and it increased from 2007 to 2008 although the acid-test ratio decreased over the same time period. Its inventory turnover and days sales in inventory showed a slight deterioration for the two years. PepsiCo’s results for 2007 and 2008 show a gross profit margin of 52.9% and 54.3% respectively and a profit margin of 11.9% and 14.3%. Both the gross profit and the profit margin decreased substantially. Coca-Cola’s liquidity is also reasonably healthy. Its current ratio was 0.92:1 in 2007 and it increased marginally from 2007 to 2008. The acid-test ratio also shows improvement from 0.58:1 in 2007 to 0.62 in 2008. Its inventory turnover and days sales showed a slight deterioration for the two years. Although Coca-Cola was profitable in both years, its profitability declined from 2007 to 2008. Its gross profit margin improved from 63.9% in 2007 to 64.4% in 2008 although its profit margin decreased from 20.7% to 18.2%. It is meaningful to compare these two companies in terms of their ratios because the companies operate in the same industry. They are different in terms of their size and a ratio analysis eliminates this difference and makes for a meaningful comparison. Although PepsiCo’s has more liquidity (its current ratio, acid-test ratio and inventory turnover are higher than Coca-Cola’s), it is substantially less profitable. It would be useful to know if their accounting polices differ in any significant ways.

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*PROBLEM 6-11A (a) Cost of Goods Available for Sale Date Jan. 1 Mar. 15 July 20 Sept. 4 Dec. 2 Total

Explanation Units Unit Cost Total Cost Beginning inventory 250 $16 $ 4,000 Purchase 700 15 10,500 Purchase 500 14 7,000 Purchase 450 13 5,850 Purchase 100 12 1,200 2,000 $28,550

(b) (1) FIFO Ending Inventory: Date Units Dec. 2 100 Sep. 4 200 300

Unit Cost $ 12 13

Total Cost $1,200 2,600 $3,800

Cost of goods sold: $28,550 - $3,800 = $24,750 Proof of cost of goods sold: Date Units Unit Cost Total Cost Jan. 1 250 $ 16 $ 4,000 Mar. 15 700 15 10,500 July 20 500 14 7,000 Sep. 4 250 13 3,250 1,700* $24,750 *1,700 = 2,000 - 300

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*PROBLEM 6-11A (Continued) (b) (Continued) (2) Average Average unit cost: $28,550  2,000 units = $14.28 per unit Ending Inventory: 300 units x $14.28 per unit = $4,284 Cost of Goods Sold: $28,550 - $4,284 = $24,266 Proof of cost of goods sold: 1,700 units x $14.28 per unit = $24,276 (difference due to rounding). (c) Sales revenue (1,700 x $32) Cost of goods sold Gross profit

FIFO Average $54,400 $54,400 24,750 24,266 $29,650 $30,134

Taking It Further: Ng should continue to use the average cost flow method. GAAP requires that cost flow methods be applied consistently from year to year. Changes in cost flow methods are allowed only if the physical flow of inventory has changed and the new method results in more relevant information.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-12A (a) (1) FIFO—Periodic Cost of goods available for sale Date Explanation Units May 1 Beginning inventory 25,000 6 Purchase 30,000 19 Purchase 35,000 28 Purchase 45,000 Total 135,000 Date May 1 2 6 10 15 19 24 28

Description Beginning inventory Sale Purchase Sale Sale Purchase Sale Purchase Ending inventory

Ending Inventory: Date Units May 28 45,000 May 19 10,000 55,000

Unit Cost $ 2.75 2.50

Unit Cost Total Cost $2.25 $56,250 2.30 69,000 2.50 87,500 2.75 123,750 $336,500 Units 25,000 (10,000) 30,000 (25,000) (5,000) 35,000 (40,000) 45,000 55,000

Total Cost $123,750 25,000 $148,750

Cost of goods sold: $336,500 - $148,750 = $187,750 Proof of cost of goods sold: Date Units Unit Cost May 1 25,000 $2.25 6 30,000 2.30 19 25,000 2.50 80,000

Total Cost $56,250 69,000 62,500 $187,750

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-12A (Continued) (a) (Continued) (2) FIFO—Perpetual

Date May 1 2 6

Purchases Units Cost

30,000

Total

35,000

10,000

$2.25

$22,500

15,000 10,000 5,000

2.25 2.30 2.30

56,750 11,500

$2.30 $69,000

10 15 19

Cost of Goods Sold Units Cost Total

2.50

87,500 15,000 25,000

2.30 2.50

97,000

28 Total

45,000 110,000

2.75 123,750 $280,250 80,000

$187,750

Balance Units Cost Total 25,000 $2.25 $56,250 15,000 2.25 33,750 15,000 2.25 30,000 2.30 102,750 20,000 15,000 15,000 35,000

2.30 2.30 2.30 2.50

10,000 10,000 45,000 55,000

2.50 2.50 2.75

46,000 34,500 122,000 25,000 148,750 $148,750

Check: $56,250 + $280,250 = $187,750 + $148,750

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*PROBLEM 6-12A (Continued) (b) Comparison

FIFO

Perpetual Ending Cost of Inventory Goods Sold $148,750 $187,750

Periodic Ending Cost of Inventory Goods Sold $148,750 $187,750

The numbers are the same because regardless of the system (perpetual or periodic), the first costs are assigned to the cost of goods sold. Taking It Further: Companies are required to disclose their inventory cost determination method (FIFO, average or specific identification), but not whether a periodic or perpetual system is used. This additional level of information does not provide information that is relevant to users of financial information. The differences between FIFO and average for example would inform users of how costs flow to the income statement when increases or decreases in costs occur. This pattern is not affected by the choice between periodic and perpetual systems.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-13A (a) (1) Average—periodic Goods Available for Sale Date Units Unit Cost Total Cost Jan. 1 250 $28 $7,000 8 110 32 3,520 15 100 36 3,600 26 110 40 4,400 27 (6) 40 (240) Total 564 $18,280 Average cost per unit: $18,280 ÷ 564 = $32.41 Ending inventory = 269a x $32.41 = $8,718 a 269 = 564 - 175 - 120 Cost of goods sold = $18,280 - $8,718 = $9,562 Proof of cost of goods sold: 295b x $32.41 = $9,561 (difference due to rounding). b 295 = 175 + 120 (2) Average—perpetual Cost of Goods Purchases Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan. 1 250 $28.00 $7,000 8 110 $32 $ 3,520 360 29.22 10,520 10 175 $29.22 $5,114 185 29.22 5,406 15 100 36 3,600 285 31.60 9,006 25 120 31.60 3,792 165 31.60 5,214 26 110 40 4,400 275 34.96 9,614 27 (6) 40 (240) 269 34.85 9,374 Total 314 $11,280 295 $8,906 269 $9,374 Proof $7,000 + $11,280 = $8,906 + $9,374

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-13A (Continued) (b) Comparison Periodic Perpetual Ending Cost of Ending Cost of Inventory Goods Sold Inventory Goods Sold Average

$8,718

$9,562

$9,374

$8,906

The numbers are different. Using the perpetual system, the average cost is recalculated after every purchase. Because the prices are rising, this results in a lower cost of goods sold. Taking It Further: The periodic and perpetual systems both involve calculating a weighted average cost of inventory. Under the periodic system, the average cost is calculated at the end of the period and involves a weighted average of beginning inventory and all purchases during the period. This average cost is applied to the total volume of items sold throughout the period to calculate cost of goods sold, even though some sales have occurred before some of the purchases. Under the perpetual system, the average cost is recalculated whenever a purchase is made. The current average cost is applied to sales in chronological order. Subsequent purchases are used to recalculate a new average cost.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-14A November Net sales ($450,000 - $10,000 - $4,500) .......................... $435,500 Cost of goods sold Beginning inventory ................................. $22,700 Purchases................................. $275,745 Less: Purchase returns and allowances ...... $11,700 Purchase discounts. 2,950 14,650 Net purchases .......................... 261,095 Add: Freight in ....................... 4,573 Cost of goods purchased ......................... 265,668 Cost of goods available for sale .............. 288,368 Ending inventory....................................... 26,270 Cost of goods sold ..................................................... 262,098 Gross profit...................................................................... $173,402 Gross profit margin = $173,402 = 39.8% $435,500 December Net sales ($600,000 - $12,000 - $5,400) .......................... $582,600 Less: Estimated gross profit (39.8% x $582,600) .......... 231,875 Estimated cost of goods sold ........................................ $350,725 Beginning inventory........................................................ $ 26,270 Purchases ........................................................ $355,235 Less: Purchase returns and allowances $12,900 Purchase discounts .......... 3,500 16,400 Net purchases ................................................. 338,835 Freight in .......................................................... 4,100 Cost of goods purchased ............................................... 342,935 Cost of goods available for sale..................................... 369,205 Less: Estimated cost of goods sold .............................. 350,725 Estimated inventory lost in fire ...................................... $ 18,480

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-14A (Continued) Taking It Further: The gross profit method is based on the assumption that the gross profit ratio remains constant from November to December. The gross profit ratio will be affected by merchandising policies or market conditions. In addition, the gross profit ratio may be affected by the product mix included in the sales amount; the method is more accurate when applied to a department or product line, rather than to operations as a whole.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-15A Video Games DVD’s Cost Retail Cost Retail Beginning inventory $ 275,000 $423,000 $ 190,000 $ 322,000 Purchases 1,180,000 1,800,000 1,045,000 1,771,000 Purchase returns (23,600) (36,000) (20,900) (35,400) Purchase discounts (5,900) (5,100) Freight in 5,000 6,200 Goods available for sale$1,430,500 2,187,000 $1,215,200 2,057,600 Net sales (1,798,000) (1,626,000) Ending inventory at retail $ 389,000 $ 431,600 Cost-to-retail ratio: Video Games—$1,430,500 ÷ $2,187,000 = 65.4% DVDs—$1,215,200 ÷ $2,057,600 = 59.1% Estimated ending inventory at cost: $389,000 x 65.4% = $254,406—Video Games $431,600 x 59.1% = $255,076—DVDs

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 6-15A (Continued) Taking It Further: Video Games—$381,250 x 65.4% = $249,338 per count $254,406 estimated $ 5,068 loss at cost Loss at retail = $389,000 - $381,250 = $7,750 DVDs—$426,100 x 59.1% =

$251,825 per count $255,076 estimated $ 3,251 loss at cost

Loss at retail = $431,600 - $426,100 = $5,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-1B (a) 1.

The unsold portion of these goods $510 ($875 - $365) is owned by Kananaskis Company not Banff Company and should not be included in Banff Company’s count. Therefore, no adjustment is required because it was correct to not include them.

2. $750 should be included in inventory as the goods were shipped FOB shipping point on February 27. Title passes to Banff on February 27, the date of shipping. 3. The goods should not be included in inventory as they were shipped FOB shipping point on February 26. Title to the goods transfers to the customer on February 26, the date of shipping. Since these items were not on the premises, they were not counted in inventory. No correction is required. 4. The amount should not be included in inventory as they were shipped FOB destination and not received until March 2. The seller still owns the inventory. Since these items were not on the premises, they were not counted in the ending inventory valuation. No correction is required. 5. The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $360. Since they were in the shipping department, it is assumed they were not included in the inventory count. 6. The damaged goods should not be included in inventory because they are not saleable and have no value. Therefore, no adjustment is required because it was correct not to include them.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-1B (Continued) (a) (Continued) 7. As these items have been sold, they should be excluded from Banff’s inventory. Therefore, no adjustment is required because it was correct to not include them. 8. Include $570 in inventory. These goods are owned by Banff Company. 9. Include $620 in inventory. These goods have not yet been sold.

(b)

$56,000 +750 +360 +570 +620 $58,300

Original Feb. 28 inventory valuation 2. 5. 8. 9. Revised Feb. 28 inventory valuation

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PROBLEM 6-1B (Continued) Taking It Further The owner might tell the accountant not to correct items 8 and 9. These transactions relate to the timing of when inventory is transferred to cost of goods sold. Not correcting these items would cause a discrepancy between the inventory records and the count and trigger an adjusting entry. Since the items are not yet sold to customers, no sale would be recorded in the same accounting period as the charge to cost of goods sold. This would decrease gross profit and minimize income taxes. This would however cause the business to pay more taxes in the following year when the merchandise is sold and the sale is recorded on the income statement. The sale would have no offsetting cost of goods sold and the full sales price would be taxable, rather than the gross profit. The owner might consider telling the accountant not to correct item 5 as well if the sale is not recorded in the February year end. Recording the sale in the same period as the cost of goods sold increases gross profit and increases the income taxes. Not correcting these items is unethical behaviour for the owner and the accountant.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-2B (a)

Aug

Cost of Goods Sold Cost/ Sales Supplier Serial # Unit price/ Unit 10 Suzuki SZ5828 $ 1,600 $ 2,700

Ending Inventory Supplier Suzuki

Serial # SZ5716

Cost/ Unit $ 1,100

Kawai

KG1520

600

1,400

Kawai

KG1268

1,500

18 Yamaha

YH4418

1,300

2,100

Steinway

ST8411

2,600

Steinway

ST0944

2,200

3,700

Suzuki

SZ6148

1,600

Kawai

KG1239

900

1,400

Suzuki

SZ5824

1,700

2,850

26 Suzuki

SZ6132

1,800

2,900

Steinway

ST0815

1,200

2,000

Yamaha

YH6318

1,500

2,500

Yamaha

YH5632

1,600

2,600

$14,400

$24,150

$ 6,800

(b) Gross profit = $24,150 - $14,400 = $9,750 Taking It Further: Irene’s Best Piano Sales is best to use the specific identification method because it sells large dollar value items that are specifically identifiable.

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PROBLEM 6-3B (a) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total June 1 20 $50.00 $1,000 4 85 $55 $4,675 105 54.05 5,675 10 90 $54.05 $4,864 15 54.05 811 18 35 58 2,030 50 56.82 2,841 25 30 56.82 1,705 20 56.82 1,136 28 15 60 900 35 58.17 2,036 30 135 $7,605 120 $6,569 35 $2,036 Proof: $1,000 + $7,605 = $6,569 + $2,036 (b) June 10 Accounts Receivable ......................... Sales (90 x $90)..............................

8,100

Cost of Goods Sold ............................ Inventory (90 x $54.05) ..................

4,864

Accounts Receivable ......................... Sales (30 x $95)..............................

2,850

Cost of Goods Sold ............................ Inventory (30 x $56.82) ..................

1,705

8,100

4,864

2,850

1,705

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-3B (Continued) (c) Sales ($8,100 + $2,850) Cost of goods sold ($4,864 + $1,704) Gross profit (d)

$10,950 6,569 $4,381

The entry to record the adjustment would be: Merchandise Inventory ...................... Cost of Goods Sold .......................

58 58

Revised gross profit is: $4,381 + 58 = $4,439 Taking It Further: The inventory overage could be due to inventory items being returned but not recorded, an error recording purchases or sales quantities, or an error in the physical count.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-4B (a)

Date June 1 4

Purchases Cost of Goods Sold Balance Units Cost Total Units Cost Total Units Cost Total

$55 $4,675

10 18

15 135

$50 55 $4,850

15 15

55 58

58 2,030

25 28 30

20 70

900 $7,605

120

1,695

$6,545

20 20 85

$50 $1,000 50 55 5,675

15 15 35

55 825 55 58 2,855

20 20 15 35

58 1,160 58 60 2,060 $2,060

Proof: $1,000 + $7,605 = $6,545 + $2,060 (b)

Before making the change to the average cost formula, the company must consider if the average formula would result in more relevant information in the financial statements. Or example, has the physical flow of inventory has changed from FIFO to average?

(c)

Comparison FIFO Ending Cost of Inventory Goods Sold $2,060 $6,545

Average Ending Cost of Inventory Goods Sold $2,036 $6,569

If prices continue to rise, the FIFO cost formula will continue to yield higher ending inventory and lower cost of goods sold than the average cost formula.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-4B (Continued) Taking It Further: The FIFO cost flow assumption produces the more meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase price. These prices approximate replacement cost, which is the most relevant value for decision making. The average cost flow assumption produces the more meaningful profit because average costs are matched against current revenues (sales). The FIFO cost flow assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. In selecting a cost flow assumption, management should consider their circumstances—the type of inventory and the flow of costs throughout the period. Management should also consider their financial reporting objectives. In the final determination, however, management should select the cost flow assumption that will provide the most relevant financial information for decisionmaking.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-5B (a)

(1) FIFO

Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Apr. 1 36 $210 $7,560 8 18 $210 $3,780 18 210 3,780 18 210 23 50 $202 $10,100 50 202 13,880 18 210 26 32 202 10,244 18 202 3,636 18 202 May 9 24 198 4,752 24 198 8,388 18 202 21 14 198 6,408 10 198 1,980 74 $14,852 100 $20,432 10 $1,980 Proof: $7,560 + $14,852 = $20,432 + $1,980 (2) Average Purchases Cost of Goods Sold Balance Date Unit Cost Total Units Cost Total Units Cost Total Apr. 1 36 $210.00 $7,560 8 18 $210.00 $ 3,780 18 210.00 3,780 23 50 $202 $10,100 68 204.12 13,880 26 50 204.12 10,206 18 204.12 3,674 May 9 24 198 4,752 42 200.62 8,426 21 32 200.62 6,420 10 200.62 2,006 30 74 $14,852 100 $20,406 10 $2,006 Proof: $7,560 + $14,852 = $20,406 + $2,006

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-5B (Continued) (b) GRINDER COMPANY Income Statement (Partial) Two Months Ended May 31, 2011 FIFO Average Sales ($5,760 + $15,000 + $9,280) ................... Cost of goods sold .......................................... Gross profit...................................................... (c)

$30,040 20,432 9,608

$30,040 20,406 9,634

The choice of inventory cost flow assumption does not affect cash flow. It is an allocation of costs between inventory and cost of goods sold.

Taking It Further: In selecting a cost flow assumption, Grinder should consider their circumstances—the type of inventory and the flow of costs throughout the period. In the final determination, however, Grinder should select the cost flow assumption that best approximates the physical flow of goods or represents recent costs on the balance sheet.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-6B (a) GENERAL JOURNAL Date

Account Titles and Explanation

Oct. 5 8

15 16 20

Debit

Inventory (110 x $13) ................... Cash .......................................

1,430

Cash (140 x $20) .......................... Sales .......................................

2,800

Cost of Goods Sold ..................... Inventory ................................. (60 x $14) + (80 x $13)

1,880

Sales Returns and Allowances .. Cash (25 x $20) .......................

500

Inventory (25 x $13) ..................... Cost of Goods Sold ................

325

Inventory (35 x $12) ..................... Cash ........................................

420

Cash (5 x $12) .............................. Inventory .................................

Cash (70 x $16) ............................ Sales .......................................

1,120

Cost of Goods Sold ..................... Inventory ................................. (55 x $13) + (15 x $12)

895

Inventory (15 x $11) ..................... Cash ........................................

165

Credit

1,430 2,800 1,880

500 325 420 60 1,120 895

165

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-6B (Continued) (b) Ending Inventory (FIFO): Date Units Unit Cost Oct. 25 15 $ 11 15 15 12 30*

Total Cost $165 180 $345

*30 = 60 + 110 - 140 + 25 + 35 - 5 - 70 + 15 (c)

Cost: $345 Net realizable value: 30 x $10 = $300 The inventory should be valued at its net realizable value of $300. This is the lower of cost and net realizable value.

(d) Cost of goods sold per (a)* Plus: write down to NRV ($345 - $300) Cost of goods sold reported on the income statement

$2,450 45 $2,495

*$2,450 = $1,880 - $325 + $895 Cost of Goods Sold ($345 - $300) ..... Merchandise Inventory .................

45 45

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PROBLEM 6-6B (Continued) Taking It Further: Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Oct 1 60 $14.00 5 110 $13 $1,430 170 13.35 8 140 $13.35 $1,869 30 13.35 10 (25) 13.35 (333) 55 13.35 15 35 12 420 90 12.82 16 (5) 12 (60) 85 12.87 20 70 12.87 901 15 12.87 25 15 11 165 3 32330 11.93 Total 155 $1,955 185 $2,437 30

Total $840 2,270 401 734 1,154 1,094 193 358 $358

Proof: $840 + $1,955 = $2,437 + $358 The ending inventory cost under the average cost formula is $358. The October 31 balance sheet amount would be $300, the lower of cost and net realizable value. The balance sheet amount is the same because net realizable value is lower than cost under both cost formulae.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 6-7B (a) Year Ended December 31, 2009

As reported

Total Assets $525,000

Owner's Cost of Equity goods sold $250,000 $ 300,000

Profit $ 40,000

Impact of Dec. 31/09 Inventory overstatement Correct amount

O 20,000 $505,000

O 20,000 $230,000

U 20,000 $ 320,000

O 20,000 $ 20,000

Year Ended December 31, 2010 Total Owner's Cost of Assets Equity goods sold $575,000 $275,000 $335,000

Profit $ 50,000

As reported

Impact of Dec. 31/09 Inventory overstatement

O 20,000

U 20,000

Impact of Dec. 31/10 Inventory understatement Correct amount

U 30,000 $605,000

U 30,000 $305,000

O 30,000 $285,000

U 30,000 $100,000

Year Ended December 31, 2011

As reported

Total Assets $600,000

Owner's Cost of Equity goods sold $280,000 $315,000

Profit $ 60,000

Impact of Dec. 31/10 Inventory understatement Correct amount

NE $600,000

NE $280,000

O 30,000 $ 30,000

U 30,000 $345,000

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PROBLEM 6-7B (Continued) (b) The errors in calculating the company’s ending inventory will not have an impact on the company’s cash account. The cash balances will be correctly stated at December 31, 2009, 2010 and 2011. Taking It Further: Part (a) shows that even though inventory and owner’s equity are correct, the income statement shows the impact of the 2010 error on cost of goods sold and profit. In addition, comparative amounts for 2010 and 2009 would show incorrect amounts for inventory, owner’s equity, cost of goods sold and profit. These errors impact trend and profitability analyses.

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PROBLEM 6-8B (a)

(Incorrect) PELLETIER COMPANY Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit

2011 2010 2009 $324,000 $312,000 $300,000 270,000 255,000 240,000 54,000 57,000 60,000 50,000 50,000 50,000 $ 4,000 $ 7,000 $10,000

(Correct) PELLETIER COMPANY Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit (loss)

2011 2010 2009 $324,000 $312,000 $300,000 260,000* 250,000** 255,000*** 64,000 62,000 45,000 50,000 50,000 50,000 $ 14,000 $ 12,000 $ (5,000)

* $260,000 = $270,000 - $10,000 ** $250,000 = $255,000 + $10,000 - $15,000 *** $255,000 = $240,000 + $15,000

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PROBLEM 6-8B (Continued) (b) The combined effect of the errors at July 31, 2011 before correction is nil. The error in 2010 closing inventory is offset by the error in 2011 opening inventory and the error in the 2009 purchases is offset by the error in 2010 purchases. The trend over the three years is completely opposite using the incorrect numbers as compared to the correct numbers. (c)

Inventory turnover ratio = Cost of goods sold ÷ Average inventory Incorrect 2010: $255,000 ÷ [($30,000 + $35,000) ÷ 2] = 7.85 2011: $270,000 ÷ [($20,000 + $30,000) ÷ 2] = 10.80 Correct 2010: $250,000 ÷ [($35,000 + $20,000) ÷ 2] = 9.09 2011: $260,000 ÷ [($20,000 + $20,000) ÷ 2] = 13.0

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PROBLEM 6-8B (Continued) Taking it Further: The incorrect annual profits show a decreasing trend of profitability with profits decreasing from $10,000 in 2009 to $7,000 in 2010 and then to $4,000 in 2011. The corrected profit (loss) show an increasing trend in profitability with profits increasing from a loss of $5,000 to profits of $12,000 in 2010 and then to a profit of $14,000 in 2011. It is not possible to determine if the errors are deliberate or not. Certain factors can indicate a higher likelihood that the errors are deliberate. Management bonuses tied to trends in profitability, or a desire to maintain profitability every year may could encourage deliberate misstatement. In addition, the magnitude of the errors is unlikely not to be noticed by management. If management were deliberately recording the errors it would indicate that they had a motivation to minimize profits for purposes of paying less income tax.

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PROBLEM 6-9B (a) (1) (2)

June 30 July 31

Total Cost $3,800,000 5,896,000

Total NRV $4,250,000 5,460,500

LCNRV $3,800,000 5,460,500

(b) (1) June 30 No entry (2) July 31 Cost of Goods Sold ................. 435,500 Merchandise Inventory ....... ($5,896,000 − $5,460,500) (c)

An adjusting entry is required at August 31 because the inventory, on which a previous write-down had been recorded, is still on hand and the net realizable value has partly recovered. If the inventory on hand at July 31 had been sold then an adjusting entry would not be required. The adjustment is: Aug. 31

(d)

435,500

Merchandise Inventory ........... Cost of Goods Sold............. [($820 − $815) × 5,500]

27,500 27,500

The notes should disclose the cost determination method, the value of inventory reported at net realizable value, the amount of any writedown to net realizable value (for the month of July) and reversals of previous writedowns (for the month of August), including the reason why the writedown was reversed. This type of disclosure would be required if the company prepares monthly financial statements.

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PROBLEM 6-9B (Continued) Taking It Further: Reporting inventory at the LCNRV is important in order to not overstate the value of inventory on the balance sheet. It would be misleading to report inventory, an asset, at an amount higher than what it could be sold for because inventory is held for resale purposes. If assets are overstated this would mean that expenses are understated which will cause profit and owner’s equity to be overstated.

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PROBLEM 6-10B Home Depot Inc. Inventory turnover Days sales in inventory

2008 $47,298 ($10,673 + $11,731)  2 = 4.22 times

365 = 86.4 days 4.22 times

Current ratio $13,362 = 1.20 : 1 $11,153 Acid-test ($525 + $972) = 0.13 : 1 ratio $11,153 Gross profit $71,288 − $47,298 margin $71,288 = 33.7% Profit $2,260 = 3.2% margin $71,288

2007 $51,352 ($11,731 + $12,822)  2 = 4.18 times 365 = 87.3 days 4.18 times

$14,674 = 1.15 : 1 $12,706 ($457 + $1,259) = 0.14 : 1 $12,706 $77,349 − $51,352 $77,349 = 33.6% $4,395 = 5.7% $77,349

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PROBLEM 6-10B (Continued) Lowe’s Companies Inc. Inventory turnover Day sales in inventory Current ratio Acid-test ratio Gross profit margin Profit margin

2008

2007

$31,729 ($8,209 + $7,611)  2 = 4.01 times 365 = 91.0 days 4.01 times

$31,556 ($7,611 + $7,144)  2 = 4.28 times 365 = 85.3 days 4.28 times

$9,251 = 1.15 : 1 $8,022 $661 = 0.08 : 1 $8,022 $48,230 − $31,729 $48,230 = 34.2% $2,195 = 4.6% $48,230

$8,686 = 1.12 : 1 $7,751 $530 = 0.07 : 1 $7,751 $48,283 − $31,556 $48,283 = 34.6% $2,809 = 5.8% $48,283

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PROBLEM 6-10B (Continued) Taking It Further: It is difficult to conclude on Home Depot’s liquidity. While its current ratio is more than 1:1 and it increased from 2007 to 2008, the acid-test ratio is very low and decreased slightly over the same time period. It would be helpful to have industry statistics to determine if the low acid-test ratio is normal for companies in this industry. Its inventory turnover and days sales in inventory showed a slight improvement for the two years. Home Depot’s show a stable gross profit margin of 33.6% and 33.7% but a substantial decrease in overall profitability as its profit margin decreased from 5.7% to 3.2%. There are similar issues in commenting on Lowe’s liquidity. Its current ratio was 1.12:1 in 2007 and it increased to 1.15:1 in 2008. The acid-test ratio also shows improvement from 0.07:1 in 2007 to 0.08 in 2008. But the acid-test ratio is very low and we would benefit from being able to compare it to industry averages. Its inventory turnover and days sales showed deterioration for the two years. Lowe’s showed a similar pattern in profitability as Home Depot. Its gross profit margin was relatively stable at 34.6 in 2007 and 34.2 in 2008 with a decline in overall profitability from 5.8% in 2007 to 4.6% in 2008. The decline in profitability is not as large as Home Depot’s. It is meaningful to compare these two companies in terms of their ratios because the companies operate in the same industry. They are different in terms of their size and a ratio analysis eliminates this difference and makes for a meaningful comparison. They have similar liquidity and profitability ratios. Lowe’s appears to have less liquidity than Home Depot with lower current and acid-test ratios, and lower inventory turnover. Lowe’s however has a higher gross profit and profit margins than Home Depot. It would be useful to know if their accounting polices differ in any significant ways. Solutions Manual 6-102 Chapter 6 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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*PROBLEM 6-11B (a) Cost of Goods Available for Sale Date Jan. 1 Feb. 20 May 5 Oct. 12 Nov. 8 Total

Explanation Units Unit Cost Total Cost Beginning inventory 100 $30 $ 3,000 Purchase 600 32 19,200 Purchase 300 36 10,800 Purchase 200 42 8,400 Purchase 150 44 6,600 1,350 $48,000

(b) (1) FIFO Ending Inventory: Date Units Nov. 8 150 Oct. 12 75 225

Unit Cost $ 44 42

Total Cost $6,600 3,150 $9,750

Cost of goods sold: $48,000 - $9,750 = $38,250 Proof of cost of goods sold: Date Units Unit Cost Jan. 1 100 $ 30 Feb. 20 600 32 May 5 300 36 Oct. 12 125 42 1,125*

Total Cost $ 3,000 19,200 10,800 5,250 $38,250

*1,125 = 1,350 - 225

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*PROBLEM 6-11B (Continued) (b) (Continued) (2) AVERAGE Average unit cost: $48,000  1,350 units = $35.56 per unit Ending Inventory: 225 units x $35.56 per unit = $8,001 Cost of Goods Sold: $48,000 - $8,001 = $39,999 Proof of cost of goods sold: 1,125 units x $35.56 per unit = $40,005 (difference due to rounding). (c) Sales revenue (1,125 x $70) Cost of goods sold Gross profit

FIFO $78,750 38,250 $40,500

Average $78,750 39,999 $38,751

Taking It Further: Savita Company should continue to use the FIFO cost flow method. GAAP requires that cost flow methods be applied consistently from year to year. Changes in cost flow methods are allowed only if the physical flow of inventory has changed and the new method results in more relevant information. The company cannot change methods simply because they wish to achieve a particular outcome for income tax purposes.

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*PROBLEM 6-12B (a) (1) Average—periodic Cost of Goods Available Date Units Unit Cost Total Cost Aug. 1 15,000 $3.75 $56,250 6 40,000 4.00 160,000 19 45,000 4.25 191,250 28 20,000 4.50 90,000 Total 120,000 $497,500 Average cost per unit: $497,500 ÷ 120,000 = $4.1458 Ending inventory = 25,500a x $4.1458 = $105,718 a 25,500 = 120,000 – 10,000 – 30,000 – 4,500 – 50,000 Cost of goods sold = $497,500 - $105,718 = $391,782 Proof of cost of goods sold: 94,500b x $4.15 = $391,778* b 94,500 = 10,000 + 30,000 + 4,500 + 50,000 * Proof is out by $4 ($391,782 − $391,778) due to rounding of average cost per unit. Actual average cost = $4.145833 per unit, not $4.1458 per unit. This difference will be more pronounced if the average cost per unit had been rounded further to either $4.146 or even $4.15.

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*PROBLEM 6-12B (Continued) (a) (Continued) (2) Average—perpetual Purchases Date Units Cost Total Aug. 1 2 6 40,000 $4.00 $160,000 10 15 19 45,000 4.25 191,250 24 28 20,000 4.50 90,000 Total 105,000 $441,250

Cost of Goods Sold Units Cost Total 10,000

$3.75

$37,500

30,000 3.9722 4,500 3.9722

119,166 17,875

50,000 4.1975 209,875 _ _ 94,500 $384,416

Units 15,000 5,000 45,000 15,000 10,500 55,500 5,500 25,500 25,500

Balance Cost $3.75 3.75 3.9722 3.9722 3.9722 4.1975 4.1975 4.4347

Total $56,250 18,750 178,750 59,584 41,709 232,959 23,084 113,084 $113,084

Proof $56,250 + $441,250 = $384,416 + $113,084

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*PROBLEM 6-12B (Continued) (b) Comparison Periodic Perpetual Ending Cost of Ending Cost of Inventory Goods Sold Inventory Goods Sold Average

$105,718

$391,782

$113,084

$384,416

The numbers are different. Using the perpetual system, the average cost is recalculated after every purchase. Because the prices are rising this results in a lower cost of goods sold.

Taking It Further: Companies are required to disclose their inventory cost determination method (FIFO, average or specific identification), but not whether a periodic or perpetual system is used. This additional level of information does not provide information that is relevant to users of financial information. The differences between FIFO and average for example would inform users of how costs flow to the income statement when increases or decreases in costs occur. This pattern is not affected by the choice between periodic and perpetual systems.

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*PROBLEM 6-13B (a)

(1) FIFO—Perpetual Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan.1 35 $60 $2,100 5 125 $64 $8,000 35 60 125 64 10,100 7 35 $60 75 64 $ 6,900 50 64 3,200 14 30 68 2,040 50 64 30 68 5,240 20 50 64 10 68 3,880 20 68 1,360 21 (5) 68 (340) 25 68 1,700 25 68 25 20 70 1,400 20 70 3,100 Total 175 $11,440 165 $10,440 45 $3,100 Proof: $2,100 + $11,440 = $10,440 + $3,100

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*PROBLEM 6-13B (Continued) (a) (Continued) (2) FIFO—Periodic Cost of goods available for sale Date Explanation Units Jan. 1 Beginning inventory 35 5 Purchase 125 14 Purchase 30 25 Purchase 20 Total 210 Ending Inventory: Date Units Jan. 25 20 14 25 45

Unit Cost $ 70 68

Unit Cost Total Cost $60 $ 2,100 64 8,000 68 2,040 70 1,400 $13,540

Total Cost $1,400 1,700 $3,100

Cost of goods sold: $13,540 - $3,100 = $10,440 Proof of cost of goods sold: Date Units Unit Cost Jan. 1 35 $60 5 125 64 14 10 68 21 (5) 68 165

Total Cost $ 2,100 8,000 680 (340) $10,440

(b) Comparison

FIFO

Perpetual Ending Cost of Inventory Goods Sold $3,100 $10,440

Periodic Ending Cost of Inventory Goods Sold $3,100 $10,440

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*PROBLEM 6-13B (Continued) Taking It Further: When using FIFO, the periodic and perpetual systems produce the same results. This is because the system assigns the oldest costs to cost of goods sold in both the periodic and perpetual systems. This pattern matches the chronological order of transactions reflected in the perpetual system.

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*PROBLEM 6-14B February Net sales ($309,000 - $6,000 - $3,000) ............................ $300,000 Cost of goods sold Beginning inventory .............................. $ 17,500 Net purchases ($203,000 - $4,300 - $2,000) . $196,700 Add: Freight in ...................... 3,000 Cost of goods purchased ..................... 199,700 Cost of goods available for sale ........... 217,200 Less: Ending inventory ......................... 25,200 Cost of goods sold .................................................. 192,000 Gross profit...................................................................... $108,000 Gross profit margin = $108,000 = 36.0% $300,000 March Net sales ($292,500 - $5,800 - $2,700) ............................ $284,000 Less: Estimated gross profit (36.0% x $284,000) .......... 102,240 Estimated cost of goods sold ........................................ $181,760 Beginning inventory........................................................ $25,200 Net Purchases ($196,000 - $3,940 - $1,950) ... $190,110 Add: Freight in ................................................. 2,940 Cost of goods purchased ............................................... 193,050 Cost of goods available for sale..................................... 218,250 Less: Estimated cost of goods sold .............................. 181,760 Estimated total cost of ending inventory ...................... 36,490 Less: Inventory not lost (20% x $36,490) ....................... 7,298 Estimated inventory lost in fire (80% x $36,490) ........... $ 29,192

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*PROBLEM 6-14B (Continued) Taking It Further: The gross profit method is based on the assumption that the gross profit ratio remains constant from February to March. The gross profit ratio will be affected by merchandising policies or market conditions. In addition, the gross profit ratio may be affected by the product mix included in the sales amount. The method is more accurate when applied to a department or product line, rather than on operations as a whole.

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*PROBLEM 6-15B Jewellery and Clothing Cosmetics Cost Retail Cost Retail Beginning inventory $ 50,600 $ 92,000 $ 29,000 $ 48,000 Purchases 770,000 1,440,000 560,000 918,000 Purchase returns (36,000) (65,500) (12,200) (19,700) Purchase discounts (5,000) (2,800) Freight in 7,900 5,700 Goods available for sale $787,500 1,466,500 $579,700 946,300 Net sales (1,348,000) (889,600) Ending inventory at retail $ 118,500 $ 56,700 Cost-to-retail ratio: Clothing—$787,500 ÷ $1,466,500 = 53.7% Jewellery and Cosmetics—$579,700 ÷ $946,300 = 61.3% Estimated ending inventory at cost: $118,500 x 53.7% = $63,635—Clothing $56,700 x 61.3% = $34,757—Jewellery and Cosmetics

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*PROBLEM 6-15B (Continued) Taking It Further: Clothing—$112,750 x 53.7% =

$60,547 per count 63,635 estimated $ 3,088 loss at cost

Loss at retail = $118,500 - $112,750 = $5,750 Jewellery and Cosmetics—$53,300 x 61.3% = $32,673 per count 34,757 estimated $ 2,084 loss at cost Loss at retail = $56,700 - $53,300 = $3,400

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CONTINUING COOKIE CHRONICLE (a)

Natalie has purchased mixers #4, #5, #6 and #7. She has sold mixers #4, #5 and #7 and has returned mixer #6. At the end of March, her ending inventory would consist of mixers #1, #2 and #3. Ending Inventory:

Mixer #1 - #12459 Mixer #2 - #23568 Mixer #3 - #36994 Total

$545 545 545 $1,635

Cost of Goods Sold:

Mixer #4 - #49295 Mixer #5 - #56204 Mixer #7 - #72531 Total

$550 550 567 $1,667

(b) Natalie has been using the specific identification method to track her inventory of mixers. She has been able to do this because each mixer has a unique serial number. This allows her to match the exact cost of the mixer to the sales revenue when the mixer is sold. But it also allows Natalie to manipulate profit by choosing the specific mixer to sell. To prevent this, Canadian and International accounting standards do not allow companies to use specific identification when goods are interchangeable. Instead, Natalie will need to choose either the average cost or FIFO cost formulas. In this situation, I recommend the average cost formula because the mixers are identical. Since she is selling mixers and the inventory items are not subject to spoilage or obsolescence, the FIFO cost formula would not be advantageous.

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CONTINUING COOKIE CHRONICLE (Continued) (c)

Average–Perpetual

Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan. 31 3 $545.00 $1,635 Feb. 2 2 $550.00 $1,100 5 547.00 2,735 16 1 $547.00 $ 547 4 547.00 2,188 Mar. 2 2 567.00 1,134 6 553.67 3,322 4 (1) 567.00 (567) 5 551.00 2,755 30 2 551.00 1,102 3 551.00 1,653 Total 3 $1,667 3 $1,649 Proof: $1,635 + $1,667 – $1,649 = $1,653 (d)

Comparison

Cost of Goods Sold Ending Inventory

From (a) Specific Identification $1,667 1,635

From (c) Average $1,649 1,653

Difference $18 18

GENERAL JOURNAL Date

Account Titles and Explanation

Mar. 31 Inventory ............................................ Cost of Goods Sold .....................

Debit

Credit

18 18

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BYP 6-1 FINANCIAL REPORTING PROBLEM (a)

Inventories are valued at the lower of laid-down cost and net realizable value. Cost includes invoice cost, duties, freight, and distribution costs. Net realizable value is defined as the expected selling price.

(b) According to Note 2, The Forzani Group uses the weighted average cost formula. The company does not specifically state if they are following a perpetual or periodic inventory system in the financial statements. Some accountants use the term “moving average cost formula” in a perpetual system and “weighted average cost formula” in a periodic system. However, the “moving average” cost that is calculated after each purchase in a perpetual system is a weighted average calculation. Therefore, we cannot conclude that the term “weighted” means periodic. It is highly likely a company this size is using a perpetual inventory system. Also the feature story on Sport Chek, one of Forzani’s stores, states that Sport Chek uses a perpetual system. Therefore, it is reasonable to conclude that all of the other stores use it too. (c)

A different cost formula would affect Forzani’s results, if the price of products increases or decreases greatly during the course of the year. Given the high level of inventory in relation to current assets and total revenue, the effect may be material.

(d) The specific identification method would not be appropriate. Most of the goods sold by Forzani are not individually distinguishable.

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BYP 6-1 (Continued) (e)

Inventory as a percentage of current assets 2009: $291,479 ÷ $382,253 = 76.3% 2008: $319,445 ÷ $456,936 = 69.9% Cost of sales as a percentage of total revenue 2009: $863,239 ÷ $1,346,758 = 64.1% 2008: $852,608 ÷ $1,331,009 = 64.1% Inventory as a percentage of current assets and cost of sales as a percentage of total revenue were fairly consistent from 2008 to 2009.

(f) Inventory Turnover 2009 2.8 $852,608 2008 ($319,445 + $302,207)  2 = 2.74 times

Days Sales in Inventory 130 days 365 = 133 days 2.74 times

Forzani’s inventory management appears to have improved in 2009. The inventory turnover has increased slightly and the days sales in inventory has decreased, indicating it is taking less time to sell the inventory.

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BYP 6-2 INTERPRETING FINANCIAL STATEMENTS (a)

2009

2008

Inventory Turnover

Days Sales in Inventory

$530,300 ($221,767 + $206,259) ÷ 2 = 2.48 times

365 = 147 days 2.48 times

$524,700 ($206,259 + $224,059) ÷ 2 = 2.44 times

365 = 150 days 2.44 times

The ratios have improved. This means that the inventory is being sold faster in 2009 than in 2008. (b)

The company may not want to reveal its gross profit and pricing structure to competitors or customers. In addition, with larger companies that have many different types of products and services, the gross profit amount loses meaning.

(c)

The company uses a perpetual system. We know this because in the summary of significant accounting policies it states they use a “moving average” cost formula. In a perpetual system, the average is calculated after each purchase (goods available for sale in dollars ÷ goods available for sale in units) and is considered to be a “moving average”. In a periodic system the average cost is calculated only once, and so does not change or “move”. Thus the term “moving average” can never be used in a periodic system.

(d)

Indigo applies the lower of cost and net realizable value rule. The amount of inventory write-downs as a result of net realizable value lower than cost was $1.7 million in fiscal 2009.

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BYP 6-2 (Continued) (e)

Amazon.com Inc. would have a better balance sheet valuation because FIFO results in an ending inventory value that approximates replacement cost. This will cause difficulties in comparing the two companies because it is impossible to know what the inventory valuation of Amazon.com would have been if it used average. However, if inventory costs are relatively stable, both inventory methods would yield similar results.

(f)

Companies use the retail inventory method because it simplifies the process of valuing inventory. But the retail inventory method provides only an estimate of the cost of the ending inventory and does not provide detailed records of inventory throughout the year. By changing to the average cost formula, Indigo will be better able to track its inventory.

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BYP 6-3 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 6-4 COMMUNICATION ACTIVITY MEMO To:

Mutahir Kazmi, President

From:

Controller

Subject:

2010 Ending Inventory Error

The combined gross profit and profit for 2010 and 2011 are correct. However, the gross profit and profit for each individual year are incorrect. As you know, the 2010 ending inventory was understated by $1 million. This error will cause the 2010 profit to be incorrect because the ending inventory is used to calculate the 2010 cost of goods sold. An understatement of ending inventory results in an overstatement of cost of goods sold. Therefore, gross profit (sales – cost of goods sold) is understated, as is profit. Unless corrected, this error will also affect 2011 profit. The 2010 ending inventory is also the 2011 beginning inventory. Therefore, the 2011 beginning inventory is also understated, which causes an understatement of cost of goods sold. The 2011 gross profit and profit are subsequently overstated. If the error is not corrected, the gross profit and profit for 2010 and 2011 will be incorrect. Although the combined profits will be correct, (because the understatement in 2010 cancels the overstatement in 2011), the trend in each year will be misleading.

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BYP 6-5 ETHICS CASE

(a)

1. Maximize gross profit—select lowest cost inventory for cost of goods sold Sales [(500 x $650) + (170 x $600)] ................... $427,000 Cost of goods sold [(140 x $300) + (200 x $340) + (330 x $370)].... 232,100 Gross profit ........................................................ $194,900 2. Minimize gross profit—select highest cost inventory for cost of goods sold Sales [(500 x $650) + (170 x $600)] ................... $427,000 Cost of goods sold [(130 x $300) + (200 x $340) + (340 x $370)].... 232,800 Gross profit ........................................................ $194,200 Difference ...........................................................

$700

Reconciliation of difference 10 x ($370 – $300) .............................................

$700

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BYP 6-5 (Continued) (b) Average cost formula Purchases Cost Total

Date Units Mar 1 3 200 $340.00 $ 68,000 5 10 340 370.00 125,800 25 3 50 3 5 Total 540 $193,800

(1) (2)

Cost of Goods Sold Units Cost Total

Units 140 340 170 323.53 55,000 170 510 500 354.51 177,255 10 670 $232,255

Balance Cost $300.00 (1) 323.53 323.53 (2) 354.51 354.51

Total $42,000 110,000 55,000 180,800 3,545

($42,000 + $68,000) ÷ (140 + 200) ($55,000 + $125,800) ÷ (170 + 340)

Sales [(500 x $650) + (170 x $600)] ................................. $427,000 Cost of goods sold ........................................................ 232,255 Gross profit ..................................................................... $194,745

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BYP 6-5 (Continued) (c)

The stakeholders are the investors and creditors of Discount Diamonds. Specific identification is not an appropriate method for this type of business, because all of the diamonds are identical. Choosing which diamonds to sell in a month is unethical because enables the company to manipulate its profit.

(d) Discount Diamonds should select the average cost formula. The specific identification method is not appropriate because all items are identical. Using the average cost formula will smooth out variations in prices and result in reasonable values for both the income statement and balance sheet.

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BYP 6-6 “ALL ABOUT YOU” ACTIVITY

(a)

Selling on consignment means that the supplier of the inventory (in this case you the student) retains ownership of the merchandise and becomes the consignor. The store (the consignee) sells the merchandise on your behalf but does not own it. The store usually takes a commission as its fee for selling the merchandise and remits the remainder to the consignor.

(b) The advantage for the student is that ownership of the books is retained. If the student changes his/her mind about selling the books, the student still owns them and can take them back. In some arrangements, the consignor may be able to state the price he/she wants to receive for the books. The disadvantage is that the seller (consignor) does not get paid until the books have been sold. (c)

The consignment arrangement may specify various aspects of the transaction to protect both parties. For example: • commission to be paid kept by the seller (consignee); • who determines the selling price (in the case of the used textbooks, the second-hand bookstore may be in a better position to determine the likely selling price); • how long the goods will be kept, or when the arrangement is terminated; • who assumes the risks of loss and damage to merchandise for sale.

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BYP 6-6 (Continued)

(d)

Any textbook’s contents will become out of date and inaccurate at some point in time. The ability to sell any used textbook is highly dependent on the edition currently in print. If the goal is to recoup money by selling a textbook, then the textbook should be sold as soon as it is no longer needed for the student’s use. Many students, however, keep their accounting textbooks during their studies as a reference tool as they progress to more advanced levels.

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Legal Notice Copyright

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CHAPTER 7 Internal Control and Cash ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Brief Problems Problems Questions Exercises Exercises Set A Set B

1. Explain the activities that help 1, 2, 3, 4, achieve internal control. 5, 6, 7

1, 2, 3, 4

1, 2, 3

2. Apply control activities to cash receipts.

2, 3

2, 3, 4, 10

6, 7

3, 4, 5, 10

8, 9, 11, 12 10, 13

6, 7, 8, 9, 4, 6, 7, 8, 10 9, 10 11 11

8, 9, 10, 11, 12

3. Apply control activities to 13, 14, 15, 4, 5, 6 cash disbursements including 16 petty cash. 4. Describe the control features 17 of a bank account.

5. Prepare a bank reconciliation. 18, 19, 20, 8, 9, 10, 21 11, 12 6. Report cash on the balance 22, 23 13, 14 sheet.

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ASSIGNMENT CHARACTERISTICS TABLE Problem Description Number 1A Identify components of internal control framework.

Difficulty Level

Time Allotted (min.)

Complex

25-35

Identify internal control activities related to cash receipts

Moderate

25-35

Identify internal controls for cash receipts and cash disbursements.

Simple

25-35

Record debit and bank credit card and petty cash transactions and identify internal controls.

Moderate

25-35

Record and post petty cash transactions and identify internal controls and petty cash procedures.

Moderate

20-30

Prepare back reconciliation and related entries.

Moderate

25-35

Prepare bank reconciliation and related entries.

Moderate

40-50

Prepare bank reconciliation and related entries.

Moderate

40-50

Prepare bank reconciliation and related entries.

Moderate

40-50

10A

Prepare bank reconciliation and identify errors.

Moderate

30-40

11A

Calculate cash balance and report other items.

Moderate

20-30

1B 2B

Identify components of internal control framework. Identify internal control weaknesses over cash receipts.

Complex Moderate

25-35 25-35

Identify internal controls for cash receipts and cash disbursements.

Simple

25-35

Record debit and bank credit card and petty cash transactions and identify internal controls.

Moderate

25-35

Record and post petty cash transactions.

Moderate

20-30

Prepare bank reconciliation and related entries.

Moderate

25-35

Prepare bank reconciliation and related entries.

Moderate

40-50

Prepare bank reconciliation and related entries.

Moderate

40-50

Prepare bank reconciliation and related entries.

Moderate

40-50

10B

Prepare bank reconciliation and related entries.

Moderate

30-40

11B

Calculate cash balance and report other items.

Moderate

20-30

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BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material 1.

Study Objective Explain the activities that help achieve internal control.

Knowledge Comprehension Application Q7-4 Q7-1 E7-1 E7-4 Q7-2 E7-2 P7-1A Q7-3 E7-3 P7-1B Q7-5 P7-2A Q7-6 P7-3A Q7-7 P7-2B BE7-1 P7-3B

Apply control activities to cash receipts.

Apply control activities to cash disbursements including petty cash.

BE7-4

Q7-13 Q7-14 Q7-15 Q7-16 P7-3A P7-3A P7-3B

Describe the control Q7-17 features of a bank account. Prepare a bank reconciliation.

BE7-7

Report cash on the balance sheet.

Q7-22 Q7-23 BE7-14

Broadening Your Perspective

Q7-8 Q7-9 Q7-10 Q7-11 Q7-12

Q7-18 Q7-19 Q7-20 Q7-21 BE7-9

P7-2A P7-3A P7-2B P7-3B

Analysis

BE7-2 BE7-3 E7-5 P7-4A P7-4B

P7-10A P7-10B

BE7-5 BE7-6 E7-7 P7-4A P7-5A P7-4B P7-5B

P7-10A P7-10B

Synthesis Evaluation

E7-6

BE7-8 BE7-10 BE7-11 BE7-12 E7-8 E7-9 E7-11 E7-12

P7-6A P7-10A P7-7A P7-10B P7-8A P7-9A P7-4B P7-6B P7-7B P7-8B P7-9B BE7-13 P7-11A E7-10 P7-11B E7-13 Continuing BYP7-1 Cookie BYP7-2 Chronicle BYP7-3 BYP7-5 BYP7-4 BYP7-6

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ANSWERS TO QUESTIONS 1.

Management has been hired by the owners to safeguard the assets used to create wealth for the owners. To protect those assets, management has the responsibility to create an environment where all employees will adhere to a corporate code of conduct. To achieve this goal management must support a rigorous internal control program, establish a hotline for anonymous reporting, and consistently disciple employees who break the established rules.

In order to be effective in their role, the employees who are involved in monitoring must be very familiar with the business’s procedures and internal control program. A thorough knowledge of what are reasonable performance levels of the business provides a means of identifying events and results which are out of the ordinary. Once identified, problems can be addressed promptly. Employees must also have the authority to act on their findings.

Agree. Internal control is the process designed and implemented by management to help an organization achieve (1) reliable financial reporting, (2) effective and efficient operations, and (3) compliance with relevant laws and regulations. Through the implementation of internal control, the efficiency of the operations will be improved.

An essential control activity is to make specific employees responsible for specific tasks. When all clerks make change out of the same cash register drawer this is a violation of establishing responsibility. In this case, each sales clerk should have a separate cash register, cash drawer, or password with pre- and post-shift counts.

Independent checks of performance are necessary even though the proper segregation of duties is in place. This procedure will ensure that the control procedures are working effectively. Periodic checking will determine if employees have not changed procedures in performing their duties. As a check, the accounting records are compared with existing assets or with external sources of information. Problems or changes can be addressed immediately to restore the proper controls and ensure the compliance to the business’s policies and procedures.

Documentation procedures contribute to good internal control by providing evidence of the occurrence of transactions and events. When signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to accounting contributes to recording transactions in the proper period. And, the prenumbering of documents helps to ensure that a transaction is not recorded more than once or not at all.

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QUESTIONS (Continued) 7.

A company’s system of internal control can only give reasonable assurance that assets are properly safeguarded and that accounting records are reliable. The concept of reasonable assurance is based on the belief that the cost of control activities should not be more than their expected benefit. Ordinarily, a system of internal control provides reasonable but not absolute, assurance. Absolute assurance would be too costly. The human element is an important factor in a system of internal control. A good system may become ineffective through employee fatigue, carelessness, and indifference. Moreover, internal control may become ineffective as a result of collusion.

Sales using debit cards and bank credit cards are both considered cash transactions to retailers. Banks usually charge the retailer a transaction fee for each debit card transaction and a fee that averages 3.5% of the credit card sale. In both types of transaction the retailer’s bank will wait until the end of the day and make a deposit for the full day’s transactions. Fees for bank credit cards are generally higher than debit card fees. Debit cards allow customers to spend only what is in their bank account whereas a bank credit card gives the customer access to money made available by a bank or other financial institution (similar to a short term loan).

At the end of a day (or shift) the cashier should count the cash in the cash register, record the amount, and turn over the cash and the record of the amount to either a supervisor or the person responsible for making the bank deposit. Exact procedures will be different in every company, but the basic principles should be the same. The person or persons who handle the cash and make the bank deposit should not have access to the cash register tapes or the accounting records. The cash register tapes should be used in creating the journal entries in the accounting records. An independent person who does not handle the cash should make sure that the amount deposited at the bank agrees with the cash register tapes and the accounting records.

10.

Cash registers with scanners are readily visible to the customer. Thus, they prevent the sales clerk from ringing up or scanning in a lower amount and pocketing the difference. In addition, the customer receives an itemized receipt, and the store’s cash register tape is locked into the register for further verification.

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QUESTIONS (Continued) 11.

All mail-in receipts should be opened in the presence of two mail clerks. These receipts are generally in the form of cheques. Each cheque should be promptly stamped “For Deposit Only.” A list of the cheques that are received each day should be prepared in duplicate. This list shows the name of the issuer of the cheque, the purpose of the payment, and the amount of the cheque. Each mail clerk should sign the list to establish responsibility for the data. The original copy of the list, along with the cheques and remittance advices, is then sent to the cashier’s department, where the daily bank deposit is prepared. A copy of the list is sent to the accounting department and they will record the collection on account. The accounting department will also compare the copy of the list with a copy of the bank deposit to make sure that all mail receipts were included in the bank deposit. In a small company, where it is not possible to have the necessary segregation of duties, the owner should be responsible for cash receipts.

12.

From a company’s perspective there are not significant differences between customers using EFT and on-line banking and EFT and automatic pre-authorized monthly payments. The main difference is that with EFT and automatic pre-authorized monthly payments, the company begins the transaction and electronically request the funds. As a result the company knows the transaction is happening and can journalize it. With EFT and on-line banking, the company cannot anticipate in advance when and how much it will collect in cash. Therefore the company will record the cash collection after the funds have been deposited in the bank account and the company has received notification from the bank.

13.

Payment by cheque or electronic funds transfer contributes to effective internal control over cash disbursements. Prenumbered cheques help to ensure that all disbursements are accounted for. In addition, the bank provides a double record of the cash disbursements, and safekeeping of the cash until paid. However, effective control is also possible when small payments are made from an imprest petty cash fund.

14.

If the company policy is to have two signing authorities, the amount of scrutiny given to a disbursement is reduced substantially as this step is omitted completely. No endorsements are obtained as would be the case in the cashing of a cheque. Endorsements provide evidence of proof of payment that is invaluable in the case of a dispute. Since cheques are not issued, there is no review of cashed cheques that can take place once paid cheques are returned with the monthly bank statement. But some banks now provide built-in software controls that companies can use to ensure that there is a second approval before funds can be transferred.

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QUESTIONS (Continued) 15.

Wanda could potentially commit a fraud by: (1) falsifying a receiving report and approving payment for a nonexistent supplier. She could open a bank account in the name of the nonexistent supplier and deposit the payments in this account allowing her to steal cash from Walter’s Watches. (2) ordering merchandise and stealing the inventory. She could cover her theft by then falsifying the receiving reports and approving the payment to the supplier even though the goods are not in the store. Instructors note: These are only two examples. Students may develop other valid examples.

16.

This could be a problem for the company as Su Mai may start taking longer and longer to repay the cash and may eventually end up stealing cash from the petty cash fund for personal expenses. Another problem is that there may not be cash in the petty cash fund when needed to pay for expenses depending on the amount Su Mai is borrowing. To strengthen the system the company could implement the following controls: • Management should not allow the fund to be used for certain types of transactions (such as making short-term loans to employees). • Each payment from the fund must be documented on a prenumbered petty cash receipt, signed by both the custodian and the person who receives the payment. • Management should periodically conduct a surprise check of the petty cash fund and ensure the cash on hand plus receipts are equal to the petty cash fund balance—they should make sure there are no unexplained shortages and all payments have been in accordance with company policies.

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QUESTIONS (Continued) 17.

A company’s internal control is improved with the use of a bank account in the following ways: (a) Physical control, and restricted access over cash is more easily maintained through the security and access controls provided by the banking system. (b) The banking system provides a duplicate record of the transactions affecting cash that are recorded in the company accounting records. (c) Endorsements of cheques by the payees provide evidence of proof of payment that is invaluable in the case of disputes. (d) Most banks offer overnight deposit facilities that secure cash until the deposits are processed, thereby discouraging robberies at the company locations and providing for better security for company employees. (e) Fast and efficient updates of cash transactions provide management with real time information that avoid mistakes and clear up inquiries through on line access to banking activity. (f) Based on the company policies, the bank will enforce company policy on allowing only authorized employees to sign cheques or have access to banking information.

18.

The employee that is assigned to prepare the bank reconciliation should be someone who has no other responsibilities that relate to cash. If a person had responsibility for handling cash and also prepared the bank reconciliation, they could use the bank reconciliation to hide fraud with cash receipts or cash disbursements.

19.

Anah is incorrect; since the March cheque has still not cleared the bank at April 30 it must be included in the April 30th bank reconciliation as an outstanding cheque because it is still outstanding on April 30th.

20.

Paul should not rely on on-line banking to give him an accurate balance in his bank account. On-line banking can provide an up to date balance but the balance will not be accurate if there are any deposits in transit or outstanding cheques. The balance will also not be accurate if the bank has made an error. Paul might also have made an EFT payment to a supplier and post-dated the payment date to the due date of an invoice. When looking at the balance on-line he may have lost track of this pending disbursement that does not yet appear on his bank account. Paul should keep his own records and reconcile his calculation of the bank balance with what the bank has reported. This is the only way to know if there are any deposits in transit, outstanding cheques or bank errors and thus have accurate information on his bank account balance.

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QUESTIONS (Continued) 21.

Jane should include the monthly interest income of $26 in her bank reconciliation. Although she may be familiar with the source of the transaction, the entry is needed in the bank reconciliation in order to balance. Furthermore, inclusion as a reconciling item will also lead her or someone else to prepare a journal entry to record the transaction in the accounting records. Failing to do so will remain an omission error and will also result in a reconciling item on the next month’s bank reconciliation.

22.

Disagree. Businesses are not always in a position to have all of the cash that is needed to settle all of the short-term liquidity needs. Due to cyclical or seasonal demand on cash, it is not always possible to have the necessary cash on hand at all times. That being the case, most businesses have arrangements with their bank that allow overdraft positions on their bank account or access to an operating line of credit, to address cash demands when they have insufficient cash on hand. Overdraft privileges and operating lines of credit are in effect temporary bank loans. Short-term liquidity needs can be met with other assets besides cash, including short-term temporary investments and accounts receivable. These assets can be converted to cash in short periods of time and should be included with cash when assessing a business’ short-term liquidity.

23.

A company may have cash that is not available for general use because it is restricted for a special purpose. If the restricted cash is expected to be used within the next year, the amount should be reported as a current asset. When restricted funds will not be used in that time, they should be reported as a noncurrent asset. A compensating balance is a minimum cash balance that a company is required to keep in its bank account as support for a bank loan. These are similar to restricted funds and are reported as noncurrent assets.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 An effective control framework is likely to have the following components: 1. Control environment 2. Risk assessment 3. Control activities 4. Information and communication, and 5. Monitoring

BRIEF EXERCISE 7-2 1. 2. 3. 4. 5. 6.

Physical and IT controls Human resource controls Independent checks of performance Segregation of duties Establishment of responsibility Documentation procedures

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BRIEF EXERCISE 7-3 Credit Card (Visa) April 9 Cash ................................................... 120.62 Credit Card Expense ($125 x 3.5%). 4.38 Sales ..............................................

125.00

Kopper Kettle Credit Card April 9 Accounts Receivable ........................ 125.00 Sales ..............................................

125.00

Debit Card April 9 Cash ................................................... 123.50 Debit Card Expense .......................... 1.50 Sales ..............................................

125.00

BRIEF EXERCISE 7-4 1. 2. 3. 4. 5. 6.

Documentation procedures Independent checks of performance Physical and IT controls Establishment of responsibility Segregation of duties Documentation procedures

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BRIEF EXERCISE 7-5 Petty Cash ......................................... Cash ...............................................

50 50

There are a number of internal controls over the petty cash fund that Fran should follow: • One person should be appointed the petty cash custodian and will be responsible for the fund. • A prenumbered petty cash receipt should be signed by the custodian and the individual receiving payment for each payment from the fund. • The controller’s office should examine all payments and stamps supporting documents to indicate they were paid when the fund is replenished. • Surprise counts should be made at any time to determine whether the fund is properly administered and that the sum of the petty cash receipts and the funds balance to the petty cash fund.

BRIEF EXERCISE 7-6 June 30

Office Supplies .................................. Delivery Expense .............................. Taxi Expense ..................................... Cash ..............................................

25 26 14 65

BRIEF EXERCISE 7-7 1. 2. 3. 4. 5.

F T F F T

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BRIEF EXERCISE 7-8 1. (c) EFT payment made by a customer 2. (d) Bank debit memorandum for service charge 3. (b) Outstanding cheques from the current month 4. (b) Bank error in recording a $1,676 deposit as $1,766 5. (b) Outstanding cheques from the previous month that are still outstanding 6. (e) Outstanding cheques from the previous month that are no longer outstanding 7. (a) Bank error in recording a company cheque made out for $160 as $610 8. (c) Bank credit memorandum for interest revenue 9. (d) Company error in recording a deposit of $1,140 as $1,410 10. (d) Bank debit memorandum for an NSF cheque 11. (a) Deposit in transit from the current month 12. (c) Company error in recording cheque made out for $450 as $540

BRIEF EXERCISE 7-9 (a)

Items that will result in an adjustment to the companies records: 1. EFT payment 2. Bank debit memorandum for service charges 8. Bank credit memorandum for interest revenue 9. Company error in recording a deposit of $1,140 as $1,410 10. Bank debit memorandum for an NSF cheque 12. Company error in recording cheque made out for $450 as $540

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BRIEF EXERCISE 7-9 (Continued) (b) Why the other items do not require an adjustment: 3. Outstanding cheques from the current month need to be deducted from the bank balance to determine the adjusted bank balance. Since the company has already recorded the cheques the company does not need to record an adjustment. 4. Bank error in recording a $1,676 deposit as $1,766 creates a $90 ($1,676 − $1,766) adjustment to the bank balance. The company has not made an error and so does not need to make an adjustment. 5. Outstanding cheques from the previous month that are still outstanding need to be deducted from the bank balance because they are still outstanding. 6. Outstanding cheques from the previous month that are no longer outstanding will not appear on the bank reconciliation. These cheques have now been deducted from both the company’s cash balance and the bank account and so neither balance needs adjusting. 7. Bank error in recording a company cheque made out for $160 as $610 creates a $450 ($160 − $610) adjustment to the bank balance. The company has not made an error and so does not need to make an adjustment. 11. Deposit in transit from the current month will be added to the bank balance to calculate the adjusted bank balance. It has already been recorded by the company so no adjustment is required.

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BRIEF EXERCISE 7-10 September: Cheques written and recorded in books in Sept. Less: Cheques paid by bank in Sept. Outstanding cheques at Sept. 30

$8,440 7,505 $ 935

October: Cheques written and recorded in books in Oct. $11,716 Plus: Outstanding cheques at Oct. 31 935 Total cheques that could be paid by bank in Oct. 12,651 Less: Cheques paid by bank in Oct. 10,712 Outstanding cheques at Oct. 31 $ 1,939

BRIEF EXERCISE 7-11 Howel Company Bank Reconciliation August 31 Cash balance per bank ..................................................... Add: Deposits in transit .................................................. Less: Outstanding cheques ............................................ Adjusted cash balance per bank .....................................

$7,770 2,405 10,175 1,523 $8,652

Cash balance per books ................................................... Add: Interest earned ........................................................

$8,850 12 8,862 Less: NSF cheque ............................................................ 180 Service charge ....................................................... 00 30 Adjusted cash balance per books ................................... $8,652

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BRIEF EXERCISE 7-12 Aug. 31

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

180

Bank Charges Expense .................... Cash ...............................................

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

180

BRIEF EXERCISE 7-13 Cash should be reported at $18,850 ($6,000 + $850 + $12,000). The postage stamps are prepaid expenses or supplies inventory. The cash refund due from CRA is a receivable. Postdated cheques are also receivables until they can be cashed on their valid date. The Treasury bill is a short-term investment that could be considered a cash equivalent.

BRIEF EXERCISE 7-14 Current Assets: Dupré Company should report the cash in bank, payroll bank, and store cash floats as cash on its balance sheet. The short-term investments should have a separate caption. Noncurrent Assets: The Plant Expansion Fund Cash should be reported as a noncurrent asset, assuming the fund is not expected to be used during the next year. The compensating bank balance should be reported as a noncurrent asset.

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SOLUTIONS TO EXERCISES EXERCISE 7-1 (a) Component of effective internal control framework: 1. Control environment

(b) How component contributes to improved internal control By clearly stating the expectations of management concerning each employees conduct, there leaves no doubt as to what is expected of each employee concerning following rules to the letter.

Information and communication

Once rules are set, mechanisms are put into place to ensure that the rules are followed. Exceptions are flagged and followed up to ensure compliance in the future.

Risk assessment

Resources are directed toward identifying where the business can put its success at risk and render it vulnerable to attack from the external environment. Once identified the risks can be properly addressed.

Monitoring

Deviations from limits set by management can be identified quickly and corrective action taken to prevent non adherence to company policies.

Control activities

The design of procedures obtained will provide management with assurance that appropriate controls are in place by design.

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EXERCISE 7-2 (a)

A dishonest store employee can steal from Discount Toys without getting caught by filling out a pre-numbered return form with all of the necessary information to pretend that a return of goods has occurred and pockets the cash. The employee need not have any merchandise, nor does he have to collude with any other employee for the theft to occur without detection.

(b)

In order to avoid the theft described in (a) above, Discount Toys should insist on the following procedures concerning returns: 1. Insist that customers provide cash register receipts as proof of their purchase. Otherwise customers can easily steal from the store by presenting an item picked up in the store, which they have not purchased and present it for a refund. 2. The original cash register receipt should have the return entered on it to ensure that the receipt cannot be used for an additional refund. 3. Have the customer fill out a form with their name and telephone number where they can be reached and do a spot check later in the day to verify that the customer did in fact request a refund that day. 4. Have a supervisor approve the return in the presence of and before the customer leaves the store, to verify that the return is valid and that merchandise was in fact obtained from the customer. 5. The cashier should be instructed to refund the customer only if an approved return was obtained by the customer. Cash should not be handed out by the employee filling out the return form.

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EXERCISE 7-2 (Continued) (b) (Continued) 6. Management should not allow the employee handing returns to have access to inventory. The returned merchandise should not be placed back on the shelf immediately. Returned merchandise should be set aside. At the end of the day, another employee should be charged with the duty of matching the merchandise returned to the duplicate return slips to ensure that employees are not creating fictitious return forms, without any merchandise being provided. 7. Accounting personnel should account for the numerical sequence of duplicate return slips. When accounting for the slips, they should apply some scrutiny to the information on the slips and ensure that the proper approval has been documented by the supervisor. Unusual amounts and frequency of returns should be reported and followed up with the general manager. 8. The general manager of the store should supervise the employees performing the return procedures to ensure that the controls are working effectively.

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EXERCISE 7-3 (a) Weakness or Strength 1. No establishment of responsibility over the cash—weakness

(b) Suggested Improvements The employees should use separate cash drawers.

Cash counts not performed independently—weakness

Cash counts should be performed by a supervisor at the end of the shift and the totals compared to the cash register tape.

Improper segregation of duties could result in the misappropriation of cash— weakness

Different individuals should receive cash, record cash receipts and deposit the cash. In a small business this may be impossible; therefore, it is imperative that management take an active role in the operations of the business so to be able to detect any accounting irregularities.

The lack of documentation procedures—weakness.

Control documents around purchasing and shipping ensure that the records are accurate and reliable and help prevent the misappropriation (loss) of assets.

Repair of physical controls—strength.

Internal reviews completed regularly and issues resolved—strength.

Human resources control over employees’ duties including vacations— strength.

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EXERCISE 7-4 (a) Weakness (a) Handbooks documenting the company policies and procedures are not available to all employees, which results in failing to communicate the expectations of management.

(b) Suggested Improvements Provide a copy of the handbooks that is accessible to all employees, to ensure the company’s expectations are clearly understood. Provide additional training if necessary.

(b)Management is ignoring the external environment that may affect the business’ vulnerabilities.

Assign to a key management staff member the responsibility of monitoring and assessing the impact of the external environment on the company’s business strategies. Perform a risk assessment and act on the findings to reduce risk to the business.

(c) Suspension of customer credit limit verification which exposes the business to the risk of non-collection of accounts receivable.

Reinstate the procedure to verify customers’ credit worthiness and credit limits prior to the shipment of merchandise.

(d)Failure to use feedback from the accounting system concerning the levels of spending compared established budgets.

Restore control and management of costs against budget by providing the proper training of employees on the accounting software that provides this management tool.

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EXERCISE 7-5 (a)

Mar. 15 Cash ($8,124.00 − $47.50) ......... 8,076.50 Debit Card Expense ($1.25 x 38) ............................. 47.50 Sales ....................................... 8,124.00

(b) June. 21 Cash ($2,200.00 − $88.00) ......... 2,112.00 Credit Card Expense ($2,200 x 4%) .......................... 88.00 Sales ....................................... 2,200.00 July 12 No entry (c)

May 26 Accounts Receivable—Ramos . 629.00 Sales .......................................

629.00

June 10 Cash ............................................ 629.00 Accounts Receivable—Ramos

629.00

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Accounting Principles, Fifth Canadian Edition

EXERCISE 7-6 (a) Weaknesses 1. Cheques are not prenumbered

(b) Suggested Improvements Use prenumbered cheques

2. The purchasing agent signs cheques

Only the controller's department personnel should sign cheques Two signatures should be required

3. Unissued cheques are stored in unlocked file cabinet

Unissued cheques should be stored in a locked file cabinet with access restricted to authorized personnel

4. Purchasing agent verifies that the goods have been received

An independent party should verify receipt of goods

5. Purchasing agent approves and pays for goods purchased

Purchasing should approve bills for payment by the controller

6. After payment, the invoice is simply filed.

The invoice should be stamped PAID, to prevent it from being processed again

7. The purchasing agent records payments in the cash disbursements journal

Only accounting department personnel should record cash disbursements

8. The controller records the cheques in cash disbursements journal

Only accounting department personnel should record cash disbursements

9. The controller reconciles the bank statement

An independent party (possibly the owner if there isn’t sufficient staff) should reconcile the bank statement

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Accounting Principles, Fifth Canadian Edition

EXERCISE 7-6 (Continued) (b) (Continued) INTEROFFICE MEMORANDUM TO:

CONTROLLER, WIARTON BAY COTTAGES

FROM:

ACCOUNTING STUDENT

SUBJECT:

INTERNAL CONTROL OVER CASH DISBURSEMENTS

DATE: I have reviewed your cash disbursements system and suggest that you make the following improvements: 1. Wiarton Bay Cottages should use prenumbered cheques. These should be stored in a locked file cabinet or safe with access restricted to authorized personnel. 2. The purchasing department should approve bills for payment. The controller’s department should prepare and sign the cheques. Two signatures should be required on every cheque. The invoices should be stamped paid so that they cannot be paid twice. 3. Only the accounting department personnel should record cash disbursements. 4. An independent statement.

party

should

reconcile

the

bank

5. An independent party should verify receipt of goods. If you have any questions suggestions, please contact me.

about

implementing

these

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Accounting Principles, Fifth Canadian Edition

EXERCISE 7-7 (a) Apr.

(b) Apr. 30

Petty Cash ......................................... Cash ...............................................

150 150

Petty Cash ($175 − $150) .................. 25 Merchandise Inventory ..................... 43 Miscellaneous Expense ($16 + $19 + $5) 40 Office Supplies .................................. 32 Delivery Expense .............................. 32 Cash ($175 − $5) ........................... Cash Over and Short ...................

170 2

Merchandise Inventory ..................... 43 Miscellaneous Expense ($16 + $19 + $5) 40 Office Supplies .................................. 32 Delivery Expense .............................. 32 Cash ($125 − $5) ........................... Cash Over and Short ................... Petty Cash ($150 − $125) .............

120 2 25

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EXERCISE 7-8 (a) TINDALL COMPANY Bank Reconciliation September 30, 2011

Cash balance per bank statement ................................... Add: Deposits in transit .................................................. 0 Less: Outstanding cheques ............................................ Adjusted cash balance per bank ..................................... Cash balance per books ..................................... Add: Correction of error in cheque No. 212 ... EFT deposits ............................................

$8,285 1,554 9,839 0 3,175 $6,664 $6,781

$ 63 74

Less: Bank service charge ................................ $ 24 NSF cheque .............................................. 230 Adjusted cash balance per books ................................... (b) Sept. 30 Cash ............................................ Office Supplies ...................... Accounts Receivable ............

137

30 Bank Charges Expense ............. Account Receivable ................... Cash ........................................

24 230

137 6,918 254 $6,664

63 74

254

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Accounting Principles, Fifth Canadian Edition

EXERCISE 7-9 (a)

Deposit in transit on May 31: $1,353

(b) Other adjustments: • Interest earned of $32 must be added to the balance per books. • EFT deposit of $849 must be added to the balance per books • The error in the May 20th deposit must be corrected on the books; therefore the balance per books must decrease by $9 ($954 − $945).

EXERCISE 7-10 (a)

Outstanding cheques on May 31st: No. 255 $ 262 No. 261 867 No. 264 650 $1,779

(b) Other adjustments: • Decrease balance per books $54 for service charges recorded by bank. • Increase balance per books $450 for error in cheque 260—should be $50 not $500. • Decrease balance per books for NSF cheque of $395.

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EXERCISE 7-11 (a) Deposits in transit: April 30 Deposits per books in April ................... Less: Deposits per bank in April........... Deposits in transit, March 31 ...... April receipts deposited in April ........... Deposits in transit, April 30 ................... Deposits in transit: May 31 Deposits per books in May .................... Less: Deposits per bank in May ............ Deposits in transit, April 30 ......... May receipts deposited in May.............. Deposits in transit, May 31 ....................

$14,400 $15,200 (1,200) 14,000 $ 400

$23,750 $22,600 (400) 22,200 $ 1,550

(b) Outstanding cheques: April 30 Cheques per books in April ................... Add: Outstanding cheques, March 31 .. Total that could be cleared in April....... Less: Cheques clearing bank in April .. Outstanding cheques, April 30 ..............

$16,700 880 17,580 (15,900) $ 1,680

Outstanding cheques: May 31 Cheques per books in May .................... Add: Outstanding cheques, April 30 .... Total that could be cleared in May ........ Less: Cheques clearing bank in May ... Outstanding cheques, May 31 ...............

$24,600 1,680 26,280 (23,750) $ 2,530

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EXERCISE 7-12 (a)

August 1 adjusted balance ....................................... Add: Cash receipts (deposits) ................................ Less: Cash payments (cheques) ............................. August 31 unadjusted balance per company ........

$17,920 68,752 (60,198) $26,474

(b) August 1 balance per bank ...................................... Add: Deposits cleared ............................................. EFT Collections ............................................... Interest earned ................................................

$19,420 55,905 2,210 46 77,581

Less: Cheques cleared ............................... $59,424 NSF cheque: N. Khan ....................... 485 Bank service charge ......................... 25 August 31 unadjusted bank balance ....................... (c) Deposits in transit: August 31 Deposits per books in August ..................... Less: Deposits per bank in August ............ $55,905 Deposits in transit: July 31 ............... (4,280) August receipts deposited in August ......... Deposits in transit: August 31 ..................... (d) Outstanding cheques: August 31 Cheques recorded per books in September ........ Add: Outstanding cheques, July 31 ..................... Total cheques that could be cleared in Aug. ....... Less: Cheques clearing bank in August .............. Outstanding cheques: August 31 .........................

59,934 $17,647

$68,752

51,625 $17,127

$60,198 5,780 65,978 (59,424) $ 6,554

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Accounting Principles, Fifth Canadian Edition

EXERCISE 7-12 (continued) (e)

Unadjusted bank balance, August 31 ..................... Add: Deposits in transit........................................... Less: Outstanding cheques ..................................... Adjusted bank balance, August 31 .........................

$17,647 17,127 (6,554) $28,220

(f)

Unadjusted cash balance, August 31 ..................... Add: EFT Collections ............................................... Interest earned ................................................ Less: NSF cheque: N. Khan ..................................... Bank service charge ....................................... Adjusted cash balance, August 31 ..........................

$26,474 2,210 46 (485) (25) $28,220

EXERCISE 7-13 (a)

Cash balance June 30, 2011 1. Currency and coin ............................................... 3. June cheques ....................................................... 5. Royal Bank chequing account ........................... 6. Royal Bank savings account .............................. 9. Cash register floats ............................................. 10. Over-the-counter cash receipts for April 30: Currency and coin .......................................... Cheques from customers .............................. Debit card slips ............................................... Bank credit card slips .................................... Total ......................................................................

79 300 2,500 4,250 300

570 130 580 750 $9,459

2. Guaranteed investment certificate—Balance sheet short-term investment 4. Postdated cheque—Balance sheet (accounts receivable) 7. Prepaid postage in postage meter—Balance sheet (prepaid expense) 8. IOU from company receptionist—Balance sheet (accounts receivable)

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SOLUTIONS TO PROBLEMS PROBLEM 7-1A There are five components of and effective internal control framework: The three components that are present in Liam’s design include: 1.

Control environment: Management has made the employees aware of their expectations particularly concerning ethical standards and the rules that must be followed in order to be in compliance with Wang’s company policies. The handbook written by Liam Taylor provides to employees Wang’s policies, rules and procedures.

Control activities: Liam has followed through from the design of policies and procedures with the implementation of approval processes in the accounting department and accounts payable department specifically to implement internal control procedures for payments.

Information and communication: Liam and Wang’s IT experts have developed powerful accounting technology tools and reports to keep abreast of Wang’s business activities in specific areas. Properly trained staff must also been hired or existing staff must be retrained in using these tools to their highest potential in order to manage the business.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-1A (Continued) Based on the description, the two components that are not mentioned and appear to be absent include: 1.

Risk assessment: Before designing policies and procedures, Liam should have made the necessary risk assessment of the environment in which Wang Manufacturing operates. Failing to do so, may cause Wang to be exposed to risks that have not been properly addressed by management. This exposure might in turn cause Wang additional difficulties in achieving its business goals and incur unforeseen costs.

Monitoring: No mention has been made of the roles managers play in monitoring the performance of the business against benchmarks such as the financial budgets Wang has set. Liam and the IT experts have developed several important reports that provide valuable timely information. There is no mention of how this information is being used by management. As well there is no description of how decisions are made by Wang’s management based on the results that are reported by the accounting system.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-1A (Continued) Taking It Further: Improvements in the components of internal control as designed by Liam for Wang include: 1.

Control activities: Liam and Wang’s management should set into place specific additional procedures besides those mentioned for accounts payable. Management should assign duties to key managers in assessing performance, follow up on problem areas and make recommendations for improvement. Once the management reports as designed by IT are delivered to these managers, (not just Liam) control procedures and a reporting mechanism to higher level management and owners should be designed.

Information and communication: The new reports developed by the IT experts are currently being viewed by Liam only. This limitation does not allow Wang to make full use of these powerful tools. For example the report comparing accounts receivable versus credit limits should be shared with the collections department and the sales team to ensure that no additional collection risks are created due to a lack of knowledge of customers’ current status with Wang.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-2A Activities

Application to Cash Receipts

Establishment of responsibility

Only cashiers are authorized to sell tickets. Only the manager and cashier can handle cash.

Segregation of duties

The duties of receiving cash and admitting customers are assigned to the cashier and to the usher. The manager maintains custody of the cash, and the company accountant records the cash.

Documentation procedures

Tickets are prenumbered. Cash count sheets are prepared. Deposit slips are prepared. Copies are used for verification and recording.

Physical controls

A safe is used for the storage of cash and a machine is used to issue tickets.

Performance reviews

Cash counts are made by the manager at the end of each cashier's shift. Daily comparisons are made by the company controller.

Other controls

Cashiers are bonded.

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PROBLEM 7-2A (Continued) Taking It Further: Actions by the usher and cashier to misappropriate cash could include: (1) Instead of tearing the tickets, the usher could return the tickets to the cashier who could resell them, and the two could divide the cash. (2) The cashier could issue a less expensive ticket than paid for, and the usher would admit the customer. The difference between the ticket issued and the cash received could be divided between the usher and cashier. (3) The cashier and usher could agree to let friends into the theatre at no cost (or in exchange for an "under the table" payment).

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PROBLEM 7-3A (a) Weaknesses & (b) Problems 1. No segregation of duties between receiving the cash and admitting students to the lessons. The teachers could admit students for free or charge extra and pocket the difference or report fewer students and pocket the extra money.

Taking It Further: Suggested Improvements The duties of receiving cash and admitting students should be assigned to separate individuals.

2. No segregation of duties in the accounting function. The general manager could prepare fictitious invoices for payment and it would not be detected.

An independent person should approve the invoices for payment and prepare the bank reconciliations.

3. No segregation of duties. Sales persons are responsible for determining credit policies and they receive a commission based on sales. They could provide credit to a bad credit risk in order to receive the commission on the sale.

An independent person should be responsible for providing credit to customers. Alternatively, a policy could be implemented where salespeople are only paid a commission on sales that are collected. This would reduce motivation to make sales to financially weak customers.

4. No individual is solely responsible for the accounting software. All programmers have access to the accounting software which could provide unauthorized changes to the accounting records.

Access to the accounting records should be restricted and protected with password or biometric restrictions.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-4A (Continued) 5. Documentation is lacking. Receiving and purchase orders have been eliminated which could result in unauthorized purchases and/or receipts or fictitious invoices being paid as no support is required. An employee could set up a bank account and collect the payment.

Receiving reports and purchase orders should be reinstated.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-4A (a)

July

1 Petty Cash .................................. Cash ........................................

250 250

8 Cash ............................................ 33,098 Debit Card Expense (134 X $1.25) 168 Credit Card Expense ($12,100 X 4%) ....................... 484 Sales ....................................... ($33,750 − $12,450 − $9,200 = $12,100) 8 Freight Out .................................. Office Supplies Expense ........... Advertising Expense ................. Drawings ..................................... Cash Over and Short ................. Cash ($250 − $72) ..................

59 37 45 42 5 178

15 Cash ............................................ 36,558 Debit Card Expense (156 X $1.25) 195 Credit Card Expense ($16,302 X 4%) ....................... 652 Sales ....................................... ($37,405 − $9,435 − $11,668 = $16,302) 15 Postage Expense ....................... Advertising Expense ................. Cleaning Supplies Expense ...... Cash Over and Short ................. Petty Cash ($250 − $200) ...... Cash ($200 − $70) ..................

33,750

37,405

45 69 60 6 50 130

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PROBLEM 7-4A (Continued) (b) The benefit of having a petty cash fund is that it can be used to pay relatively small amounts, while still maintaining control. Some expenses are best made by cash rather than by cheque because of the nature of the expense. There are some instances where either a cheque is not accepted or it is not practical to issue a cheque. Because of the costs involved in issuing a cheque, the business is justified in paying small amounts of purchases with petty cash. There are a number of internal controls over the petty cash fund that Malik should follow: • One person should be appointed the petty cash custodian and will be responsible for the fund. • A prenumbered petty cash receipt should be signed by the custodian and the individual receiving payment for each payment from the fund. • The controller’s office should examine all payments and stamps supporting documents to indicate they were paid when the fund is replenished. • Surprise counts should be made to determine whether the fund is properly administered and that the sum of the petty cash receipts and remaining cash is equal to the petty cash fund balance. Taking It Further: The advantage of accepting debit and bank credit card transactions as opposed to accepting only cash and personal cheques from customers is that the company knows immediately if the customer has enough money or established credit to pay for their purchases. A second advantage is that it will likely increase sales if customers can use debit or credit cards. The disadvantage is that the bank charges a fee on all transactions using debit and credit cards.

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PROBLEM 7-5A (a) Based on the total receipts found in the petty cash fund, the amount of cash at November 30 should be $8 ($100 − $12 − $3 − $16 − $22 − $39). (b) Nov.

(c)

1 Petty Cash .................................. 100.00 Cash ........................................

100.00

30 Parking Expense ($12 + $16) .... Vehicle Maintenance Expense ($3 + $22 + $39) ...................... Cash Over and Short ................. Cash ($100.00 − $2.27) ..........

28.00

97.73

Nov. 30 Petty Cash .................................. Cash ........................................

50.00

64.00 5.73

50.00

(d) The petty cash custodian prepares a schedule or summary of the payments that have been made and sends the schedule, supported by petty cash receipts and other documentation, to the controller’s office. The receipts and supporting documents are examined in the controller’s office to verify that they were proper payments from the fund. The request is approved and a cheque is issued to restore the fund to its established amount. At the same time, all supporting documentation is stamped “Paid” so that it cannot be submitted again for payment. In order the increase the size of the fund, it is efficient to do so at the same time as a petty cash replenishment is done. The increase in the fund of $50 is added to the cheque amount required to restore the fund and the amount of the increase is debited to the Petty Cash account. If the increase is to be done at other than a replenishment date, a separate cheque must be issued and charged to Petty Cash.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-5A (Continued) Taking It Further: There are a number of internal controls over the petty cash fund that should be put into place: • One person should be appointed the petty cash custodian and will be responsible for the fund. • The petty cash fund should be kept in a secure location, out of reach by other employees. • A prenumbered petty cash receipt should be signed by the custodian and the individual receiving payment for each payment from the fund. • Before reimbursement, the custodian must insist that supporting documents be provided as evidence of the amount that has been paid. • The controller’s office should examine all payments and stamps supporting documents to indicate they were paid when the fund is replenished. • Surprise counts should be made to determine whether the fund is properly administered and whether the sum of the petty cash receipts and remaining cash is equal to the petty cash fund.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-6A (a) LISIK COMPANY Bank Reconciliation October 31, 2011 ______________________________________________________ Cash balance per bank statement ................................... Add: Deposit in transit ...................................... $963 Bank error—Lasik cheque ...................... 600 Less: Outstanding cheques ($330 + $466 + $587 + $293) ................................ Adjusted cash balance per bank ..................................... Cash balance per books ................................................... Add: Collection of EFT ....................................... $2,055 Interest revenue ....................................... 39 Less: NSF cheque .............................................. $715 Error in Oct. 12 deposit ($856 − $836) .... 20 Error in recording cheque #1181 ($685 − $568)........................................... 117 Bank service charge 35 Cheque printing charge ........................... 40 Adjusted cash balance per books ...................................

$10,973 1,563 12,536 1,676 $10,860 $ 9,693 2,094 11,787

927 $10,860

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-6A (Continued) (b) Oct. 31 Cash ............................................. Accounts Receivable ............. Interest Revenue ....................

2,094 2,055 39

31 Accounts Receivable—W. Hoad 715 Sales ............................................. 20 Accounts Payable—Helms & Co. 117 Bank Charges Expense ($35 + $40) 75 Cash ......................................... 927 Check: $9,693 + $2,094 − $927 = $10,860 adjusted cash balance Taking It Further: Any business that chooses not follow the policy of performing bank reconciliations on its bank accounts promptly runs several risks: 1.

3. 4.

The business will be relying on a bank balance which is based on the accounting records that are missing unrecorded reconciling items. This could lead to decision that might cause the bank account to fall into overdraft position, causing issues with the bank and additional interest charges. Unauthorized disbursements will remain undetected. If the perpetrator has since left the business, the amount may not be recoverable. Deposits that did not reach the bank account and have been diverted intentionally could be permanently lost. Errors in the accounting records remain undetected. If the error is with a customer deposit, it will be embarrassing or impossible to the business to rectify the error and obtain additional collections from the customer. Errors made on payments to suppliers or will hurt the business’s relationship with its suppliers.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-7A (a)

General Ledger Cash Balance: Book balance, February 28 (Adjusted cash balance per bank reconciliation) Add: Cash receipts ................................................... Less: Cash payments ............................................... Unadjusted cash balance, March 31 .......................

$12,258 10,673 (11,821) $11,110

(b) YAP CO. Bank Reconciliation March 31, 2011

Cash balance per bank statement ................................... Add: Deposits in transit ..................................................

$12,500 1,025 13,525

Less: Outstanding cheques No. 3470 ................................................ $1,535 No. 3479 ................................................ 159 No. 3481 ................................................ 862 No. 3482 ................................................ 1,126 Bank error—cheque #3474....................... 200 Adjusted cash balance per bank .....................................

3,882 $9,643

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-7A (Continued) (b) (Continued) Cash balance per books ................................................... Add: Correction to cheque #3473 ($1,641 – $1,461)................................................... Interest revenue ..................................................... Less: Loan payment—principal ........................ $1,000 Loan payment—interest .......................... 62 NSF cheque Mr. Jordan ........................... 550 Service charge ......................................... 49 Correction in recording cash receipts March 20 ($1,823 − $1,832) .................... 9 Adjusted cash balance per books ................................... (c)

Mar. 31 Cash ............................................ Accounts Payable ................. Interest Revenue ...................

203

31 Note Payable .............................. Interest Expense ........................ Accounts Receivable ................. Bank Charges Expense ............. Accounts Receivable ................. Cash ........................................

1,000 62 550 49 9

$11,110 180 23 11,313

1,670 $9,643

180 23

1,670

Check: $11,110 + $203 − $1,670 = $9,643 adjusted cash balance Taking It Further: The accountant for Yap Co. needs to notify the bank of the details of the bank error for cheque #3474. The bank will need to withdraw a further $200 from Yap’s bank account. Until such time as the bank corrects this error the amount of $200 will remain a reconciling item on the bank side of the bank reconciliation.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-8A (a)

Book balance, October 31 (from Oct. 31 bank reconciliation) ....................................................... Add: Cash receipts per journal ............................ Less: Cash payments per journal......................... Unadjusted cash balance, November 30 .............

$ 8,496 15,690 (14,026) $10,160

(b) MALONEY COMPANY Bank Reconciliation November 30, 2011 Cash balance per bank statement .................................. Add: Deposits in transit ................................................. Less: Outstanding cheques No. 2451 ........................................... $1,260 No. 2472 ........................................... 504 No. 2478 ........................................... 538 No. 2482 ........................................... 612 No. 2484 ........................................... 830 No. 2485 ........................................... 975 No. 2487 ........................................... 1,200 Adjusted cash balance per bank .................................... Cash balance per books .................................................. Add: EFT collected by Bank ........................ $2,479 Error in Nov. 20 deposit ($2,966 − $2,699) 267 Less: NSF cheque – Pendray Holdings ...... $ 260 Error in recording cheque #2476 ($2,830 − $2,380) ............................... 450 Loan payment ...................................... 2,250 Adjusted cash balance per books ..................................

$14,527 1,338 15,865

5,919 $ 9,946 $10,160 2,746 12,906

2,960 $ 9,946

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-8A (Continued) (c)

Nov. 30 Cash ............................................ Accounts Receivable ............ Interest Revenue ................... Accounts Receivable ............

2,746

30 Accounts Receivable ................. Accounts Payable ...................... Note Payable .............................. Interest Expense ........................ Cash ........................................

260 450 2,000 250

2,430 49 267

2,960

Check: $10,160 + $2,746 − $2,960 = $9,946 adjusted cash balance Taking It Further: When performing the bank reconciliation, it is easier to detect a company error than an error committed by the bank. For errors in recording transactions on the Cash account of the company, the source documents and data supporting the entries are readily at hand to retrace the transaction and the resulting error. In the procedure of retracing or matching entries appearing on the bank statement to the accounting records, research can be performed to determine that the error was in the recording of the transaction on the company books. Although rare, some errors can occur that are caused by the bank. These errors could include for example a transaction belonging to a different business recorded on the bank statement of the company. Determining that the error is a bank error is done by process of elimination, after determining that the error is clearly not a recording error in the books of the company. In this case, since the transaction recorded by the bank is not supported by source documents of the company, an inquiry needs to be made with the bank, particularly in the case of a deposit. If the error relates to a cheque, the paid cheque can be inspected for some clues as to the source and nature of the error.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-9A (a)

Balance per Bank Statement Balance April 30, 2011 .............................................. Add: Deposits ............................................. $10,528 Interest ............................................... 12 Less: Cheques cleared ............................... $5,608 NSF cheques ..................................... 280 Service charge .................................. 28 Unadjusted bank balance, May 31, 2011 .............

$ 4,261 10,540 14,801

5,916 $8,885

Balance Per Books Reconciled balance, (per April 30 bank reconciliation) ($4,261 – $217 – $326 – $105) ................................. $ 3,613 Add: Cash receipts ................................................... 11,172 Less: Cash payments ............................................... 9,128 Unadjusted cash balance, May 31, 2011 ................. $ 5,657

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PROBLEM 7-9A (Continued) (b) GURJOT IMPORTS Bank Reconciliation May 31, 2011 ______________________________________________________ Unadjusted bank balance Add: Deposits in transit .................................................. Less: Outstanding cheques No. 290 .................................................. $ 105 No. 307 .................................................. 3,266 No. 310 .................................................. 2,400 Adjusted bank balance ..................................................... Unadjusted cash balance ................................................. Add: Interest ..................................................... $ 12 Error in cheque # 306 ($150 − $105) ...... 45 th Error in May 5 deposit ($2,620 – $2,260) 360 Less: NSF cheque .............................................. $280 Cheque # 308 not recorded ..................... 1,648 Bank service charges .............................. 28 Adjusted cash balance ......................................................

$8,885 1,004 9,889

5,771 $4,118 $5,657

417 6,074

1,956 $4,118

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-9A (Continued) (c)

May 31 Cash ........................................... Interest Revenue ................... Telephone Expense .............. Accounts Receivable ............

417

31 Accounts Receivable—R. Siddiqi 280 Bank Charges Expense ............. 28 Rent Expense ............................. 1,648 Cash ........................................

12 45 360

1,956

Check: $5,657 + $417 − $1,956 = $4,118 adjusted cash balance (d) The reported cash balance on the May 31, 2011 balance sheet is $4,118. Taking It Further: The bank officials would expect that the bank account balance and the balance on Gurjot Import’s balance sheet will not equal. Depending on the time lag between the recording of transactions on the books and the bank, it is possible that the difference is substantial, at all times. This is normal and should not be alarming. The discrepancy between the two balances would be larger for businesses that operate seven days a week. In their case, deposits of the weekend would not be processed by the bank until the Monday. In that case, the bank balance would seem low until such time as the deposits are processed by the bank. On the other hand, if the business mails many payments made by cheque to several areas of the country, it is possible that large amounts of outstanding cheques will make the bank account appear high until the cheques are presented for payment and clear the bank account.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-10A SALLY’S SWEET SHOP Bank Reconciliation November 30, 2011

(a)

Cash balance per bank statement Less: Outstanding cheques No. Amount 361 $514 484 160 485 267 492 175 493 321 494 173 Adjusted cash balance per bank

$21,580

Cash balance per books Add: Credit memo (collection of EFT) Adjusted balance per books (before theft) Less: Amount of theft Adjusted cash balance per books

$20,761 750 21,511 1,541 $19,970

1,610 $19,970

(b) Jennifer attempted to cover the theft of $1,541 by: 1. Not dealing with outstanding cheques properly: Outstanding cheques totalling $1,610 should have been deducted from the bank balance. The cheques totalling $669 should not have been deducted from the book balance. The total impact is $2,279.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-10A (Continued) (b) Continued 2. Jennifer’s sub-total and grand total on her bank reconciliation do not add properly by a difference of $262 (overstatement). 3. The starting balance on Jennifer’s bank reconciliation for the book balance of the cash account is different by $1,000. (overstatement) Check: $2,279 + $262 − $1,000 = $1,541 Taking It Further: •

Performance reviews have not been properly conducted because the cashier/bookkeeper prepared the bank reconciliation and is put into the position of checking her own work. Bank reconciliations are not being approved as the errors in Jennifer’s bank reconciliation would have been noticed on a review for approval.

•

Segregation of duties has not been properly followed because the cashier had access to the accounting records and also prepared the bank reconciliation.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-11A (a)

Cash balance: 1. Cash on hand ...................................................... $ 5,000 2. Petty cash fund ................................................... 125 3. Commercial bank savings account .................. 100,000 Commercial bank chequing account ........... 25,000 US bank account ............................................ 48,000 10. Special bank account–customer cash deposits 9,250 Total ................................................................ $187,375

(b) 2.

The petty cash fund should have been replenished at year-end. Since this has not happened, the company must record the petty cash expenses and reduce petty cash by $375. Only $125 is actually cash at this point in time. Once the petty cash fund is reimbursed, $500 cash will be available once again.

Restricted cash of $150,000 would be reported as a current or noncurrent asset, depending on the intended period of use.

5. An unused line of credit would not be reported on the balance sheet. It may be disclosed in the notes. 6. Amounts due from employees (travel advances) would be included in Accounts Receivable. 7. Short-term investments (money market fund, treasury bills and shares) would be listed separately in the current asset section. 8. Unused postage stamps would be included in prepaid expenses or supplies. 9. NSF cheques would be included in Accounts Receivable, assuming the company expects collection.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-11A (Continued) Taking It Further: It is important to present restricted cash separately from cash on the balance sheet so that creditors and other users of the financial statements realize that the amounts that are restricted are not available for the every day disbursements required by the business in normal operations. The business cannot count on these funds to pay off liabilities when they are due.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-1B There are five components of and effective internal control framework: The three components that are present at Patel Construction Company include: 1.

Control environment: Management has made the employees aware of their expectations and the rules that must be followed in order to be in compliance with Patel’s company policies. The 15 page document provides several policies, rules and procedures.

Risk assessment: The risks to which Patel is exposed have been dealt with particularly from the perspective of obtaining more than adequate insurance coverage.

Information and communication: Patel has purchased powerful accounting technology tools in order to keep abreast of their costs as they compare to budgeted expenditures and historical spending patterns. Properly trained staff must also been hired or existing staff must be retrained in using these tools to their highest potential in order to manage the business.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-1B (Continued) Based on the description, the two components that are not mentioned and appear to be absent include: 1.

Control activities: Although policies and procedures are documented in a 15 page document, no mention is made of the activities surrounding the enforcement of the policies, nor the procedures that have been put into place to ensure that the policies are followed.

Monitoring: As in the case of control activities, no mention has been made of the roles managers play in monitoring the performance of the business against benchmarks such as the budgets Patel has set. Management has purchased a sophisticated accounting system that is capable of providing the information but there is no mention of how this information is being used. As well, there is no description of how decisions are made by Patel’s management based on the results that are reported by the accounting system.

Taking It Further: Improvements in the components of internal control as designed by Patel include: 1.

Control environment: Although Patel’s 15 page document on specific policies and procedures might seem extensive it is likely inadequate to deal with the risks that are particular to the industry in which Patel Construction Company operates. One such policy that comes to mind is the issue of safety and dealing with injuries on the job site, and related claims to the Workplace Safety and Insurance Board (WSIB).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-1B (Continued) Taking It Further: (Continued) 2.

Control activities: While the company is obtaining more than adequate insurance coverage, it is mistaken in that insurance coverage is a substitute for the implementation of proper procedures for internal control. Patel should reinstate the procedure of having supervisors review and approve timesheets. Patel would be negligent in its management if it failed to do so. Without this control Patel would expose themselves to the unnecessary risks of losses which the insurance company might dispute in a future claim.

Information and communication: Since Patel is in the construction business it should use the up-to-date software for contract accounting which will give them the best competitive advantage in bidding on construction contracts. As well, the use of past history of construction jobs will help Patel properly monitor and control costs on current and future projects.

Monitoring: Management should assign duties to key managers in assessing performance, follow up on problem areas and make recommendations for improvement.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-2B (a)

The weaknesses in internal accounting control over collections are: (1) Each usher could take cash from the collection plates en route to the basement office. (2) The head usher counts the cash alone which gives him/her an opportunity to steal. (3) The head usher’s notation of the count is left in the unlocked safe. This means that someone could take money out of the safe and redo the note stating the new amount. (4) The financial secretary counts the cash alone. Again, this gives her an opportunity to steal. (5) The financial secretary withholds $150 to $200 per week. She does not have to provide any support for how she spends this cash. (6) The cash is vulnerable to robbery when kept in the unlocked safe overnight. (7) Cheques are made payable to “cash.” This means anyone could cash the cheque. (8) The financial secretary has custody of the cash, maintains church records, and prepares the bank reconciliation.

(b) The improvements should include the following: (1) The ushers should transfer their cash collections to a cash pouch (or bag) held by the head usher. (2) The head usher and finance committee member should take the cash to the office. The cash should be counted by the head usher and the financial secretary in the presence of the finance committee member. (3) Following the count, the financial secretary should prepare a deposit slip in duplicate for the total cash received, and the secretary should immediately deposit the cash in the bank’s night deposit vault.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-2B (Continued) Taking It Further: The improvements for the finance committee should include the following: (1) A finance committee member should witness the ushers transferring their cash collections to a cash pouch (or bag) held by the head usher. (2) A finance committee member should be present when the cash is counted by the head usher and the financial secretary, when the cash is taken to the office. (3) At the end of each month, a member of the finance committee should prepare the bank reconciliation. (4) All cheques should be made payable in the church’s name. (5) A petty cash fund should be set up for small expenditures. (6) All amounts collected at weekly services should be deposited.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-3B a) Weaknesses & (b) Problems 1. Cash is collected and kept in the car. This could result in theft.

Taking It Further Suggested Improvements Cash should be deposited in the bank each day.

2. The person purchasing the merchandise is the same person that verifies receipt of the goods and approves invoices for payment. Because this person is responsible for all activities related to purchasing, errors and theft could occur.

An independent person should verify the receipt of goods. The purchaser should approve bills for payment by the controller.

3. All three cashiers use the same cash drawer. This could result in difficulty establishing responsibility for errors.

Each employee should use a separate cash drawer.

4. The office manager deposits the cheques and posts the entry in the accounting records. This could result in the office manager depositing cheques in his/her own account, taking the cash and not posting the entry for accounting purposes.

Mail should be opened by two individuals. The reconciliation of daily cash receipts should be forwarded to the accounting department and used as a basis for entering the receipt information into the accounting records.

5. The custodian creates receipts for employees when they don’t have them. He could create fictitious receipts and take cash himself or give it to friends.

Prenumbered petty cash receipts must be signed by the custodian and the individual receiving payment for each payment from the fund. Surprise counts can be made at any time to determine whether the fund is intact. Employees should be required to take vacation.

Larry never takes a vacation.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-4B (a)

May

1 Petty Cash .................................. Cash ........................................

150 150

8 Cash ............................................ 15,503 Debit Card Expense (52 X $0.75) 39 Credit Card Expense ($6,400 x 3.25%) ..................... 208 Sales ....................................... ($15,750 − $5,075 − $4,275 = $6,400) 8 Freight Out .................................. Postage Expense ....................... Advertising Expense ................. Miscellaneous Expense ............ Cash Over and Short ................. Cash ($150 − $9) ....................

42 28 57 10 4 141

15 Cash ............................................ 17,880 Debit Card Expense (80 X $0.75) 60 Credit Card Expense ($8,000 x 3.25%) ..................... 260 Sales ....................................... ($18,200 − $4,267 − $5,933 = $6,400) 15 Petty Cash ($250 − $150) ........... B. Ramesh, Drawings ................ Office Supplies ........................... Coffee Supplies .......................... Cash Over and Short ................. Cash ($250 − $4) ....................

15,750

18,200

100 50 77 20 1 246

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-4B (Continued) (b) The benefit of having a petty cash fund is that it can be used to pay relatively small amounts, while still maintaining control. Some expenses are best made by cash rather than by cheque because of the nature of the expense. There are some instances where either a cheque is not accepted or it is not practical to issue a cheque. Because of the costs involved in issuing a cheque, the business is justified in paying small amounts of purchases with petty cash. There are a number of internal controls over the petty cash fund that Ramesh should follow: • One person should be appointed the petty cash custodian and will be responsible for the fund. • A prenumbered petty cash receipt should be signed by the custodian and the individual receiving payment for each payment from the fund. • The controller’s office should examine all payments and stamps supporting documents to indicate they were paid when the fund is replenished. • Surprise counts should be made to determine whether the fund is properly administered and whether the sum of the petty cash receipts and remaining cash is equal to the petty cash fund. Taking It Further: The advantage of accepting debit and bank credit card transactions as opposed to accepting only cash and personal cheques from customers is that the company knows immediately if the customer has enough money or established credit to pay for their purchases. A second advantage is that it will likely increase sales if customers can use debit or credit cards. The disadvantage is that the bank charges a fee on all transactions using debit and credit cards.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-5B (a)

June 8 Petty Cash .................................. Cash ........................................

200

21 Freight Out .................................. Postage Expense ....................... Office Supplies Expense ........... Miscellaneous Expense ............ Cash Over and Short ................. Cash ($200 − $13) ..................

84 42 47 12 2

30 Freight Out .................................. Charitable Contributions Expense Postage Expense ....................... Miscellaneous Expense ............ Cash Over and Short ............ Cash ($200 − $5) ....................

86 40 28 44

1 Petty Cash .................................. Cash ........................................

100

23 Freight Out .................................. Entertainment Expense ............. Postage Expense ....................... Merchandise Inventory .............. Miscellaneous Expense ............ Cash Over and Short ................. Cash ($300 − $58) ..................

36 53 33 60 54 6

31 Postage Expense ....................... Travel Expense ........................... Freight Out .................................. Office Supplies Expense ........... Cash Over and Short ............ Cash ($250 − $63) .................. Petty Cash ($300 − $250) ......

95 46 44 57

July

200

187

3 195

100

242

5 187 50

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-5B (Continued) (b) Date

Explanation

June 8 July 1 31

Petty Cash Ref. Debit

Credit Balance

200 100 50

200 300 250

Taking It Further: Some expenses are made from petty cash rather than by cheque because of the nature of the expense. There are some instances where either a cheque is not accepted or it is not practical to issue a cheque. Because of the costs involved in issuing a cheque the business is justified in paying small amounts of purchases with petty cash. There are internal controls over payments from petty cash. A custodian is responsible for the fund. A prenumbered petty cash receipt signed by the custodian and the individual receiving payment is required for each payment from the fund. The controller’s office examines all payments and stamps supporting documents to indicate they were paid when the fund is replenished. Surprise counts can be made to determine whether the fund is properly administered and whether the sum of the petty cash receipts and remaining cash is equal to the petty cash fund.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-6B (a) AGRICULTURAL GENETICS COMPANY Bank Reconciliation May 31, 2011

Cash balance per bank statement ................................... Add: Deposit in transit ...................................... $1,141 Bank error, May 12 deposit ($638 − $386) 252 Less: Outstanding cheques ($233 + $732 + $813 + $401) .................................. Adjusted cash balance per bank ..................................... Cash balance per books ................................................... Add: Error in recording cheque No. 1151 ($855 − $585)............................................. $ 270 EFT collections ........................................ 2,382 Interest revenue ....................................... 24 Less: NSF cheque and service charge ............ $820 Error in recording cheque No. 1192 ($1,387 − $1,738) ...................................... 351 Bank service charge ................................ 50 Adjusted cash balance per books ...................................

$11,689 1,393 13,082 2,179 $10,903 $ 9,448

2,676 12,124

1,221 $10,903

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-6B (Continued) (b) May 31 Cash ............................................ 2,676 Accounts Payable—L. Kingston Accounts Receivable ............ Interest Revenue ...................

270 2,382 24

31 Accounts Receivable—P. Dell .. Computer Equipment ................ Bank Charges Expense ............. Cash ........................................

1,221

820 351 50

Check: $9,448 + $2,676 – $1,221 = $10,903 adjusted cash balance Taking It Further: Businesses should expect that the bank and book balances are not equal. Depending on the time lag between the recording of transactions on the books and the bank, it is possible that the difference is substantial, at all times. This is normal and should not be alarming. The discrepancy between the two balances would be larger for businesses that operate seven days a week. In their case, deposits of the week end would not be processed by the bank until the Monday. In that case, the bank balance would seem low until such time as the deposits are processed by the bank. On the other hand, if the business mails many payments made by cheque to several areas of the country, it is possible that large amounts of outstanding cheques will make the bank account appear high until the cheques are presented for payment and clear the bank account.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-7B (a)

Cash balance per books, August 31, 2011 (from Aug. 31 bank reconciliation) .................... Add: Cash receipts ................................................ Less: Cash payments ........................................... Unadjusted cash balance per books, September 30, 2011 .............................................

$10,216 16,830 14,816 $12,230

(b) KATSARIS COMPANY Bank Reconciliation September 30, 2011 Cash balance per bank statement ................................ Add: Deposits in transit ............................................... Less: Outstanding cheques No. 3470 ...................................... $1,100 No. 3474 ...................................... 1,050 No. 3478 ...................................... 538 No. 3481 ...................................... 807 No. 3484 ...................................... 1,274 No. 3486 ...................................... 1,390 Adjusted cash balance per bank ................................. Cash balance per books ............................................... Add: EFT collected by bank ....................................... Less: NSF cheque .................................... $1,027 Error in recording cheque No. 3485 ($541 − $441)................................. 100 Bank service charges .................... 45 th Error in Sept. 20 deposit ($2,954 − $2,945) .......................... 9 Adjusted cash balance per books ................................

$19,155 1,198 20,353

6,159 $14,194 $12,230 3,145 15,375

1,181 $14,194

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-7B (Continued) (c)

Sept. 30 Cash ............................................ Accounts Receivable ............ Interest Revenue ................... 30 Accounts Receivable —Hopper Holdings................ Accounts Payable ...................... Bank Charges Expense ............. Accounts Receivable ................. Cash ........................................

3,145 3,080 65

1,027 100 45 9 1,181

Check: $12,230 + $2,140 – $465 = $14,194 adjusted cash balance Taking It Further: The accountant for Katsaris Company needs to notify Hopper Holdings of the NSF cheque they had given to Katsaris as a payment on account. A replacement cheque should be requested immediately.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-8B (a) Book balance, May 1 (per Apr. 30 bank reconciliation) $ 7,776 Add: Cash receipts ..................................................... 6,825 Less: Cash payments .................................................. 13,526 Unadjusted cash balance, May 31 ............................. $ 1,075 (b) RIVER ADVENTURES COMPANY Bank Reconciliation May 31, 2011 ______________________________________________________ Cash balance per bank statement ................................... Add: Deposits in transit ............................... $1,286 Error in cheque 564 ($603 − $306) ..... 297 Less: Outstanding cheques No. 533 .............................................. $279 No. 555 .............................................. 79 No. 558 .............................................. 943 No. 560 .............................................. 890 No. 566 .............................................. 950 Adjusted cash balance per bank ..................................... Cash balance per books ................................................... Add: EFT proceeds ($1,615 + $35) .............. $1,650 th Error in May 26 deposit ($980 − $890) .................................... 90 Error in cheque #563 ($2,887 − $2,487) .............................. 400 Less: NSF cheque .......................................... $ 440 Bank service charges .......................... 25 Adjusted cash balance per books ...................................

$4,308 1,583 5,891

3,141 $2,750 $1,075

2,140 3,215 465 $2,750

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-8B (Continued) (b) May 31 Cash ........................................... Accounts Receivable ............ Interest Revenue ................... Accounts Receivable ............ Accounts Payable .................

2,140

31 Accounts Receivable—R. King Bank Charges Expense ............. Cash ........................................

440 25

1,615 35 90 400

465

Check: $1,075 + $1,650 + $90 + $400 − $440 − $25 = $2,750 adjusted cash balance Taking It Further: When performing the bank reconciliation, it is easier to detect a company error than an error committed by the bank. For errors in recording transactions on the Cash account of the company, the source documents and data supporting the entries are readily at hand to retrace the transaction and the resulting error. In the procedure of retracing or matching entries appearing on the bank statement to the accounting records, research can be performed to determine that the error was in the recording of the transaction on the company books. Although rare, some errors can occur that are caused by the bank. These errors could include for example a transaction belonging to a different business recorded on the bank statement of the company. Determining that the error is a bank error is done by process of elimination, after determining that the error is clearly not a recording error in the books of the company. In this case, since the transaction recorded by the bank is not supported by source documents of the company, an inquiry needs to be made with the bank, particularly in the case of a deposit. If the error relates to a cheque, the paid cheque can be inspected for some clues as to the source and nature of the error.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-9B (a)

Balance per Bank Statement Balance November 30, 2011 ..................................... Add: Deposits ............................................ $11,651 Interest .............................................. 12 Less: Cheques cleared .............................. $6,498 NSF cheques .................................... 730 Service charge ................................. 88 Balance, December 31, 2011 ....................................

$ 7,211 11,663 18,874

7,316 $11,558

Balance Per Books Reconciled Balance, (per Nov. 30 bank reconciliation) ($7,211 + $1,128 − $612 − $178) ............................... $ 7,549 Add: Cash receipts ................................................... 12,041 Less: Cash payments ............................................... (10,898) Unadjusted cash balance, December 31, 2011 ...... $ 8,692

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Accounting Principles, Fifth Canadian Edition

PROBLEM 7-9B (Continued) (b) KIRAN’S KAYAKS Bank Reconciliation December 31, 2011 ______________________________________________________ Balance per bank statement ............................................. Add: Deposits in transit .................................................. Less: Outstanding cheques No. 169 .................................................. $ 178 No. 186 .................................................. 3,491 No. 189 .................................................. 1,721 Adjusted cash balance per bank ..................................... Balance per books ............................................................. Add: Interest ..................................................... $ 12 th Error in Dec. 13 deposit ($3,691 − $2,991) 700 Less: NSF cheque .............................................. $730 Error in cheque No. 187 ($833 − $633)... 200 Bank service charges .............................. 88 Adjusted cash balance ...................................................... (c)

Dec. 31 Cash ........................................... Accounts Receivable ............ Interest Revenue ...................

$11,558 2,218 13,776

5,390 $8,386 $8,692 712 9,404

1,018 $8,386

712

31 Accounts Receivable—M. Sevigny 730 Office Supplies Expense ........... 200 Bank Charges Expense ............. 88 Cash ........................................

700 12

1,018

Check: $8,692 + $712 − $1,018 = $8,386 adjusted cash balance (d) The reported cash balance on the December 31, 2011 balance sheet is $8,386.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-9B (Continued) Taking It Further: Failing to complete the bank reconciliation and recording the necessary adjusting entries prior to the preparation of the closing entries will result in error in the balance of all of the accounts affected by the amount of the adjusting entries. Consequently the profit of Kiran’s Kayaks will be overstated.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-10B (a) CAREFREE COMPANY Bank Reconciliation March 31, 2011 Balance per bank statement ............................................. Add: Deposit in transit .................................................... Less: Outstanding cheques .............................. $1,650 Bank error deposit Careless Company . 1,100 Adjusted cash balance per bank ..................................... Balance per books ............................................................. Add: Error in cheque No. 173 ($294 − $249)... $ 45 Interest earned ......................................... 15 Proceeds of EFT ....................................... 2,645

$7,350 750 8,100 2,750 $5,350 $3,125

2,705 5,830

Less: Service charge .......................................... $ 40 Hydro ......................................................... 120 Telephone ................................................. 85 NSF cheque ($220 + $15 service charge) 235 Adjusted cash balance per books ...................................

480 $5,350

(b) Mar. 31 Cash ............................................ Accounts Payable ................. Interest Revenue ................... Accounts Receivable ............

2,705 45 15 2,645

31 Bank Charges Expense ............. Hydro Expense ........................... Telephone Expense ................... Accounts Receivable ................ Cash ........................................

40 120 85 235 480

Check: $3,125 + $2,705 − $480 = $5,350 adjusted cash balance

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-10B (Continued) Taking It Further: Internal control features added by the bank reconciliation process: • Performance review: Allows for an independent check on accounting records But having a bank account also assists with internal control as follows: • Safeguards assets: Safeguards cash • Documentation: Creates a duplicate record of all bank transactions

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-11B (a)

Cash and Cash Equivalents balance: 1. 2. 3. 6. 7.

Cash on hand ....................................................... Petty cash fund .................................................... Bank chequing account ...................................... US Dollar Account ............................................... American Express credit card slips* [$650 − ($650 x 3%)] ........................................ Total..................................................................

$ 1,494 32 7,460 1,995 630 $11,611

*American Express credit card slips are effectively a deposit in transit because the funds will be deposited in the bank account in two days. (b) 2. The petty cash fund should have been replenished at year-end. Since this has not happened, the company must record: • Accounts receivable of $75 for the IOU • Expenses of $40 ($115 − $75 IOU) • Cash shortage of $3 • and a reduction of cash of $118 ($150 − $32) 4. The BMO money-market fund and the 6-month term deposit should be reported as short-term investments, in the current assets section on the balance sheet. 5. The cash due from the customer should be reported as an account receivable, in the current assets section on the balance sheet.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 7-11B (Continued) (b) (Continued) 8. The cash received from the property sale is restricted and should be reported as either a current or noncurrent asset depending on when the property sale will be completed. 9. The deposit with Ontario Hydro should be recorded as an advance or deposit in the current assets section of the balance sheet. Taking It Further: Cash may be reported as a non-current asset when the cash is not available to be used in the next twelve months. If the company has placed cash in trust for a property sale as in item 8 above, but the sale is not expected to occur in the next twelve months, the amount should be classified as non-current on the balance sheet. It would be important classify this amount as non-current to assist the users of the financial statement to properly evaluate the liquidity of the business and to properly measure the amount of cash that is available to settle liabilities in the future.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a) The weaknesses in internal accounting controls in the system recommended by John and the corresponding control activity that has been violated are: 1.

The cash could be stolen from John’s vehicle before it is deposited in the bank—physical controls violated.

2, 3, 4, 5, and 7: John could potentially steal from the company and then cover the theft. Too many cash functions are performed by the same person, in this case John. John could hide unauthorized cheques or keep cash and hide unrecorded deposits in the bank reconciliation— segregation of duties violated. There is no mention of the approval of the bank reconciliation—Independent check of performance violated. In addition only one signature is required on each cheque. 6.

The accounting information for the business could be lost or stolen if it is all stored on John’s laptop—physical and IT controls violated.

John should not be able to write cheques to himself as this leaves the company vulnerable to theft—segregation of duties violated and well as physical control over cash violated.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) Improvements should include the following: 1.

Cash should be deposited in the bank daily. At a minimum the cash should be locked in a safe until such as time as it can be deposited.

2, 3, 4, and 7: John should be responsible for the accounting function only. Natalie (or some other independent person) should sign all cheques and make all deposits. Cheques should only be signed when there is documentation present to support the payment. There should be two signatures on each cheque. All invoices should be stamped “PAID” or initialled to avoid duplicate payment. 5.

The bank reconciliation should be prepared by a person independent from the handling and recording of cash. However, this may not be possible in a small organization such as Cookie Creations. At a minimum, Natalie and not John should prepare bank reconciliation monthly.

The accounting records should be maintained on site and regular back-ups should be prepared. It would be best if John used a computer at Cookie Creations to prepare the accounting information. However, if he is going to use his laptop, Natalie should ensure that she is provided with a regular back-up of all the accounting records. This ensures that if John should ever lose his laptop or decide to no longer perform Cookie Creation’s accounting, Natalie would still have access to the company’s accounting records.

John should submit a monthly invoice to Natalie for her approval. Natalie should then write and sign the cheque.

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CONTINUING COOKIE CHRONICLE (Continued) (c)

In order to get better assurance that the work performed by John is proper and timely, Natalie can do spot checks on key accounts in the accounting system. She can also access the bank records on line regularly to review the activity in the business bank account and satisfy herself that all of the cash received by the business reaches the bank account and that disbursements out of the account are valid. This would strengthen the component of internal control for independent check for performance.

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BYP 7-1 FINANCIAL REPORTING AND ANALYSIS (a)

Regarding the company’s system of internal control, the Management’s Responsibilities for Financial Reporting states that “such systems are designed to provide reasonable assurance that the financial information is accurate, relevant and reliable, and that the Company’s assets are appropriately accounted for and adequately safeguarded.” The Auditor’s Report does not comment on the company’s system of internal controls. However, in the performance of the audit, the system of internal control will have been examined and any weaknesses discovered communicated to the Audit Committee.

(b) According to the statement of Management’s Responsibility for Financial Reporting, management is responsible for the financial statements. Management has responsibility for preparing the statements and ensuring the company maintains an adequate system of internal controls. (c)

The Company’s external auditors are Ernst & Young LLP, Chartered Accountants. Since the introduction of new legislation, the focus on internal control has been heightened. More emphasis and attention is paid to the fact that the responsibility lies with management for the design and implementation of strong internal controls over financial reporting. More information is being disclosed about management’s work in this role. As well, management must communicate any flaws and deficiencies in the system of internal control as well as plans that are in place for implementing improvements.

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BYP 7-1 (Continued) (d) The Forzani audit committee is a committee of three of the members of the Board of Directors, who are not officers or employees of the corporation or of its subsidiaries. They receive a written mandate from the Board of Directors. If there are any issues relating to financial reporting that require attention, the audit committee would get involved. They would draw on the necessary resources (likely including the external auditor) to resolve issues and advise the remaining members of the board. If issues or concerns are uncovered or develop from conducting the audit, the external auditors would first address the audit committee to outline the problems and suggest a strategy for resolution. The audit committee meets with management and the external auditor to satisfy itself that the committee is properly discharging its responsibilities. The committee also reviews the financial statement and the auditor’s report, and examines other auditing, accounting and financial reporting matters. (e)

In 2009, cash decreased by $44,010,000 ($47,484,000 – $3,474,000).

(f)

The major reasons for the $44 million decrease in cash are: i) Decrease in long-term debt ii) Purchase of capital assets and goodwill iii) Share repurchase and dividend payments to shareholders

(g) Dollar amounts in thousands (1) Ending cash balance (2) As a percentage of total assets ($689,460) (3) As a percentage of current assets ($382,253) (4) As a percentage of current liabilities ($302,451)

$3,474 0.5% 0.9% 1.1%

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BYP 7-2 INTERPRETING FINANCIAL STATEMENTS (a)

Cash equivalents are highly liquid investments, with maturities of three months or less when purchased, that can be converted into specific amounts of cash. They include money-market funds, money-market savings certificates, bank certificates of deposit, and treasury bills.

(b) TELUS financial statement users will have a clearer picture of the exact cash position of the business with the implementation of the new rule. Having cash combined with cash equivalents on the balance sheet provided slightly less information than showing cash alone, as it was not possible to know the exact cash position at the end of the year.

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Current ratio

3. Acid-test ratio =

Industry

$1,558 – $3,057

= ($1,499)

$1,558 $3,057

0.51:1

0.64:1

0.32:1

0.43:1

$4 + $966 $3,057 2007

Working capital 1. (deficiency) 2.

Current ratio

Acid-test ratio =

$1,341 – $2,686

= ($1,345)

$1,341 $2,686

0.50:1

0.76:1

$20 + $42 + $711 $2,686

0.29:1

0.52:1

The company’s current ratio and acid-test ratios are consistently worse than the industry average. As well, the large working capital deficiency each year indicates that TELUS Corporation has very poor liquidity. (d) It is possible to have too much cash. When a business is extremely liquid with cash, it likely is not getting a good return on this asset and so it has become inefficient. As well, excess cash positions invite takeovers as the company that is making the purchase is looking to use the excess cash for its own operations. On the other hand, when credit is difficult to obtain, having excess cash allows a company to capitalize on buying opportunities.

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BYP 7-3 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 7-4 COMMUNICATION ACTIVITY Ms. L.S. Osman Tenacity Corporation Re: Internal control over your business Dear Ms. Osman: Your company has grown significantly over the past several years to the point where controls over cash must be implemented. The most significant weakness we identified was the lack of segregation of duties in the accounting department. In the past, operations were small enough that one person could perform the accounting and you could review almost all transactions. However, this is no longer the situation and the lack of segregation of duties could have adverse consequences for your business. For example, because Blake Pike is responsible for ordering parts, taking delivery, authorizing payments and signing cheques, it is possible that he could pay himself as a payee. Also, without segregating the signing process from the bank reconciliation process, any misappropriation of funds could proceed undetected. There is currently no independent check of the work done by Blake; not even reviewing the bank reconciliation he prepares. Because Blake is involved in all aspect of the handling of purchasing and paying for parts, without anyone supervising his work or checking his work, it is possible for Blake to take parts from your business and cover for the shortage in the accounting records. It is also possible for him to pay a friend for parts that have not been received.

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BYP 7-4 (Continued) To minimize the risk of misappropriation of parts and cash the following segregation of duties should be implemented: 1.

There should be segregation between the individuals who order parts, take delivery of the auto parts, authorize the payments and then sign the cheques for the payments of the auto parts. What is essential in the assignment of duties is that those individuals who have access to parts or cash should not have access to the accounting records and vice-versa.

Individuals other than those handling parts should be assigned the responsibility to sign cheques once they have checked that parts were actually received and for orders that were authorized.

An individual other than the individuals handling parts and signing cheques should be assigned the responsibility of preparing the monthly bank reconciliation.

Monthly bank reconciliations should be reviewed by a person independent of the recording process. In your case, the reviewer should probably be you.

I would be pleased to discuss the weaknesses and my recommended improvements to your system of internal control with you, at your convenience. Yours sincerely,

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BYP 7-5 ETHICS CASE (a)

The stakeholders in this situation are the clients of the banks and the bank’s managers, employees, and shareholders.

(b) The amount of revenue depending on order of processing would be: (1) (2) (3)

(c)

Largest to smallest: 4 bounced cheques x $35 = $140 Smallest to largest: 1 bounced cheque x $35 = $35 In the order of cheque numbers: 1 bounced cheques x $35 = $35

Whether this is ethical is subject to debate. On the one hand, it can be argued that customers have a responsibility to maintain an adequate balance in their accounts. Some customers are frequently overdrawn. Only severe penalties will persuade them to maintain an adequate balance or at least not issue or release cheques without sufficient funds on deposit. However, it could be argued that charging $35 for something that has a cost to the bank of $1.50 is “gouging”—that is, taking unfair advantage of the customer.

(d) In deciding what approach to take, the bank must consider its relationship with the customer. Clearly, by adopting a “largest to smallest” approach, it is going to anger some customers, who may well decide to leave the bank and go to a more customer-friendly bank. However, it could be argued that some of the customers the bank may lose are customers that are frequently overdrawn and therefore costly to the bank. Also, it can be time-consuming to change banks, and most people don’t have the spare time to change banks unless they really need to. (e)

Answer will vary depending on student’s opinion.

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BYP 7-6 “ALL ABOUT YOU”ACTIVITY (a) Identity thieves may get your personal information by: 1) removing mail from your mailbox or fraudulently redirecting your mail; 2) stealing personal and private information from wallets, purses, mail, your home, vehicle, computer, and websites you've visited or e-mails you've sent; 3) retrieving personal information in your garbage or recycling bin by "dumpster diving"; 4) posing as a creditor, landlord or employer to get a copy of your credit report or access to your personal information from other confidential sources; 5) tampering with automated banking machines (ABMs) and point of sale terminals, enabling thieves to read your debit or credit card number and Personal Identification Number (PIN); 6) searching public sources, such as newspapers (obituaries), telephone books, and records open to the public (professional certifications); 7) buying the information from a dishonest employee working where personal and/or financial information is stored. (b)

Some of the signs your identity might have been stolen: 1) Bills and statements don't arrive when they are supposed to — they may have been stolen from the mailbox or someone has changed the mailing address.

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BYP 7-6 (Continued) (b) (Continued) 2) You receive calls from collection agencies or creditors for an account you don't have or that is up to date. Someone may have opened a new account in your name, or added charges to an account without your knowledge or permission. 3) For information about changes to the Consumer Reporting Act that came into effect January 1, 2008, see the Personal Finance section of this site. 4) Financial account statements show withdrawals or transfers you didn't make. 5) A creditor calls to say you've been approved or denied credit that you haven't applied for. Or, you get credit card statements for accounts you don't have. 6) You apply for credit and are turned down, for reasons that do not match your understanding of your financial position. (c) 1.

Some of the physical and IT controls that can be implemented to safeguard your identity include: i)

Always store any cards and documents, such as birth certificates, social insurance numbers and passports, containing personal information in a secure place, and shred them after they expire.

ii) Look into encryption, firewalls and virus protection for your computer. iii) Install fire-wall, anti-virus, anti-spyware and security software and keep it up to date.

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BYP7-6 (Continued) (c) (Continued) 2.

Some of the checks that you can do to recognize identity theft and prevent it from continuing include: i)

Review the balances on your statements from banks, credit cards and companies regularly and report any discrepancies, however minor, right away. Fraudsters often steal in small amounts from many cards to evade detection.

ii)

Once a year, get a copy of your credit report from the two national credit reporting agencies, Equifax Canada and TransUnion Canada. The report tells you what information the bureau has about your credit history, financial information, any judgments, collection activity and who has asked for your information.

iii)

If your bills don't arrive, or you applied for a new credit card that hasn't come on time, call the credit grantor immediately.

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Legal Notice Copyright

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CHAPTER 8 Accounting for Receivables ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Problems Exercises Exercises Set A

Problems Set B

1. Record accounts receivable transactions.

1, 2, 3, 4

1, 2, 3, 6

1, 2, 7, 8, 9, 10

1, 2, 8, 9, 10

2. Calculate the net realizable value of accounts receivable and account for bad debts.

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

5, 6, 7, 8, 9

4, 5, 6, 7, 10, 11

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

1, 2, 3, 4, 5, 6, 7, 8, 9

3. Account for notes receivable. 4. Demonstrate the presentation, analysis, and management of receivables.

14, 15, 16, 17, 18 19, 20, 21, 22, 23

10, 11, 12, 13 13, 14, 15

8, 9, 10

9, 10

3, 10, 11, 12, 13

8, 10, 11, 12, 13

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number 1A 2A 3A

Description Record accounts receivable and bad debts transactions; show balance sheet presentation. Record accounts receivable and bad debts transactions; show financial statement presentation. Calculate bad debt amounts and answer questions.

Difficulty Level Simple

Time Allotted (min.) 20-30

Moderate

35-45

Moderate

15-25

Prepare aging schedule and record bad debts and explain method.

Moderate

20-30

Prepare aging schedule and record bad debts.

Moderate

15-25

Calculate allowance for doubtful accounts and bad debts; show financial statement presentation. Determine missing amounts. Identify impact of accounts receivable and bad debts transactions; determine statement presentation. Record receivables transactions.

Complex

20-30

Complex Moderate

20-30 20-30

Moderate

35-45

Moderate

30-40

Moderate

20-30

12A

Record note receivable transactions; show balance sheet presentation. Prepare assets section of balance sheet; calculate and interpret ratios. Comment on approach; calculate and interpret ratios.

Moderate

15-25

13A

Evaluate liquidity.

Moderate

15-25

Record accounts receivable and bad debts transactions; show balance sheet presentation. Record accounts receivable and bad debts transactions; show financial statement presentation. Calculate bad debt amounts and answer questions.

Simple

20-30

Moderate

35-45

Moderate

15-25

7A 8A 9A 10A 11A

2B 3B 4B

Prepare aging schedule and record bad debts and comment.

Moderate

20-30

Prepare aging schedule and record bad debts.

Moderate

15-25

Complex

20-30

Complex Moderate

20-30 30-35

Moderate

20-30

Moderate

30-40

Moderate

20-30

12B

Record note receivable transactions; show balance sheet presentation. Prepare assets section of balance sheet; calculate and interpret ratios. Calculate and interpret ratios.

Moderate

15-25

13B

Evaluate liquidity.

Moderate

15-25

7B 8B 9B 10B 11B

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

1. Record

accounts receivable transactions.

2. Calculate the

net realizable value of accounts receivable and account for bad debts.

3. Account for

Knowledge Q8-1 Q8-3 BE8-1

Q8-6 Q8-8 Q8-10

Q8-14

notes receivable. 4. Demonstrate

the presentation, analysis, and management of receivables. Broadening Your Perspective

Q8-22

Comprehension Application Q8-2 BE8-2 P8-2A Q8-4 BE8-3 P8-8A BE8-4 P8-9A E8-1 P8-10A E8-2 P8-1B E8-3 P8-2B E8-6 P8-8B P8-1A P8-9B Q8-5 BE8-5 P8-4A Q8-7 BE8-6 P8-5A Q8-9 BE8-7 P8-6A Q8-11 BE8-8 P8-8A Q8-12 BE8-9 P8-1B Q8-13 E8-4 P8-2B E8-5 P8-3B E8-6 P8-4B E8-7 P8-5B E8-11 P8-6B P8-1A P8-8B P8-2A P8-9B P8-3A Q8-15 BE8-10 E8-10 Q8-16 BE8-11 P8-9A Q8-17 BE8-12 P8-10A Q8-18 BE8-13 P8-9B E8-8 P8-10B E8-9 Q8-19 BE8-13 P8-8A Q8-20 BE8-14 P8-10A Q8-21 E8-3 P8-8B Q8-23 E8-10 P8-10B E8-13 E8-11

Continuing Cookie Chronicle BYP8-3

Analysis

Synthesis Evaluation

P8-7A P8-7B

BE8-15 E8-12 P8-11A P8-12A P8-13A P8-11B P8-12B P8-13B BYP8-1 BYP8-2 BYP8-6

BYP8-4 BYP8-5

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ANSWERS TO QUESTIONS 1.

Accounts and notes receivable are sometimes called trade receivables because they result from sales transactions and occur in the normal course of business operations.

(a) Using an accounts receivable subsidiary ledger makes it possible to determine the balance owed by an individual customer at any point in time. This makes it easier to manage receivables , follow up on payments and decide if additional credit should be granted. (b) The balance in the general ledger control account should agree with the total of the individual accounts in the subsidiary ledger.

Interest is recorded on an account receivable balance once the customer has failed to pay the account within the due date given in the negotiated terms documented on the invoice. Sometimes a grace period, of three days for example, is given for payments received beyond the due dates, before interest is applied to the account. The rate of interest calculated must correspond to the terms given in the invoice.

Ashley is not correct. Bank credit card sales are cash sales. When bank credit card sales are made, the bank will electronically deposit cash into the retail company’s bank account. Sales on credit cards that are not directly associated with a bank are reported as credit sales, not cash sales. This occurs because it takes time for the retailer to collect the amounts outstanding from any non bank credit card company.

Rod cannot completely eliminate bad debts for the company even though he performs a complete credit check on each customer. Reliable customers may suddenly not be able to pay bills because of an unexpected decrease in revenues or an unexpected increase in expenses.

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QUESTIONS (Continued) 6.

The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and recorded at the end of an accounting period. Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (2) When collection efforts demonstrate that actual accounts receivable need to be written off, the amount of the uncollectible receivable is debited to Allowance for Doubtful Accounts and credited to Accounts Receivable, reducing the balances of both accounts.0 (3) If an account previously written off is later collected, the original writeoff is reversed to reinstate the account receivable and then the collection is recorded. By recording the accrual of the amount of the bad debt expense, as given in item (1) above, the expense is recorded in the same accounting period as the sale occurred. The matching of expenses to revenues is achieved by this accrual.

(a) The Allowance for Doubtful Accounts is a contra asset account that shows the amount of the receivables that are expected to become uncollectible in the future. It is deducted from receivables to provide proper valuation for accounts receivable. (b) The account will have a debit balance when the actual amount of receivables written off exceeds the estimated amount of uncollectible accounts that was recorded at the end of the previous period.

The bad debts expense is a temporary account and so reflects only the current year’s estimates. The allowance is a permanent account; therefore its balance is a result of estimates and write-offs over many years.

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QUESTIONS (Continued) 9.

The two approaches of estimating uncollectibles under the allowance method are (1) percentage of receivables (balance sheet approach) and (2) percentage of sales (income statement approach). Under the percentage of receivables approach, the balance in the allowance for doubtful accounts is derived either (a) by applying a percentage estimate of bad debts to total receivables or (b) from an analysis of individual customer accounts. This method emphasizes net realizable value of accounts receivable. The percentage of sales approach establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This method emphasizes the matching of expenses with revenues.

10.

The percentage of receivables approach is called the balance sheet approach because the calculation and the required balance in the allowance for doubtful accounts are based on a percentage of outstanding accounts receivable. As both the allowance for doubtful accounts and accounts receivable appear on the balance sheet, it is called the balance sheet approach. The percentage of sales approach is called the income statement approach because the calculation of the bad debts expense is based on a percentage of net credit sales. As both bad debts expense and net credit sales appear on the income statement, it is called the income statement approach.

11.

As accounting standards increasingly emphasize the balance sheet, it has been argued that the percentage of receivables approach is the more appropriate method to use. While most companies prefer using the percentage of receivables approach, the percentage of sales methods is still allowed.

12.

Net realizable value is the difference between Accounts Receivable (normal debit balance) and the Allowance for Doubtful Accounts (normal credit balance). Soo Eng should realize that the decrease in net realizable value occurs when estimated uncollectibles are recognized in an adjusting entry (debit Bad Debts Expense; credit Allowance for Doubtful Accounts) in the period the sale occurred. The write-off of an uncollectible account reduces both accounts receivable and the Allowance for Doubtful Accounts by the same amount. Thus, the difference between these two accounts—net realizable value—does not change. Accounts receivable .................................................. Less: Allowance for doubtful accounts ...................... Net realizable value ..................................................

X X X

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QUESTIONS (Continued) 13.

The first entry is made to reverse the write-off of the account receivable in order to reinstate the accounts receivable. The second entry records the collection of the account receivable. Although the outcome could be accomplished with one combined entry, it is best to have separate journal entries for the reversal and subsequent collection. By both debiting and crediting accounts receivable, the customers subsidiary ledger account will be updated to show the reversal of the previous write-off and the collection of the cash. This will provide more accurate information about the customer in case the customer wants to receive credit again in the future.

14.

Notes and accounts receivable are credit instruments. Both are valued at their net realizable value. Both can be sold to another party. Accounting for the recognition of a note receivable and an account receivable are the same. Accounting for the disposition of a note receivable and an account receivable are the same. An account receivable is an informal promise to pay, while a note receivable is a written promise to pay. An account receivable results from a credit sale while a note receivable can result from financing a purchase, lending money, or extending an account receivable beyond normal amounts or due dates. An account receivable is usually due in a short period of time (e.g. 30 days) while a note receivable can extend for longer period of time (e.g. 30 days to many years). An account receivable does not incur interest unless the account is overdue. A note usually bears interest for the entire period.

15.

A company may prefer a note receivable because it gives a stronger legal claim to assets and normally includes interest.

16.

Notes are not recorded at their maturity value, which includes principal and interest, because the interest on the note is earned over time. The value of the asset would be overstated if the interest was included. According to revenue recognition criteria, interest is recorded as earned.

17.

Interest is incurred and recorded when an account receivable is overdue. Interest on an overdue account is debited to the Accounts Receivable account. Notes receivable bear interest for the entire loan period. A separate account for the interest receivable is used, and the recorded principal amount does not change.

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QUESTIONS (Continued) 18.

A dishonoured note is a note that is not paid in full at maturity. The payee still has a claim against the maker of the note for both the principal and the unpaid interest. If there is hope of collection, the payee can transfer the amount owing to an accounts receivable account. If there is no hope of collection, the payee could write-off the note.

19.

Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Short term receivables are reported in the current asset section of the balance sheet, following cash and short term investments. In this case, notes receivable due in three months would be disclosed first, followed by net accounts receivables (accounts receivable less the allowance for doubtful accounts) and finally other receivables which would include sales taxes recoverable and income taxes receivable. The note receivable due in two years would be included in Long-term Investments on the company’s balance sheet.

20.

An increase in the acid-test ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. For example, increased receivables will result in a higher current asset position, and higher acidtest ratio. However, the increase in receivables may be due to slower collections rather than improved sales. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: current ratio, receivable turnover and collection period; inventory turnover and days sales in inventory ratios.

21.

When a company’s receivable turnover is larger, (more times) this means that the business has been able to convert accounts receivable to cash more quickly than it did in the past. The management of receivable has therefore improved.

22.

The reasons companies sometimes sell their receivables are: (1) For competitive reasons, sellers often must provide financing to purchasers of their goods for extended periods. Selling receivables provides a more current source of cash to help finance operations. (2) Receivables may be sold because they may be the only reasonable source of cash readily at hand. (3) Billing and collection are often time-consuming and costly. As a result, it is often easier for a retailer to sell the receivable to another party who has expertise in billing and collection matters. This will also speed up the collection of cash.

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QUESTIONS (Continued) 23.

Securitization involves many investors, the cost is lower, the receivables are of higher quality, and the seller usually continues to be involved with collecting the receivables. In factoring, the sale is usually to only one company, the cost is higher, the receivables quality is lower, and the seller does not normally have any involvement with collecting the receivables.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) (b) Accounts Note Transaction: Receivable Receivable

(d) Owner's Equity

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

Increase Increase Increase No effect Increase No effect No effect

Increase No effect Increase No effect Increase No effect Increase

Increase No effect No effect Decrease No effect Decrease No effect

No effect No effect Increase No effect No effect Increase No effect

BRIEF EXERCISE 8-2 (a) July 1

(b) July 3

Accounts Receivable ......................... 15,000 Sales ............................................... Cost of Goods Sold ............................ 9,500 Merchandise Inventory ..................

Sales Returns and Allowances.......... Accounts Receivable ..................... Merchandise Inventory ...................... Cost of Goods Sold .......................

15,000 9,500

2,500 2,500 1,580

Cash .................................................... 12,250 Sales Discount [($15,000 − $2,500) x 2%].................... 250 Accounts Receivable [$15,000 − $2,500] ..........................

1,580

12,500

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BRIEF EXERCISE 8-3 (a) Aug. 1

(b) Aug. 5

Accounts Receivable ......................... 25,000 Sales ...............................................

25,000

Sales Returns and Allowances.......... Accounts Receivable .....................

4,500

(c) Sep. 30 Accounts Receivable ......................... Interest Revenue ........................... [($25,000 − $4,500) x 12% x 1/12] (d) Oct. 4

4,500

205

Cash [$25,000 − $4,500 + $205] ......... 20,705 Accounts Receivable .....................

205

20,705

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BRIEF EXERCISE 8-4 (a)

Nonbank credit card:

July 11

(b)

12 388 400

Visa card:

July 11

(c)

Credit Card Expense [$400 x 3%] ...... Accounts Receivable [$400 − $12] .... Sales ...............................................

Credit Card Expense [$400 x 3%] ...... Cash [$400 − $12] ............................... Sales ...............................................

12 388 400

Stewart Department Store Credit Card:

July 11

Accounts Receivable ........................ Sales ...............................................

400 400

BRIEF EXERCISE 8-5 (a) Dec. 31 Bad Debts Expense ........................... [($300,000 x 4%) − $2,500] Allowance for Doubtful Accounts .

9,500

(b) Dec. 31 Bad Debts Expense ........................... 13,500 [($300,000 x 4%) + $1,500] Allowance for Doubtful Accounts .

9,500

13,500

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BRIEF EXERCISE 8-6 Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total

Accounts Receivable $184,000 60,000 36,000 20,000 $300,000

% Estimated Uncollectible 1% 4% 10% 20%

Dec. 31 Bad Debts Expense [$11,840 − $2,500] ............................... Allowance for Doubtful Accounts.

Estimated Uncollectible Accounts $ 1,840 2,400 3,600 4,000 $11,840

9,340 9,340

BRIEF EXERCISE 8-7 Apr. 30

Bad Debts Expense ........................... 13,050 [($950,000 − $60,000 − $20,000) x 1.5%] Allowance for Doubtful Accounts .

13,050

BRIEF EXERCISE 8-8 (a)

Jan. 24 Allowance for Doubtful Accounts Accounts Receivable ............

8,000 8,000

(b)

Accounts receivable Less: Allowance for doubtful accounts Net realizable value

(1) Before Write-Off $650,000

(2) After Write-Off $642,000

36,000 $614,000

28,000 $614,000

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BRIEF EXERCISE 8-9 June 4

Accounts Receivable ......................... Allowance for Doubtful Accounts.

8,000

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

8,000

BRIEF EXERCISE 8-10 Note (a) Total Interest 1. $15,000 x 7% x 9/12 = $788 2. $44,000 x 8% x 6/12 = $1,760 3. $30,000 x 6% x 15/12 = $2,250

(b) Interest 2010 $15,000 x 7% x 5/12 = $438 $44,000 x 8% x 4/12 = $1,173 $30,000 x 6% x 2/12 = $300

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 8-11 Mar. 31 Accounts Receivable–Opal ............... 24,000 Sales ...............................................

24,000

Cost of Goods Sold ............................ 14,500 Merchandise Inventory ..................

14,500

1 Notes Receivable–Opal ...................... 24,000 Accounts Receivable–Opal ...........

24,000

May

May 31

Oct.

Interest Receivable [$24,000 x 7% x 1/12] .......................... Interest Revenue ............................

140

1 Cash .................................................... 24,700 Interest Receivable ........................ Interest Revenue [24,000 x 7% x 4/12] Notes Receivable ...........................

140

140 560 24,000

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BRIEF EXERCISE 8-12 (a) June 1 Notes Receivable................................ 27,000 Accounts Receivable .....................

27,000

Sept. 1 Cash .................................................... 27,473 Notes Receivable ........................... Interest Revenue [$27,000 x 7% x 3/12]

27,000 473

(b) June 1 Notes Receivable................................ 27,000 Accounts Receivable .....................

27,000

Sept. 1 Accounts Receivable ......................... 27,473 Notes Receivable ........................... Interest Revenue [27,000 x 7% x 3/12]

27,000 473

27,000

Sept. 1 Allowance for Doubtful Accounts ..... 27,000 Notes Receivable ...........................

27,000

Note: The Allowance for doubtful accounts is used assuming Lee Company uses only one allowance account for both accounts and notes receivable.

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BRIEF EXERCISE 8-13 (a) 2010 July 1

Oct 1

Dec 31

2011 Jan 1

Notes Receivable................................ 100,000 Cash................................................ Cash .................................................... Interest Revenue ............................ ($100,000 x 4% x 3/12)

1,000

Interest Receivable............................. Interest Revenue ............................ ($100,000 x 4% x 3/12)

1,000

Cash .................................................... Interest Receivable ........................

1,000

100,000

1,000

(b) Included in the current assets section of the balance sheet will be $1,000 of interest receivable. Included under the long-term investments section of the balance sheet will be the $100,000 note receivable. Included in other revenue on the income statement will be $2,000 ($1,000 + $1,000) of interest revenue. Included in the notes to the financial statements will be the terms of the note, 4% due on July 1, 2015. This information could also appear on the face of the balance sheet next to the caption for the note receivable under long-term investment.

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BRIEF EXERCISE 8-14 WAF COMPANY Balance Sheet (Partial) November 30, 2011

Assets Current assets Cash............................................................................. $ 74,000 Short-term investments.............................................. 80,500 Accounts receivable ................................... $109,000 Less: Allowance for doubtful accounts ... 6,950 102,050 Notes receivable ......................................................... 50,000 GST recoverable ......................................................... 21,850 Interest receivable ...................................................... 2,500 Merchandise inventory ............................................... 110,800 Prepaid expenses ....................................................... 15,300 4 Total current assets ............................................... $457,000

BRIEF EXERCISE 8-15 Receivables turnover $5,242,602 ÷ [($139,144 + $202,285) ÷ 2] = 30.7 times Collection period 365 days ÷ 30.71 = 11.9 days The company’s receivables turnover and collection period have improved dramatically since the previous year, and so the company’s liquidity should have improved.

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SOLUTIONS TO EXERCISES EXERCISE 8-1 (a) Transaction Date

Cash

April 6 April 8 April 16 April 17 April 18 June 17 June 20

NE NE +$5,880 NE NE NE +$5,177

Accounts Receivable

Inventory

Owner's Equity

+$6,500 −$500 −$6,000 +$5,500 −$400 +$77 −$5,177

−$3,000 +$235 NE −$2,525 NE NE NE

+$3,500 −$265 −$120 +$2,975 −$400 +$77 NE

(b) Apr. 6 Accounts Receivable—Pumphill ...... Sales ............................................... Cost of Goods Sold ............................ Merchandise Inventory ..................

6,500 6,500 3,000 3,000

8 Sales Returns and Allowances.......... Accounts Receivable—Pumphill .. Merchandise Inventory ...................... Cost of Goods Sold .......................

500

16 Cash [$6,000 − $120] .......................... Sales Discounts [($6,500−$500) x 2%] .......................... Accounts Receivable—Pumphill ..

5,880

17 Accounts Receivable—EastCo ......... Sales ............................................... Cost of Goods Sold ............................ Merchandise Inventory ..................

5,500

500 235 235

120 6,000

5,500 2,525 2,525

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EXERCISE 8-1 (Continued) May 18 Sales Returns and Allowances.......... Accounts Receivable—EastCo .....

400 400

June 17 Accounts Receivable—EastCo [($5,500 − $400) x 18% x 1/12]............ Interest Revenue ............................

20 Cash ($5,500 − $400 + $77) ................ Accounts Receivable—EastCo .....

5,177

EXERCISE 8-2 (a) Mar. 2 Accounts Receivable—Noren................... Sales ......................................................

575 575

4 Sales Returns and Allowances................. Accounts Receivable—Noren ..............

5 Accounts Receivable—Davidson ............. Sales ......................................................

380

8 Cash ........................................................... Sales ......................................................

421

17 Accounts Receivable—Noren................... Sales ......................................................

348

19 Cash ........................................................... Accounts Receivable—Davidson ........

100

22 Accounts Receivable—Smistad ............... Sales ......................................................

299

27 Cash ........................................................... Accounts Receivable—Noren ..............

500

380

421

348

100

299

500

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EXERCISE 8-2 (Continued) (a) (Continued) Mar. 29 Accounts Receivable—Davidson ............. Sales ......................................................

310 310

(b) Date

Elaine Davidson Explanation Ref. Debit

Mar. 5 19 29

Sales Collection Sales

Date

Explanation

Mar. 2 4 17 27

Sales Return Sales Collection

Date

Explanation

Mar. 22

Sales

Credit Balance

380 310

380 280 590

Andrew Noren Ref. Debit

Credit Balance

100

575 75 348 500

575 500 848 348

Erik Smistad Ref. Debit

Credit Balance

299

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EXERCISE 8-2 (Continued) (b) (Continued)

Date

General Ledger Accounts Receivable Explanation Ref. Debit

Mar. 2 4 5 17 19 22 27 29

Sales Return Sales Sales Collection Sales Collection Sales

(c)

Credit Balance

575 75 380 348 100 299 500 310

Subsidiary ledger account balances: Elaine Davidson....................................................... Andrew Noren .......................................................... Erik Smistad ............................................................ Total ......................................................................... Balance per general ledger control account .........

575 500 880 1,228 1,128 1,427 927 1,237

590 348 299 $1,237 $1,237

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EXERCISE 8-3 (a) Oct. 15 Accounts Receivable ......................... 15,000 Service Revenue ............................ 20 Cash [$7,500 − $263] .......................... Credit Card Expense [$7,500 x 3.5%] Service Revenue ............................

15,000

7,237 263 7,500

30 Accounts Receivable [$2,000 − $85] . 1,915 Credit Card Expense [$2,000 x 4.25%] 85 Service Revenue ............................

2,000

31 Cash [$5,000 − $50] ............................ Debit Card Expense [100 x $0.50] ..... Service Revenue ............................

4,950 50 5,000

Nov. 15 Cash .................................................... Accounts Receivable .....................

9,000

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

1,915

30 Accounts Receivable [$6,000 x 24% x 1/12] .......................... Interest Revenue ............................

9,000

1,915

120 120

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EXERCISE 8-3 (Continued) (b) KRAZY HAIR SALON Income Statement Two Months Ended November 30, 2011 Service revenue ............................................................. Operating expenses Credit and debit card expense ................................. Profit from operations ................................................... Other revenue Interest revenue ........................................................ Profit...............................................................................

$ 29,500 398 29,102 120 $ 29,222

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EXERCISE 8-4 (a) (1)

(2)

Dec. 31 Bad Debts Expense ................... 15,800 Allowance for Doubtful Accounts [($180,000 x 10%) − $2,200]

15,800

31 Bad Debts Expense ................... 20,250 Allowance for Doubtful Accounts 20,250 [($1,420,000 − $50,000 − $20,000) x 1.5%]

(b) Accounts receivable Less: Allowance for doubtful accounts Net realizable value

(1) $180,000

(2) $180,000

18,000* $162,000

22,450** $157,550

*$18,000 = $2,200 + $15,800 **$22,450 = $2,200 + $20,250 (c) (1) Bad debt expense = $18,000 + $2,600 = $20,600 (2) Bad debt expense = $20,250 (1) Accounts receivable $180,000 Less: Allowance for doubtful accounts 18,000* Net realizable value $162,000

(2) $180,000 17,650** $162,350

*$18,000 = −$2,600 + $20,600 **$17,650 = −$2,600 + $20,250

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Accounting Principles, Fifth Canadian Edition

EXERCISE 8-5 (a) Age of Accounts 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

Amount $130,000 25,200 17,000 12,800

% 2 10 30 50

Estimated Uncollectible $2,600 2,520 5,100 6,400 $16,620

(b) Mar. 31 Bad Debts Expense ................... 19,920 Allowance for Doubtful Accounts 19,920 [$16,620 + $3,300*] *$3,300 = Debit balance in Allowance prior to adjustment = April 1, 2010 balance – write offs during year = $16,700 – $20,000 (c)

Accounts receivable Less: Allowance for doubtful accounts Net realizable value

$185,000 16,620 $168,380

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Accounting Principles, Fifth Canadian Edition

EXERCISE 8-6 (a)

$30,000

Amount of credit sales in sales account

(b)

$500

Write-offs of accounts receivable

(c)

$ 9,000 +30,000 −500 −28,000 $10,500

Opening balance Item (a) Sales on account Write offs of accounts receivable Collection on account Ending balance

(d)

$900 −500 −1,000 $ 600

Opening balance Write offs Required ending balance in Allowance (e) Bad debt expense recorded

(e)

$1,000

Required balance based on aging– given

Entries (not required): (a)

(b)

Accounts Receivable ......................... 30,000 Sales ............................................... Allowance for Doubtful Accounts ..... Accounts Receivable .....................

500

Bad Debts Expense ............................ Allowance for Doubtful Accounts.

600

30,000

500

600

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Accounting Principles, Fifth Canadian Edition

EXERCISE 8-7 (a) 2010 Dec. 31 Bad Debts Expense [(4% x $550,000) + $1,200].................. 23,200 Allowance for Doubtful Accounts.

23,200

2011 May 21 Allowance for Doubtful Accounts ..... Accounts Receivable–Worthy.......

1,850

21 Allowance for Doubtful Accounts ..... Accounts Receivable–Dusaki .......

3,450

July 11 Accounts Receivable–Dusaki ............ Allowance for Doubtful Accounts.

3,450

11 Cash .................................................... Accounts Receivable–Dusaki .......

3,450

(b)

Date 2010 Dec. 31 31 2011 May 21 21 July 11

General Ledger Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Balance AJE Write-off Write-off Recovery

DR 1,200 23,200 22,000 1,850 3,450 3,450

20,150 16,700 20,150

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EXERCISE 8-7 (Continued) (c) Accounts receivable Less: Allowance for doubtful accounts Net realizable value (d) Accounts receivable Less: Allowance for doubtful accounts Net realizable value

Before Write-Off $575,000

After Write-Off $569,700

22,000 $553,000

16,700 $553,000

Before Write-Off $521,000

After Write-Off $521,000

16,700 $504,300

20,150 $500,850

EXERCISE 8-8 Nov. 1 Notes Receivable–Morgan ................. 48,000 Cash ................................................ 15 Accounts Receivable–Giorgi ............. Sales ............................................... Cost of Goods Sold ............................ Merchandise Inventory ..................

9,000 9,000 5,500 5,500

Dec. 1 Notes Receivable–Wright .................. 18,000 Sales ............................................... Cost of Goods Sold ............................ 11,000 Merchandise Inventory .................. 15 Notes Receivable–Giorgi ................... Accounts Receivable–Giorgi ........

48,000

18,000 11,000

9,000 9,000

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EXERCISE 8-8 (Continued) Dec. 31 Interest Receivable ............................. Interest Revenue* .......................... *Calculation of interest revenue: Morgan: $48,000 x 8% x 2/12 Wright: $18,000 x 6% x 1/12 Giorgi: $9,000 x 7% x 0.5/12 Total accrued interest

756 756

$640 90 26 $756

Mar. 1 Cash .................................................... 18,270 Interest Receivable ........................ Interest Revenue [$18,000 x 6% x 2/12] ..................... Notes Receivable-Wright ...............

180 18,000

June 15 Allowance for Doubtful Accounts ..... Interest Receivable ........................ Notes Receivable–Giorgi ...............

26 9,000

9,026

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Accounting Principles, Fifth Canadian Edition

EXERCISE 8-9 May

1 Notes Receivable–Jioux .................... 10,500 Accounts Receivable—Jioux ........

June 30 Interest Receivable ............................. Interest Revenue [$10,500 x 5% x 2/12] .....................

July 31 Notes Receivable–Irvine .................... Cash ................................................

3,000

Aug. 31 Cash ($3,000 x 6% X 1/12) .................. Interest Revenue ............................

Sept. 30 Cash ($3,000 x 6% X 1/12) .................. Interest Revenue ............................

Oct. 31 Cash .................................................... Interest Revenue ............................ Notes Receivable–Irvine ................

3,015

10,500

3,000

Nov. 1 Accounts Receivable–Jioux .............. 10,763 Notes Receivable ........................... Interest Receivable ........................ Interest Revenue [10,500 x 5% x 4/12]

15 3,000

10,500 88 175

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EXERCISE 8-10 (a)

Total interest revenue for the year ended December 31, 2011 − $5,028 calculated as follows: Note 1. 2. 3. 4. 5.

Calculation

Interest Revenue $15,000 x 4% x 12/12 = $ 600 $46,000 x 5% x 12/12 = 2,300 $32,000 x 4% x 11/12 = 1,173 $22,000 x 6% x 7/12 = 770 $9,000 x 5% x 2/12 = 75 Total $4,918

Interest Revenue is reported under other revenues on the income statement. (b)

Notes receivable reported under the current asset section of the balance sheet total $102,000 (Notes 1, 2, 3 and 5 which are all due before December 31, 2012). Notes receivable reported under the long-term investments section of the balance sheet total $22,000 (Note 4 which is due May 31, 2013). Interest receivable reported under the current asset section of the balance sheet total $534 calculated as follows: Note

Calculation

1. 2. 3. 4. 5.

$15,000 x 4% x 1/12 = $46,000 x 5% x 1/12 = $32,000 x 4% x 1/12 = $22,000 x 6% x 1/12 = $ 9,000 x 5% x 2/12 =

Interest Receivable $ 50 192 107 110 75 Total $534

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EXERCISE 8-11 (a) Feb. 29 Bad Debts Expense ............................ 25,000 Allowance for Doubtful Accounts. [$500,000 (see (1) below) x 5%]

25,000

(b) AJS COMPANY Balance Sheet (Partial) December 31, 2011

Assets Current assets Cash............................................................................ $ 85,000 Short-term investments............................................. 50,000 Accounts receivable (1).............................. $500,000 Less: Allowance for doubtful accounts ... 25,000 475,000 Interest receivable ...................................................... 1,125 Merchandise inventory ............................................... 325,000 Supplies....................................................................... 10,000 Total current assets .............................................. $946,125 (1)

$3,000,000 − $100,000 − $2,400,000 = $500,000

(c)

Receivables Turnover: ($3,000,000 − $100,000) ÷ [($500,000 + $0*) ÷ 2] = 11.6 times *Accounts receivable at the beginning of the year would have been $0 because this was the first year of business. Average Collection Period: 365 days ÷ 11.6 = 31.5 days

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Accounting Principles, Fifth Canadian Edition

EXERCISE 8-12 (a)

Current Ratio: 2007: $1,048 ÷ $1,590 = 0.66 2008: $1,756 ÷ $1,892 = 0.93

(b) Receivables Turnover: 2007: $7,897 ÷ [($397 + $711) ÷ 2] = 14.25 times 2008: $8,482 ÷ [($939 + $397) ÷ 2] = 12.70 times Average Collection Period: 2007: 365 days ÷ 14.25 = 25.6 days 2008: 365 days ÷ 12.70 = 28.7 days (c)

Accounts receivable, at approximately 52% ($913 ÷ $1,756) of current assets, are a material component.

(d) Management of receivables has not improved. This is evidenced by the increase in the average collection period from 25.60 days to 28.7 days and the decrease in the turnover from 14.25 times to 12,70 times. CN’s liquidity has not improved in 2008.

EXERCISE 8-13 CN securitizes a large portion of its receivables to accelerate its cash receipts to provide it with cash. At December 31, 2008, the amount of receivables that were sold ($71 million) is dramatically lower than the amount that was sold at December 31, 2007 ($588 million) and 2006 ($393 million). This reduction in receivables sold implies that CN had a lower need for cash during 2008 as its liquidity improved. The balance in Accounts Receivable will decrease when they are securitized and will increase when CN reduces the amount securitized. This partly explains why Accounts Receivable was at its lowest amount at December 31, 2007 when the amount of securitized receivables was at its highest.

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SOLUTIONS TO PROBLEMS PROBLEM 8-1A (a)

1. Accounts Receivable..................... 1,700,000 Sales .......................................... 2. Sales Returns and Allowances ..... Accounts Receivable ................

1,700,000

250,000 250,000

3. Cash................................................ 1,500,000 Accounts Receivable ................ 4. Allowance for Doubtful Accounts Accounts Receivable ................

55,000

5. Accounts Receivable..................... Allowance for Doubtful Accounts

6,750

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

6,750

1,500,000 55,000 6,750 6,750

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PROBLEM 8-1A (Continued) (b) Date Jan. 1

Date Jan. 1

(c)

Accounts Receivable Explanation Ref. Debit Balance 1. 2. 3. 4. 5. 5.

Credit Balance

✓ 1,700,000

480,000 2,180,000 250,000 1,930,000 1,500,000 430,000 55,000 375,000 6,750 381,750 6,750 375,000

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Balance 4. 5. (c)

✓ 55,000 6,750 40,900

Bad Debts Expense .................................... 40,900 Allowance for Doubtful Accounts [($375,000 x 7%) + $14,650] ...................

33,600 21,400 Dr. 14,650 Dr. 26,250

40,900

(d) Accounts Receivable ............................................. $375,000 Less: Allowance for Doubtful Accounts ................ 26,250 Net Realizable Value ............................................... $348,750 (e)

Current assets: Accounts receivable ........................... $375,000 Less: Allowance for doubtful accounts 26,250

$348,750

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PROBLEM 8-1A (Continued) Taking It Further: When deciding if the business should continue to accrue bad debt expenses at the rate of 7% of accounts receivable, Bordeaux should consider the following factors: 1. Any change in the collection risk of customers. 2. Trends in the economy which would add risk to the collection of current accounts. 3. The age of the accounts receivable. 4. Experience with current customers concerning business failures. 5. The deterioration in the accounts receivable turnover. 6. Changes in terms offered to customers. The fact that Bordeaux’s write offs of, net of bad debt recoveries ($48,250) exceeded the opening balance of the Allowance for doubtful accounts at the beginning of the year of $33,600 by $14,650 may indicate that 7% is too low.

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PROBLEM 8-2A (a)

Accounts Receivable ................................. 400,000 Sales .......................................................

400,000

Cash ............................................................ 361,500 Accounts Receivable .............................

361,500

(b) Allowance for Doubtful Accounts ............. 10,500 Accounts Receivable .............................

10,500

(c)

Accounts Receivable ................................. Allowance for Doubtful Accounts ........

1,750

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

1,750

Posting to accounts not required:

Date

Accounts Receivable Explanation Ref. Debit Balance Sales Collections Write-offs Recovery Payment

Date

Credit Balance

✓ 400,000 361,500 10,500 1,750 1,750

100,000 500,000 138,500 128,000 129,750 128,000

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance

Balance Write-offs Recovery Bad debts expense PROBLEM 8-2A (Continued)

✓ 10,500 (d)

1,750 9,750

7,000 3,500 Dr. 1,750 Dr. 8,000

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(d) Bad Debts Expense ($8,000 + $1,750) ....... Allowance for Doubtful Accounts ........

9,750 9,750

(e) Current assets: Accounts receivable .............................. $128,000 Less: Allowance for doubtful accounts 8,000 (f)

$120,000

The bad debts expense on the income statement for the period would be $9,750.

(g) Bad Debts Expense [2.25% x $400,000] .... Allowance for Doubtful Accounts ........

9,000 9,000

Posting to accounts not required: Date

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Balance Write-offs Recovery Bad debts expense

✓ 10,500 (d)

1,750 9,000

Current assets: Accounts receivable .............................. $128,000 Less: Allowance for doubtful accounts 7,250

7,000 3,500 Dr. 1,750 Dr. 7,250

$120,750

The bad debts expense on the income statement for the period would be $9,000.

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PROBLEM 8-2A (Continued) Taking It Further: Since the adjusted balance of the Allowance for doubtful accounts is very similar under both the percentage of receivables and percentage of sales approach, there does not appear to be an issue whether Huang Co. should use one or the other approach. Had there been a material difference, the Huang should likely use the percentage of receivables approach, which is more in conformity with the emphasis on the balance sheet approach encouraged by the International Financial Accounting Standards.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 8-3A (a)

$15,000 ($17,500 − $2,500) (or the net amount written off) is the amount Hohenberger would record as bad debts expense.

(b) $19,000 [$24,000 − ($20,000 − $17,500 + $2,500)] (c)

$22,500 ($1,000,000 x 2.25%) The balance in the allowance for doubtful accounts would not affect the amount of the journal entry.

(d) $27,000 [$24,000 − ($12,000 − $17,500 + $2,500)] (e)

The write-off of an uncollectible account does not affect the current year’s bad debts expense at the time of recording the write-off (debit the allowance and credit the accounts receivable). The bad debts expense is affected when the allowance is estimated. When the estimate of the expense is made at the end of the year, consideration is given to the amount of the write-offs that have been recorded for the year. If no write-offs have been recorded, it is possible that no further accrual is needed to increase the allowance account. On the other hand, if an unusually large amount of write-offs are recorded during the year, management will need to revise its estimate to a higher percentage of credit sales or accounts receivable when recording the bad debt expense accrual. This revision will be the required to ensure that the allowance for doubtful accounts is sufficiently increased to so that that the accounts receivable are recorded properly, at a fair net realizable value, on the balance sheet.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 8-3A (Continued) (f)

The collection of an account that had previously been written off would decrease the net realizable value of accounts receivable. The overall effect of reversing the write-off and collecting the receivable is a debit to cash and a credit to the allowance for doubtful accounts. The latter will decrease the net realizable value of the accounts receivable.

Taking It Further: Companies use the allowance method of accounting for uncollectible accounts because generally accepted accounting principles (GAAP) require the use of this method when bad debt expenses are material in an accounting period. The reason GAAP requires the use of this method is that it provides the business the advantage of properly reporting the accounts receivable on the balance sheet at the net realizable value and it also provides a better matching on the income statement of the bad debt expense to the sales generated in the same accounting period.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-4A (a)

Total Estimated percentage uncollectible Estimated uncollectible accounts

Total $520,000

$40,000

0-30 31-60 $240,000 $120,000

61-90 $100,000

91-120 $60,000

1.5%

10%

30%

$3,600

$8,400

$10,000

$18,000

(b)

Bad Debts Expense .................................. 26,000 Allowance for Doubtful Accounts [$40,000 − $14,000] ........................ 26,000

(c)

Allowance for Doubtful Accounts ........... 21,000 Accounts Receivable .................... 21,000

(d)

Accounts Receivable .............................. Allowance for Doubtful Accounts

4,400

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

3,900

(e)

4,400 3,900

When the year end adjusting journal entry is prepared, bad debts expense is increased and the allowance for doubtful accounts is also increased. This results in recording Bad Debts Expenses in the same period as the sales to which they relate, which means the expense has been matched with the revenue.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-4A (Continued) Taking It Further: The advantage of using an aging schedule to estimate uncollectible accounts is the amount calculated is much more sensitive to the amount of time the receivable has been outstanding. The disadvantage of using an aging schedule (as compared to estimating uncollectible accounts as a percentage of total receivables) is it can be time consuming to gather the information if the accounting system that is being used does not calculate an aging of the accounts receivable.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-5A (a)

2011 # of Days Outstanding 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

2010 # of Days Outstanding 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

Amount $115,000 35,000 45,000 80,000 $275,000

Amount $145,000 63,000 38,000 24,000 $270,000

% 2.5 6 18 35

Estimated Uncollectible $ 2,875 2,100 8,100 28,000 $41,075

% 2.5 6 18 35

Estimated Uncollectible $ 3,625 3,780 6,840 8,400 $22,645

(b) 1. Bad Debts Expense .................................... 17,845 Allowance for Doubtful Accounts [$22,645 − $4,800] .................................. 2.

17,845

Allowance for Doubtful Accounts ............. 26,500 Accounts Receivable .............................

26,500

Accounts Receivable ................................. Allowance for Doubtful Accounts ........

1,500 1,500

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

1,500

Bad Debts Expense .................................... 43,430 Allowance for Doubtful Accounts ........ [$41,075 − ($22,645 − $26,500 + $1,500)]

1,500

43,430

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-5A (Continued) (c)

2010 Accounts Receivable ............................................. $270,000 Less: Allowance for Doubtful Accounts ................ 22,645 Net Realizable Value ............................................... $247,355 2011 Accounts Receivable ............................................. $275,000 Less: Allowance for Doubtful Accounts ................ 41,075 Net Realizable Value ............................................... $233,925

Taking It Further: Although accounts receivable have only increased $5,000 or 2% ($275,000 − $270,000) the estimated uncollectible amounts have increased by $18,430 or 81% ($41,075 − $22,645). The most significant increase occurred in over 90 day balance where estimated uncollectibles rose from $24,000 to $80,000, demonstrating a dramatic deterioration in the age of the accounts receivable, resulting in a much larger allowance for doubtful accounts.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-6A (a)

The Allowance for Doubtful Accounts should have a balance of $36,425 at year-end. The supporting calculations are shown below:

Days Account Outstanding

Amount

Expected % Uncollectible

Estimated Uncollectible

0-15 days $177,500 .03 16-30 days 57,500 .08 31-45 days 40,000 .20 46-60 days 20,000 .25 61-75 days 10,000 .60 Over 75 days 7,500 .90 Balance for Allowance for Doubtful Accounts

$5,325 4,600 8,000 5,000 6,000 6,750 $35,675

(b)

Current Assets: Accounts receivable ....................................................... $312,500 Less allowance for doubtful accounts .......................... 35,675 Accounts receivable .............................................. $276,825

(c)

The amount of the bad debt expense reported on the income statement would be $43,175, as calculated below: Estimated amount required in the Allowance for Doubtful Accounts Plus debit balance in the account before adjustment Required charge to bad debt expense

$35,675 7,500 $43,175

Taking It Further: Accruals for bad debts are calculated using estimates. Any changes that occur to the accounts subsequent to recording the accrual are treated as changes in estimates and are not used to revise prior years’ expenses, but absorbed in the accounting period in which the changes in estimates occur.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-7A

Beg. Bal. Sales End. Bal.

Write-off

Accounts Receivable 854,000 Recoveries (b) 4,200 (a) 5,250,000 Write-offs (c) 50,400 4,200 Collections (d) 5,126,100 927,500 Allowance for Doubtful Accounts Beg. Bal. Bad debt (c) 50,400 Recoveries End. Bal.

73,300 (e) 52,500 (b) 4,200 79,600

Sales Sales

(f) 5,250,000

Bad Debts Expense 52,500 Bad Debts Expense .................................... Allowance for Doubtful Accounts (e) ...

52,500 52,500

Accounts Receivable (a) ............................ 5,250,000 Sales (f) .................................................. ($52,500 = 1% of sales; therefore sales = $5,250,000) Accounts Receivable ......................................... Allowance for Doubtful Accounts (b)........ Cash .................................................................... Accounts Receivable (b) ............................ Bad debt recovery entries

5,250,000

4,200 4,200 4,200

Allowance for Doubtful Accounts (c) ........ 50,400 Accounts Receivable (c) ....................... Force ($73,300 + $52,500 + $4,200 – $79,600 = $50,400)

4,200

50,400

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-7A (Continued) Cash ............................................................ 5,126,100 Accounts Receivable (d) ....................... 5,126,100 Force ($854,000 + $5,250,000 + $4,200− $50,400 − $4,200 − $927,500 = $5,126,100)

Taking It Further: Bad debt expense is a temporary account reported on the income statement. The balance is closed to Income Summary at the end of the accounting period. Allowance for doubtful accounts is a permanent account which is a contra asset to accounts receivable. Its purpose is to reduce the value of the asset to its net realizable value.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-8A (a) Transaction Cash Sept. 1. NE 2. NE 3. +$59,200 4. NE 5. NE Oct. 1. NE 2. +$350 3. +$58,500 4. NE 5. NE 6. NE

(1) (2)

Acc. Receiv.

Allow. for Doubt. Accts.

+$56,300 −$900 −$59,200 +$745 NE

NE −$25,335 NE +$400 NE NE NE NE (1)+$1,108 NE

+$30,965 +$30,965 −$500 −$500 NE NE +$745 +$745 −$1,108 −$1,108

+$63,900 NE −$58,500 −$7,500 +$710 NE

NE −$28,700 +$350 NE NE NE −$7,500 NE NE NE (2)+$5,864 NE

+$35,200 +$35,200 NE NE NE NE NE NE +$710 +$710 −$5,864 −$5,864

Invent.

Total Assets

Owner's Equity

($56,300 − $900) x 2% = $1,108 Bad Debts Expense = [($70,055 x 4%) + $3,062] = $5,864 (See Accounts Receivable and Allowance For Doubtful Accounts balances in ledger that follows.)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-8A (Continued) (a) (Continued) Ledgers not required, used for accumulating balances

Date Sept. 1. 2. 3. 4. Oct. 1. 2. 2. 3. 4. 5.

Date Sept. 5. Oct. 2. 4. 6.

Accounts Receivable Explanation Ref. Debit Opening Balance Sales Returns Collections Interest charges

Credit Balance

✓ 56,300 900 59,200 745

Sales Recovery Collection recovery Collections Write-offs Interest charges

35,200 450 450 58,500 7,500 710

74,500 130,800 129,900 70,700 71,445 135,345 135,795 135,345 76,845 69,345 70,055

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Opening Balance Bad debts expense Recovery Write-offs Bad debts expense

✓ 1,108 350 7,500

(b) Current assets: Accounts receivable .............................. Less: Allowance for doubtful accounts $67,253

5,864

2,980 4,088 4,438 3,062Dr. 2,802

$70,055 2,802

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-8A (Continued) (c)

The bad debts expense on the income statement for the period would be $16,832 ($9,860 + $1,108 + $5,864)

Taking It Further: Bassano Co. can use the percentage of sales method at month end periods for the purpose of accruing bad debt expenses and then use the percentage of accounts receivable method at the end of the fiscal year because the statements are not distributed to anyone outside of the company. The percentage of sales method is easy to administer and provides an adequate estimate for interim internal financial statement reporting. For the fiscal year end, the percentage of receivables method provides a balance sheet approach providing a focus of the valuation of the year end balances of accounts receivable to the net realizable value.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-9A Jan. 2 Accounts Receivable —Brooks Company ............................ 18,000 Sales ............................................... Cost of Goods Sold ............................ 12,000 Merchandise Inventory .................. Feb. 1 Notes Receivable—Brooks Company 18,000 Accounts Receivable —Brooks Company........................ 15 Notes Receivable—Gage Company .. 13,400 Sales ............................................... Cost of Goods Sold ............................ 8,800 Merchandise Inventory .................. 26 Accounts Receivable—Mathias Co ... Sales ............................................... Cost of Goods Sold ............................ Merchandise Inventory ..................

8,000

Mar. 31 Notes Receivable—Mathias Co ......... Accounts Receivable — Mathias Co .................................

8,000

31 Interest Receivable ............................. Interest Revenue ............................

281

Brooks Company $18,000 x 6% x 2/12 .... Gage Company, $13,400 x 6% x 1.5/12 .... Total ...........................................................

18,000 12,000

18,000

13,400 8,800

8,000 5,400 5,400

8,000

281 $180 101 $281

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-9A (Continued) Apr. 15 Cash .................................................... 13,535 Notes Receivable—Gage Company Interest Revenue [$13,400 x 6% x 0.5/12] .................. Interest Receivable ........................ May 31 Accounts Receivable—Mathias Co. .. 8,093 Notes Receivable—Mathias Co. .... Interest Revenue ($8,000 x 7% x 2/12) June 1 Cash .................................................... 18,360 Notes Receivable—Brooks Company Interest Revenue ($18,000 x 6% x 2/12) ..................... Interest Receivable ........................ July 13 Notes Receivable—Tritt Inc. .............. Sales ............................................... Cost of Goods Sold ............................ Merchandise Inventory ..................

5,000

Oct. 13 Allowance for Doubtful Accounts ..... Notes Receivable—Tritt Inc...........

5,000

13,400 34 101

8,000 93

18,000 180 180

5,000 3,300 3,300

5,000

Taking It Further: The advantages of a note receivable compared to accounts receivable are that a note receivable gives a stronger legal claim to assets and includes interest. The disadvantage of a note receivable is that it postpones the collection of cash. The delay in collection can add to the risk for non collection as time goes by if the financial condition of the customer is deteriorating further. Although the note can provide interest revenue if collected, if the note is dishonoured, the interest is not collected, nor the principal amount of the note.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-10A (a) Interest Receivable at September 30, 2011 RJF Inc. RES Co. IMG Ltd. DRA Co. MGH Corp.

$19,000 x 4.5% x 1/12 = $17,000 x 5% x 6/12 = $17,500 x 5.5% x 1/12 = $6,000 x 8.5% x 1/12 = $20,500 x 6% x 0/12 = Total

$71 425 80 43 0 $619

The notes receivable balance at September 30, 2011 is $80,000 ($19,000 + $17,000 + $17,500 + $6,000 + $20,500). (b) Oct.

1 Cash ........................................... Interest Receivable ($19,000 x 4.5% x 1/12) .........

1 Cash ........................................... Interest Receivable ($17,500 x 5.5% x 1/12) .........

31 Accounts Receivable—DRA Co. Notes Receivable—DRA Co . Interest Receivable ($6,000 x 8.5% x 1/12) ........... Interest Revenue ($6,000 x 8.5% x 1/12) ...........

6,086

31 Cash ........................................... 17,496 Notes Receivable—RES Co . Interest Receivable ($17,000 x 5% x 6/12) ............ Interest Revenue ($17,000 x 5% x 1/12) ............

6,000 43 43

17,000 425 71

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-10A (Continued) (b) (Continued) Oct. 31 Interest Receivable.................... 254 Interest Revenue ................... RJF Inc. $19,000 x 4.5% x 1/12 = $ 71 IMG Ltd. $17,500 x 5.5% x 1/12 = 80 MGH Corp. $20,500 x 6% x 1/12 = 103 Total $254

254

Date Oct.

1 31 31

Date

Balance

✓ 6,000 17,000

Oct.

1 1 1 31 31 31

80,000 74,000 57,000

Accounts Receivable Explanation Ref. Debit

Credit Balance

6,086

Interest Receivable Explanation Ref. Debit

Credit Balance

Oct. 31

Date

Credit Balance

Balance

✓ 71 80 43 425

Adjusting entry

254

619 548 468 425 0 254

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-10A (Continued) (d) TARDIF COMPANY Balance Sheet (partial) October 31, 2011 ______________________________________________________ Assets Current assets Interest receivable ......................................................

$254

Long-term investments Notes receivable .........................................................

$57,000

(e)

Oct. 31 Allowance for Doubtful Accounts Notes Receivable—DRA Co. . Interest Receivable ($6,000 x 8.5% x 1/12) ............

6,043 6,000 43

The interest previously accrued on this note should be written off, as well as the note itself. Also, no interest would be accrued for October. Taking It Further: The DRA note carries a higher interest rate as it is likely that DRA Co. has a poor credit rating and is represents a collection risk that is higher than the average customer.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-11A (a) TOCKSFOR COMPANY Balance Sheet (Partial) September 30, 2011 (in thousands)

Assets Current assets Cash............................................................................... $ 395.6 Short-term investments................................................ 194.9 Notes receivable ........................................................... 96.0 Accounts receivable ....................................... $590.4 Less: Allowance for doubtful accounts ........ 35.4 555.0 Merchandise inventory ................................................. 630.9 Prepaid expenses and deposits .................................. 20.1 Supplies......................................................................... 21.7 Total current assets ...................................................... 1,914.2 Long-term investments Notes receivable ......................................................... 191.1 Property, plant and equipment Equipment ......................................................$1,732.8 Less: Accumulated depreciation ................ 858.7 874.1 Total assets .............................................................. $2,979.4

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-11A (Continued) (b) 2011 Receivables turnover:

2010

$4,565.5 − $31.3 ($590.4 + $611.1) ÷ 2 = 7.5

= 8.3*

365 ÷ 7.5 = 48.7 days

365 ÷ 8.3 = 44 days

*Given in the problem Average collection period:

Tocksfor’s receivables turnover ratio was lower in 2011, which means that Tocksfor was taking a little longer in 2011 in turning receivables into cash. Taking It Further: When analyzing the accounts receivable turnover and average collection period, consideration should be given to any changes in policy implemented by management during 2011 with respect to granting credit or offering discounts to their customers. As well, sales of accounts receivable during the year would also affect the receivables turnover.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-12A (a)

Since consideration of the age of the accounts is taken into account in arriving at the required balance of the allowance for doubtful accounts, Shaw is using the percentage of receivables approach.

(b) Rogers

Shaw

($ in millions) Beginning of Year Jan. 1, 2008 and Sept. 1, 2007 Accounts receivable (net) Add: allowance Gross Accounts receivable

$1,245 151 $1,396

$155.5 15.2 $170.7

End of Year Dec. 21, 2008 and Aug. 31, 2008 Accounts receivable (net) Add: allowance Gross Accounts receivable

$1,403 163 $1,566

$188.1 15.4 $203.5

Receivables turnover:

Rogers

Shaw

$11,335 ($1,396 + $1,566) ÷ 2

$3,104.9 ($170.7 + $203.5) ÷ 2

= 7.7 Average collection period:

365 ÷ 7.7 = 47 days

= 16.6

365 ÷ 16.6 = 22 days

Shaw’s receivables turnover more than 100% higher than Rogers’, which means Shaw was more efficient than Rogers in collecting its receivables.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-12A (Continued) Taking It Further: In the case of Shaw and Rogers, the difference in the dates for the fiscal year ends should not affect the comparability of the ratios for receivables turnover and average collection period. Since these are service businesses that do not have seasonal trends, the twelve month period used for sales in the calculation should be comparable. The year end balance of accounts receivable will also not be affected by the date of the year end. On the other hand if the businesses being compared have seasonal trends, the accounts receivable balances at the year end would be significantly affected and so comparisons of the receivable turnover and average collection period might not be fair.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-13A (a)

Collection period Days sales in inventory Operating cycle (b)

2011 365 ÷ 7.3 = 50.0 days 365 ÷ 6.3 = 57.9 days 50.0 + 57.9 = 107.9 days

2010 365 ÷ 10.1 = 36.1 days 365 ÷ 6.1 = 59.8 days 36.1 + 59.8 = 95.9 days

2009 365 ÷ 10.3 = 35.4 days 365 ÷ 6.4 = 57.0 days 35.4 + 57.0 = 92.4 days

Overall, Satellite Mechanical’s liquidity has deteriorated over the three year period. Current ratio has improved from 1.4 to 1 to 2.0 to 1. The Acid-test ratio has also improved from .7 to 1 to 1.1 to 1. This has occurred because both accounts receivable and inventory have increased over the three year period and has resulted in the operating cycle weakening from 92.4 days to 107.9 days.

Taking It Further: The dramatic deterioration in the collection period in 2011 of 13.9 days (50.0 days – 36.1 days) is explained by Satellite’s change in policy concerning no longer offering sales discounts to its customers. Satellite should continue to weigh the benefit of saving the cost of sales discounts against the addition cost of financing accounts receivable longer by 13.9 days. If Satellite determines that the benefit no longer exceeds the costs, they should reconsider their sales discount policy for the future.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-1B (a)

1. Accounts Receivable.................... Sales .........................................

5,200,000

2. Sales Returns and Allowances .... Accounts Receivable ...............

80,000

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

5,400,000

4. Accounts Receivable.................... Interest Revenue ......................

400,000

5. Allowance for Doubtful Accounts Accounts Receivable ...............

130,000

6. Accounts Receivable.................... Allowance for Doubtful Accounts

50,400

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

50,400

5,200,000

80,000

5,400,000

400,000

130,000

50,400

(b) Date Jan. 1

Accounts Receivable Explanation Ref. Debit Balance 1 2 3 4 5 6 6

✓

Credit Balance

1,990,000 5,200,000 7,190,000 80,000 7,110,000 5,400,000 1,710,000 400,000 2,110,000 130,000 1,980,000 50,400 2,030,400 50,400 1,980,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-1B (Continued) (b) (continued)

Date Jan. 1

(c)

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Balance 5 6

✓ 130,000 50,400

Balance before adjustment [see (b)] ...................... Balance needed [$1,980,000 x 6%] ......................... Adjustment required ...............................................

119,400 10,600 Dr. 39,800

$39,800 118,800 $79,000

The journal entry would therefore be as follows: Dec. 31

Bad Debts Expense ................... 79,000 Allowance for Doubtful Accounts

79,000

(d) Accounts Receivable ........................................... $1,980,000 Less: Allowance for Doubtful Accounts .............. 118,800 Net Realizable Value ............................................. $1,861,200

(e)

Current assets: Accounts receivable ........................... $1,980,000 Less: Allowance for doubtful accounts 118,800 $1,861,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-1B (Continued) Taking It Further: When deciding if the business should continue to accrue bad debt expenses at the rate of 6% of accounts receivable, Underwood should consider the following factors: 1. Any change in the collection risk of customers. 2. Trends in the economy which would add risk to the collection of current accounts. 3. The age of the accounts receivable. 4. Experience with current customers concerning business failures. 5. The deterioration in the accounts receivable turnover. 6. Changes in terms offered to customers. Underwood’s write offs of, net of bad debt recoveries ($79,600) was less than the opening balance of the Allowance for doubtful accounts at the beginning of the year of $119,400. Unless there are indications that the percentage should be changed based on the factors listed above, the 6% should be continued at December 31, 2011.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-2B (a)

Accounts Receivable .................................1,900,000 Sales ....................................................... 1,900,000 Cash ............................................................2,042,000 Accounts Receivable ............................. 2,042,000

(b) Allowance for Doubtful Accounts ............. 58,000 Accounts Receivable ............................. (c)

Accounts Receivable ................................. Allowance for Doubtful Accounts ........

4,000

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

4,000

58,000

4,000

Posting to accounts not required:

Date

Accounts Receivable Explanation Ref. Debit Balance Sales Collections Write-offs Recovery Payment

Date

✓

Credit Balance

800,000 1,900,000 2,700,000 2,042,000 658,000 58,000 600,000 4,000 604,000 4,000 600,000

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance

Balance Write-offs Recovery Bad debts expense PROBLEM 8-2B (Continued)

✓ 58,000 (d)

4,000 46,000

44,000 14,000 Dr. 10,000 Dr. 36,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

(d) Bad Debts Expense ($36,000 + $10,000) ... 46,000 Allowance for Doubtful Accounts ........ (e)

(f)

Current assets: Accounts receivable ........................... $600,000 Less: Allowance for doubtful accounts 36,000

46,000

$564,000

The bad debts expense on the income statement for the period would be $46,000.

(g) Bad Debts Expense (1.25% x $1,900,000) . 23,750 Allowance for Doubtful Accounts ........

23,750

Current assets: Accounts receivable ........................... $600,000 Less: Allowance for doubtful accounts 13,750

$586,250

($10,000 debit + $23,750 credit = $13,750 credit) The bad debts expense on the income statement for the period would be $23,750.

Taking It Further: Fassi Co.’s adjusted balance of the Allowance for doubtful accounts is materially different under each of the approaches ($36,000 − $13,750 = $22,250 difference). Fassi can increase the estimate of percentage used for the percentage of sales approach to an adequate level or it should use the percentage of receivables approach which is more in conformity with the emphasis on the balance sheet approach encouraged by the International Financial Accounting Standards.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-3B (a)

$40,000 ($48,000 − $8,000)

(b) $62,000 [$52,000 − ($30,000 − $48,000 + $8,000)] (c)

$49,500 ($3,300,000 x 1.5%)

(d) $49,750 ($52,000 − $2,250) (e)

The write-off of an uncollectible account does not affect the net realizable value of accounts receivable. Accounts receivable are decreased and the allowance for doubtful accounts is also decreased resulting in no change in the amount of the net realizable value of accounts receivable.

(f)

The specific accounts that will be uncollectible are not known when bad debts are estimated and recorded. If the accounts receivable general ledger account was credited, without crediting any subledger accounts, the accounts receivable subledger would not balance with its controlling account.

Taking It Further: Companies should use the allowance method of accounting for uncollectible accounts because generally accepted accounting principles require the use of this method when bad debt expenses are material in an accounting period. The allowance method of accounting for bad debts estimates uncollectible accounts at the end of each accounting period. This ensures that receivables are reduced to their net realizable value on the balance sheet. It also gives better matching of expenses with revenues on the income statement because credit losses that are expected to happen from sales or service revenue in that accounting period are recorded in the same accounting period as when the revenue was earned.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 8-4B (a)

Total estimated uncollectible accounts Number of Days Outstanding Total 0-30 31-60 61-90 Over 90 Accounts $192,500 $110,000 $50,000 $20,000 $12,500 receivable % uncollectible 1.5% 5% 15% 20% Estimated uncollectible $9,650 $1,650 $2,500 $3,000 $2,500 accounts

(b) Bad Debts Expense .................................... 14,650 Allowance for Doubtful Accounts ........ [$9,650 + $5,000] (c)

Allowance for Doubtful Accounts ............. 11,900 Accounts Receivable .............................

(d) Accounts Receivable ................................. Allowance for Doubtful Accounts ........

2,100

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

2,100

(e)

14,650

11,900 2,100 2,100

If Imagine Co. used 8% of total accounts receivable rather than aging the accounts, the adjustment would be $20,400 [($192,500 x 8%) + $5,000]. The remaining entries would remain unchanged.

Taking It Further: Aging the accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance and bad debts expense. It also focuses management’s attention on the receivables and the loss percentages, which can result in better receivables management.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 8-5B (a)

2011 # of Days Outstanding 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

2010 # of Days Outstanding 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

Amount $190,000 40,000 65,000 75,000 $370,000

Amount $220,000 105,000 40,000 25,000 $390,000

% 3 6 12 24

Estimated Uncollectible $ 5,700 2,400 7,800 18,000 $33,900

% 3 6 12 24

Estimated Uncollectible $ 6,600 6,300 4,800 6,000 $23,700

(b) 1. Bad Debts Expense .................................... 27,900 Allowance for Doubtful Accounts [$23,700 + $4,200] .................................. 2.

27,900

Allowance for Doubtful Accounts ............. 25,500 Accounts Receivable .............................

25,500

Accounts Receivable ................................. Allowance for Doubtful Accounts ........

2,500 2,500

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

2,500

Bad Debts Expense .................................... 33,200 Allowance for Doubtful Accounts ........ [$33,900 − ($23,700 − $25,500 + $2,500)]

2,500

33,200

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PROBLEM 8-5B (Continued) (c)

2010 Accounts Receivable ............................................. $390,000 Less: Allowance for Doubtful Accounts ................ 23,700 Net Realizable Value ............................................... $366,300 2011 Accounts Receivable ............................................. $370,000 Less: Allowance for Doubtful Accounts ................ 33,900 Net Realizable Value ............................................... $336,100

Taking It Further: Although total accounts receivable decreased by $20,000 or 5% ($390,000 − $370,000), the estimated uncollectible amounts increased by $10,200 ($33,900 − $23,700) or 43%. The most significant increase occurred in over 90 day balances. The balance rose from $25,000 to $75,000, demonstrating a dramatic deterioration in the age of the accounts receivable, resulting in a higher allowance.

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PROBLEM 8-6B (a)

The Allowance for Doubtful Accounts should have a balance of $72,850 at year-end. The supporting calculations are shown below:

Days Account Outstanding

Amount

Expected Percentage Uncollectible

Estimated Uncollectible

0-15 days $355,000 .03 16-30 days 115,000 .08 31-45 days 80,000 .20 46-60 days 40,000 .25 61-75 days 20,000 .60 Over 75 days 15,000 .90 Balance for Allowance for Doubtful Accounts

$10,650 9,200 16,000 10,000 12,000 13,500 $71,350

(b)

Current Assets: Accounts receivable ....................................................... $625,000 Less allowance for doubtful accounts .......................... 71,350 Accounts receivable .............................................. $553,650

(c)

The amount of the bad debt expense reported on the income statement would be $36,350, as calculated below: Estimated amount required in the Allowance for Doubtful Accounts Balance in the account before adjustment Required charge to bad debt expense

$71,350 35,000 $36,350

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PROBLEM 8-7B

Beg. Bal. Sales Recoveries End Bal.

Write-offs

Accounts Receivable 320,000 Collections (a) 2,527,900 Write-offs (b) 2,250 Recoveries (c) 380,000

2,442,450 (d) 25,450 2,250

Allowance for Doubtful Accounts Beg. Bal. (e) 22,400 Recoveries (b) 2,250 25,450 Bad debts (f) 31,200 End. Bal. 30,400 Sales Sales

(a) 2,527,900

Bad Debts Expense (f) 31,200 Beginning balance of the Allowance for Doubtful Accounts is 7% of the beginning balance of Accounts Receivable of $320,000 ($320,000 x .07) = $22,400 (e) Ending balance of the Allowance for Doubtful Accounts of $30,400 is 8% of the ending balance of Accounts Receivable (c) of $380,000 ($30,400 ÷ .08) Allowance for Doubtful Accounts ................ Accounts Receivable (d) ..........................

25,450

Accounts Receivable (b) ............................... Allowance for Doubtful Accounts (b)... Cash ............................................................... Accounts Receivable ............................ Bad debt recovery entries

2,250

25,450

2,250 2,250 2,250

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PROBLEM 8-7B (Continued) Bad Debts Expense (f) .................................. 31,200 Allowance for Doubtful Accounts (f) ....... Force: ($30,400 − $22,400 − $2,250 + $25,450 = $31,200)

31,200

Accounts Receivable (a) ............................... 2,527,900 Sales (a) ..................................................... 2,527,900 Force: ($380,000 − $320,000 − $2,250 + $2,250 + $25,450 + $2,442,450) = $2,527,900

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PROBLEM 8-8B (a) Transaction Cash April 1. NE 2. NE 3. +$69,200 4. NE 5. NE May 1. NE 2. $450 3. +$78,500 4. NE 5. NE 6. NE

(1) (2)

Acc. Receiv.

Allow. for Doubt. Accts.

+$64,600 −$800 −$69,200 +$1,645 NE

NE −$35,530 NE NE NE NE NE NE (1)+$1,914 NE

+$29,070 +$29,070 −$800 −$800 NE NE +$1,645 +$1,645 −$1,914 −$1,914

+$76,600 NE −$78,500 −$9,580 +$1,570 NE

NE −$42,130 $450 NE NE NE −$9,580 NE NE NE (2)+$6,818 NE

+$34,470 +$34,470 NE NE NE NE NE NE +$1,570 +$1,570 −$6,818 −$6,818

Invent.

Total Assets

Owner's Equity

($64,600 − $800) x 3% = $1,914 Bad Debt Expense = [($75,535 x 6%) + 2,286] = $6,818 (See Accounts Receivable and Allowance For Doubtful Accounts balances in ledger that follows.)

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PROBLEM 8-8B (Continued) (a) (Continued) Ledgers not required, used for accumulating balances

Date April 1. 2. 3. 4. May 1. 2. 2. 3. 4. 5.

Date April 5. May 2. 4. 6.

Accounts Receivable Explanation Ref. Debit Opening Balance Sales Returns Collections Interest charges

Credit Balance

✓ 64,600 800 69,200 1,645

Sales Recovery Collection recovery Collections Write-offs Interest charges

76,600 450 450 78,500 9,580 1,570

89,200 153,800 153,000 83,800 85,445 162,045 162,495 162,045 83,545 73,965 75,535

Allowance for Doubtful Accounts Explanation Ref. Debit Credit Balance Opening Balance Bad debts expense Recovery Write-offs Bad debts expense

✓ 1,914 450 9,580

(b) Current assets: Accounts receivable .............................. Less: Allowance for doubtful accounts $71,003

6,818

4,930 6,844 7,294 2,286 Dr. 4,532

$75,535 4,532

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PROBLEM 8-8B (Continued) (c)

The bad debts expense on the income statement for the period would be $28,612 ($19,880 + $1,914 + $6,818)

Taking It Further: Assiniboia Co. can use the percentage of sales method at month end periods for the purpose of accruing bad debt expenses and then use the percentage of accounts receivable method at the end of the fiscal year because the monthly statements are not distributed to anyone outside of the company. The percentage of sales method is easy to administer and provides an adequate estimate for interim internal financial statement reporting. For the fiscal year end, the percentage of receivables method provides a balance sheet approach providing a focus of the valuation of the year end balances of accounts receivable to the net realizable value.

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PROBLEM 8-9B

Jan. 2 Accounts Receivable—George Co. ... 15,000 Sales ............................................... Cost of Goods Sold ............................ 8,200 Merchandise Inventory ..................

15,000 8,200

Feb. 1 Notes Receivable—George Co. ......... 15,000 Accounts Receivable—George Co

15,000

Mar. 31 Cash ($18,000 + $150 + $225) ............ 18,375 Notes Receivable—Annabelle Co. Interest Revenue ($18,000 x 5% x 3/12) Interest Receivable [$18,000 x 5% x 2/12]

18,000 225 150

May

1 Cash ($15,000 + $225) ........................ 15,225 Notes Receivable—George Co ..... Interest Revenue ............................ [$15,000 x 6% x 3/12] 25 Notes Receivable—Avery Inc. ........... Accounts Receivable—Avery Inc.

9,000

Jun. 25 Cash .................................................... Interest Revenue ............................ [$9,000 x 6% x 1/12]

Jul. 25 Allowance for Doubtful Accounts ..... Notes Receivable-Avery Inc. .........

9,000

Oct. 1

6,000

Notes Receivable—E. Haworth.......... Cash ................................................

15,000 225

9,000

6,000

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PROBLEM 8-9B (Continued)

Nov. 30 Notes Receivable—MRC Corp ........... Cash ................................................

5,000 5,000

Dec. 1 Since the collection of the note was not made, no entry should be recorded at this date. By the end of the fiscal year, progress for collection should demonstrate if the account should be written off, along with any interest accrued, or if the allowance for doubtful accounts should be increased for this additional collection risk. Dec. 31 Interest Receivable ............................. Interest Revenue ............................

139

Emily Haworth $6,000 x 8% x 3/12 = MRC Corp. $5,000 x 4.5% x 1/12 = Total ....................................................

$ 120 19 $139

139

Taking It Further: Consideration would have to be given as to whether the note should be written off. At the very least, an allowance should be created with respect to the Emily Haworth note, based upon the estimated probability of collection. Interest should continue to be accrued until it is determined from collection efforts that the note and the interest are unlikely to be collected.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 8-10B (a)

The interest receivable at June 30, 2011 is: ALD Inc. $6,000 x 4% x 1/12 = $ 20 KAB Ltd. $10,000 x 5% x 1/12 = 42 BFF Co. $15,000 x 5.5% x 5/12 = 344 DNR Co. $4,800 x 8.75% x 1/12 = 35 MJH Corp. $9,000 x 5% x 0/12 = 0 Total $441

The notes receivable balance at June 30, 2011 is $44,800 ($6,000 + $10,000 + $15,000 + $4,800 + $9,000). (b) July 1 Cash ............................................... Interest Receivable ($6,000 x 4% x 1/12) ...................

2 Cash ............................................... Interest Receivable ($10,000 x 5% x 1/12) .................

31 Cash ............................................... 15,413 Interest Revenue ($15,000 x 5.5% x 1/12) .............. Interest Receivable.................... Notes Receivable—BFF Co. ..... 31 Accounts Receivable—DNR Co. ... Notes Receivable—DNR Co. ..... Interest Receivable ($4,800 x 8.75% x 1/12) .............. Interest Revenue ($4,800 x 8.75% x 1/12) ..............

69 344 15,000

4,870 4,800 35 35

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PROBLEM 8-10B (Continued) (b) (Continued) July 31 Interest Receivable ....................... Interest Revenue ....................... ALD Inc. $ 6,000 x 4% x 1/12 = KAB Ltd. $10,000 x 5% x 1/12 = MJH Corp. $ 9,000 x 5% x 1/12 = Total

100 100 $ 20 42 38 $100

Notes Receivable Explanation Ref. Debit Balance

✓ 15,000 4,800

July 1 1 31 31 31 31

44,800 29,800 25,000

Accounts Receivable Explanation Ref. Debit

Credit Balance

4,870

Interest Receivable Explanation Ref. Debit

Credit Balance

July 31 Date

Credit Balance

Balance

✓ 20 42 344 35

Adjusting entry

100

441 421 379 35 0 100

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PROBLEM 8-10B (Continued) (d) OUELLETTE CO. Balance Sheet (partial) July 31, 2011 ______________________________________________________ Assets Current assets Notes receivable ......................................................... Accounts receivable ................................................... Interest receivable ...................................................... Total current assets ............................................... Long-term investments Notes receivable ......................................................... (e)

$19,000 4,870 100 $23,970 $6,000

Interest should not be accrued on this note if it is unlikely to be collected. In addition, consideration would have to be given as to whether the note should be written off. At the very least, an allowance should be created with respect to the DNR note, based upon the estimated probability of collection.

Taking It Further: The DNR not carries a higher interest rate as it is likely that DNR Co. has a poor credit rating and is represents a collection risk that is higher than the average customer.

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PROBLEM 8-11B (a) NORLANDIA SAGA COMPANY Balance Sheet (Partial) November 30, 2011 (in thousands) Assets Current assets Cash............................................................................... $ 417.1 Short-term investments................................................ 224.6 Notes receivable ........................................................... 51.2 Accounts receivable ....................................... $311.4 Less: Allowance for doubtful accounts ........ 14.8 296.6 Merchandise inventory ................................................. 336.5 Prepaid expenses and deposits .................................. 19.3 Supplies......................................................................... 15.9 Total current assets ...................................................... 1,361.2 Long-term investments Notes receivable ........................................................... 101.9 Property, plant and equipment Equipment ...................................................... $924.2 Less: Accumulated depreciation ................. 471.7 452.5 Total assets .............................................................. $1,915.6

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PROBLEM 8-11B (Continued) (b) 2011 Receivables turnover:

2010

$2,823.8 − $18.5 ($311.4 + $271.7) ÷ 2 = 9.6

= 9.1*

365 ÷ 9.6 = 38 days

365 ÷ 9.1 = 40 days

*Given in the problem Average collection period:

Norlandia’s receivables turnover ratio was a little higher in 2011, which means that Norlandia was more efficient in 2011 in turning receivables into cash. Taking It Further: When analyzing the accounts receivable turnover and average collection period, consideration should be given to any changes in policy implemented by management during 2011 with respect to granting credit or offering discounts to their customers. As well, sales of accounts receivable during the year would also affect the receivables turnover.

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PROBLEM 8-12B Nike

Adidas

($ in U.S. millions)

(in Euro millions)

Beginning of Year Jan. 1, 2008 Accounts receivable (net) Add: allowance Gross Accounts receivable

$2,494.7 71.5 $2,566.2

€1,459 111 €1,570

End of Year Dec. 31, 2008 Accounts receivable (net) Add: allowance Gross Accounts receivable

$2,795.3 78.4 $2,873.7

€1,624 119 €1,743

Receivables turnover:

Nike

Adidas

$18,627.0 ($2,566.2 + $2,873.7) ÷ 2

€10,794 (€1,570 + €1,743) ÷ 2

= 6.8 Average collection period:

365 ÷ 6.8 = 53.7 days

= 6.5

365 ÷ 6.5 = 56.2 days

Adidas’ receivables turnover ratio was a little higher than Nike’s, which means that Adidas was more efficient than Nike in turning receivables into cash.

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PROBLEM 8-12B (Continued) Taking It Further: One of the advantages in making use of ratios is that comparisons of companies can be made even if the businesses are of vastly different sizes or they are using different currencies in their reporting, as is the case with Nike and Adidas. The ratio is a fraction and so can be used. The receivable turnover and collection period comparison between Nike and Adidas is valid. As for the comparison of sales, a conversion into a common currency (possibly U.S. dollars) would have to be made to the Adidas sales figures in order to determine the amount of the difference in sales between these two companies.

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PROBLEM 8-13B (a)

Collection period Days sales in inventory Operating cycle

(b)

2011 365 ÷ 10.6 = 34.4 days 365 ÷ 7.3 = 50.0 days 34.4 + 50.0 = 84.4 days

2010 365 ÷ 8.9 = 41.0 days 365 ÷ 7.6 = 48.0 days 41.0 + 48.0 = 89.0 days

2009 365 ÷ 9.0 = 40.6 days 365 ÷ 7.5 = 48.7 days 40.6 + 48.7 = 89.3 days

The current ratio has deteriorated from 1.9 to 1 to 1.6 to 1. The acid-test ratio has also deteriorated from 1.2 to 1 to .8 to 1. But the improvement in the accounts receivable turnover in 2011 may have reduced the balance in accounts receivable which would reduce both the current and the acid-test ratios. Inventory turnover had slightly deteriorated but the improvement in the accounts receivable turnover outweighs the deterioration in the inventory turnover and the net result is a reduction in the operating cycle. This is a sign of improved liquidity. As the deterioration in the acid-test ratio is likely the result of the improved accounts receivable turnover, it appears that overall, Western Roofing’s liquidity has improved over the three year period.

Taking It Further: The dramatic improvement in the collection period in 2011 of 5.6 days (41.0 days – 34.4 days) is explained by Western’s change in policy concerning offering sales discounts to its customers. Although this ratio dramatically improved, Western must weigh the benefit of collecting accounts receivable faster with the cost of the discounts. If Western determines that the cost exceeds the benefit, they should reconsider the policy for the future.

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CONTINUING COOKIE CHRONICLE (a)

Answers to Natalie’s questions 1. Calculations you should perform on the statements are: • Working capital = Current assets − Current liabilities • Current ratio = Current assets ÷ Current liabilities • Acid-test ratio = (Cash + Short-term investments + Accounts receivable) ÷ Current liabilities • Inventory turnover = Cost of goods sold ÷ Average inventory • Days sales in inventory = Days in the year ÷ Inventory turnover • Operating cycle = Days sales in inventory + Collection period Given the type of business, it is unlikely that Curtis would have a significant amount of accounts receivable. Positive working capital and a current ratio of greater than 1 is an indication that the company has good liquidity and will be more likely to be able to pay for the mixer. Note that the current ratio should be considered strong only if it is not artificially inflated by receivables or inventory. The inventory turnover and days sales in inventory will provide additional information – the days sales in inventory will tell you how long, on average it takes for inventory to be sold. The operating cycle will tell how long, on average, it takes to sell the inventory on account, and collect the cash. Of course, with few receivables, the operating cycle will not likely differ significantly from the days sales in inventory.

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CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) 2. Other alternatives to extending credit to Curtis include: • Waiting for 30 days to make the sale • Have Curtis borrow from the bank • Have Curtis use a bank credit card to finance the purchase. 3. A promissory note gives you the advantage of earning interest for the 30 days that it is outstanding. If Curtis does not pay the note and the interest after 30 days, you are in a better position to take legal action to collect, having a promissory note in hand. 4. The advantages of allowing customers to use bank credit cards include: making the purchase easier for the customer, potentially increasing sales, as customers are not limited to the amount of cash in their wallet, and reducing the accounts receivable you have to manage if credit cards are used instead of granting credit to customers. The disadvantage is the cost to your business. When a customer makes a purchase using a credit card, you will have to pay a percentage of the sale to the credit card company. The rate varies but 3% would not be unusual. You will also have to pay to rent the equipment. The fee is not large but is an ongoing expense.

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CONTINUING COOKIE CHRONICLE (Continued) (b) June 1 Note Receivable—Lesperance ....... Sales ............................................ Cost of Goods Sold ......................... Merchandise Inventory ...............

1,050 1,050 551 551

30 No entry July 15 Cash ................................................. Interest Revenue ($1,050 × 8.5% × 1.5/12) .............. Note Receivable—Lesperance ...

1,061 11 1,050

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BYP 8-1 FINANCIAL REPORTING PROBLEM (a) ($ in thousands) Receivables turnover

2009

2008

= 16.8*

$1,331,009 [($75,506 + $65,543) ÷ 2] = 18.9

Average collection period

= 21.7 days*

365 days = 19.3 days 18.9

*Given in text Inventory turnover

= 2.8**

$852,608 [($319,445 + $302,207) ÷ 2] = 2.7

Days sales in inventory

130 days**

365 days = 135.2 days 2.7

21.7 days + 130 days = 151.7 days

19.3 days + 135.2 days = 154.5 days

**From Chapter 6 Operating cycle

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BYP 8-1 (Continued) (b)

Overall, operating cycle has decreased slightly and this is a modest improvement. It is taking Forzani’s 151.7 days to purchase its inventory, sell it on account, and collect the cash. The average collection period has increased from 19.3 days to 21.7 days, an increase of two days. The number of days sales in inventory has decreased from 135.2 days to 130 days, a decrease of 5 days. It would appear that Forzani is managing its inventory more efficiently which has resulted in the decrease in number of days to sell inventory and a net decrease in the overall operating cycle of three days (154.5 – 151.7). Explained another way, if the days sales in inventory decreased 5 days and the collection period increased two days, it is logical to expect a net change in the operating cycle of three days.

(c)

Sales made using Visa or MasterCard do not result in accounts receivable. The amounts of the sales clear the businesses’ bank account the day following the date of the sale, and so are almost cash sales. Forzani does not have its own credit cards. If it did, it would have some interest revenue on the income statement. The other indicator confirming that it does not have its own credit card is that Forzani does not report in its notes to the financial statements that it has a business segment for providing financing to customers. The income statement shows that there are two main categories of sales. The sales at retail are for cash or close to cash, such as Visa or MasterCard through the corporate stores. The second category is for sales at wholesale to franchisee stores and others. The latter category would likely be the source of the sales on account.

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BYP 8-1 (Continued)

(d)

The reason for providing the aging of overdue accounts and the balance in the allowance for doubtful accounts in note 16 (c) is to advise the reader of the financial statements that the balance in allowance for doubtful accounts is far smaller than the amount of the accounts receivable that are overdue (older than 61 days). (b)

(e) As explained in part (c), the accounts receivable arise from sales at the wholesale level. Not all wholesale sales are on account. In order to have an average collection period of 121 days, the receivables turnover would need to be 3 times per year. Using this turnover ratio of 3 times and the average accounts receivable for 2009 of about $80,000, the credit sales must have been approximately $240,000 or 68% of total wholesale sales ($240,000 ÷ $352,715).

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BYP 8-2 INTERPRETING FINANCIAL STATEMENTS (a) ($ in thousands)

2008

2007

Current ratio Industry: 1.3 :1

$3,237a ÷ $3,529 = 0.9:1

$3,160b ÷ $3,156 = 1:1

Acid-test ratio Industry: 0.8 :1

$2,240c ÷ $3,529 = 0.63:1

$2,007d ÷ $3,156 = 0.64:1

Receivables turnover Industry: 10.6

$18,336 ($1,584 + $1,441) ÷ 2 = 12.1

$15,020 ($1,441 + $1,054) ÷ 2 = 12.0

365 ÷ 12.1 = 30.2 days

365 ÷ 12.0 = 30.4 days

Average collection period Industry: 34 days

$3,237 = $660 + $1,584 − $4 + $909 + $88 $3,160 = $569 + $1,441 − $3 + $1,012 + $141 c $2,240 = $660 + $1,584 − $4 d $2,007 = $569 + $1,441 − $3 a

Suncor’s current ratio has deteriorated from 2007 to 2008; its acid-test ratio has also deteriorated from 2007 to 2008 buy only by a very small amount. Both ratios are below the industry average. On the other hand, Suncor’s receivables turnover and average collection period are strong, consistent with 2007, and better than the industry averages. Overall, Suncor appears to have good liquidity.

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BYP 8-2 (Continued) (b) The absolute amount of the allowance for doubtful accounts, in relation to the gross accounts receivable is very small (one quarter of one percent or 0.0025) in 2008. In 2006, the absolute amount of the amount in the allowance for doubtful accounts was the same, but as a percentage of accounts receivable, it was slightly (0.0038) higher. The small size of the allowance for doubtful accounts might be a reflection on the financial strength of the customers to whom Suncor sells or it might be due to the fact that uncollectible accounts are promptly written off. (c)

By regularly selling its accounts receivable, Suncor could more quickly convert receivables into cash. The company may have determined that the fees associated with selling the receivables are higher than the interest costs for shortterm borrowings to finance operations. Increased profitability caused by the rise in oil prices and better collection efforts would justify abandoning this expensive way of speeding up collections.

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BYP 8-3 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 8-4 COMMUNICATION ACTIVITY Memorandum To:

Management

From:

Student

Re:

Management of the credit function

During the year, Toys for Big Boys has experienced a significant increase in sales due to the efforts of the sales staff. However, it is important that the sales staff be aware that, in order for the company to generate the cash it needs to continue operations, it is essential that Toys for Big Boys be able to generate cash from these sales. Cash is needed to pay for the inventory the company has purchased and to cover other operating expenses such as sales commissions. Over the past year, the company has noticed a trend whereby the sales have doubled, accounts receivable have quadrupled and cash flow has halved. Sales staff assumed the role of managing the credit function, but it appears that they were too focused on sales without considering the quality of the sales and the ability of the customer to pay the receivable within a reasonable period of time. Given the increase in the accounts receivable, it is likely that the company has now assumed additional credit risk. The longer a customer takes to pay, the more likely that he will default on the receivable.

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BYP 8-4 (Continued) The selling staff has been placed in a conflict of interest position. While it is in their best interest to stimulate sales, this may deter them from performing adequate credit checks. To improve this process I would recommend using a separate credit department to evaluate the credit worthiness of all potential credit customers. If this change is not implemented, at the very least a set of specific criteria should be developed which would ensure that the selling staff only grant credit to those customers who meet the company’s credit standards.

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BYP 8-5 ETHICS CASE (a)

The stakeholders in this situation are: The president of Proust Company The controller of Proust Company The company’s bank Any other parties who rely upon the company’s financial statements

(b) Yes. The controller has an ethical dilemma—should he/she follow the president's “suggestion” and prepare misleading financial statements (understated profit) or should he/she attempt to stand up to and possibly anger the president by preparing a fair (realistic) income statement. (c)

Proust Company's growth rate should be a product of fair and accurate financial statements. One should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of “creative accounting”.

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BYP 8-6 “ALL ABOUT YOU” ACTIVITY (a)

Additional benefits that can be obtained from the use of a credit card, beyond those answers already provided for the feature question include: credit cards can 1. help you establish a credit history and earn a credit rating; 2. be more convenient to carry than cash; and 3. give you incentives, such as reward points, that you can redeem for merchandise or services. Additional risks from the use of a credit card, beyond those answers already provided for the feature question include: credit cards can 1. damage your credit rating if your payments are late; 2. have complicated terms and conditions; and 3. cost much more than other forms of credit, such as a line of credit or a personal loan.

(b) The grace period is the period of time given by the credit card company between the statement date and the due date for payment. The interest free period includes the grace period as well as the period of time between the purchase date and the statement date. Consequently the interest free period is from Sept. 15 to 21 days beyond October 7 or October 28, resulting in 43 days. (c)

Cash advances are withdrawals of cash that are added to the credit card balance. Balance transfers are charges put on one credit card to pay off some or all of the balance on another credit card.

(d) Number of days for the cash advance: April 1 — May 15 = 45 days. Interest charge: $1,000 × 19% × 45/365 = $23.42.

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BYP 8-6 (Continued) (e) Calculation Results Option A: Option B: Make Make the the minimum minimum payment plus an payment each additional $10 month each month. Time to 10 years and 5 pay off months Interest paid

$889.40

Option C: Pay a fixed amount of $100.00 each month.

4 years and 7 months

11 months

$413.60

$97.28

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Legal Notice Copyright

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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

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

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

6, 7, 8

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

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

16, 17, 18 12, 13, 14 9, 10

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

5. Calculate and record depreciation of natural resources.

19, 20, 21 15

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

12, 13, 14 10, 11

17, 18, 19 15, 16

10, 11

9, 11, 12, 9, 11, 12, 13 13

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Time Level Allotted (min.)

Record property transactions.

Simple

20-30

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 Moderate disposal under straight-line and diminishing balance methods.

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

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

Description

Difficulty Time Level Allotted (min.)

Calculate and compare depreciation and gain or loss on disposal under straight-line and units of production methods.

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, note 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 P9-1A Q9-2 BE9-2 P9-3A Q9-3 BE9-4 P9-4A Q9-4 E9-1 P9-7A Q9-5 E9-2 P9-1B E9-3 P9-3B E9-12 P9-4B P9-6B

Analysis Synthesis Evaluation

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

2. Explain and calculate depreciation.

Q9-8

Q9-6 Q9-7 Q9-9 Q9-10 Q9-11

3. Revise periodic depreciation.

Q9-10, Q9-12 Q9-13 Q9-14 Q9-15

Q9-18 4. Account for the disposal of property, plant, and equipment.

Q9-16 Q9-17

5. Calculate and record Q9-19 depreciation of natural resources. 6. Identify the basic accounting issues for intangible assets.

Q9-20 Q9-21

Q9-25 BE9-17

Q9-26

7. Illustrate the reporting and analysis of longlived assets. Broadening Your Perspective

Q9-22 Q9-23 Q9-24

BE9-5 BE9-6 BE9-7 BE9-8 BE9-9 E9-2 E9-3 E9-4 E9-5 E9-12 P9-2A P9-3A BE9-10 BE9-11 E9-6 E9-7 E9-8 P9-4A P9-5A BE9-12 BE9-13 BE9-14 E9-9 E9-10 P9-6A P9-7A BE9-15 E9-11

P9-6A P9-7A P9-8A P9-9A P9-2B P9-3B P9-6B P9-7B P9-8B P9-9B P9-12B P9-6A P9-12A P9-4B P9-5B P9-6B P9-12B P9-8A P9-9A P9-6B P9-7B P9-8B P9-9B P9-12A P9-12B

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

BYP9-5 BYP9-6

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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. An item of property, plant, and equipment is recognized (recorded) as an asset if it is probable that the company will receive future economic benefits from the item.

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.

Two examples of operating expenditures incurred on new equipment are payment of an annual licence fee and payment of an annual insurance premium for the equipment. Two examples of capital expenditures include the shipping cost of a machine to its work site and testing it to ensure it is ready for its intended use. The operating expenditures would be expensed in the period incurred and the capital expenditures would be included as part of the cost of the new machine.

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.

The cost model is more widely used than the revaluation model because the financial information reported is more reliable, although it might be less relevant. Whereas the revaluation model might report more relevant market values, it 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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QUESTIONS (Continued) 7.

The purpose of depreciation is to allocate the cost of a long-lived, depreciable asset over its useful life in a systematic way. A common misunderstanding about depreciation is that depreciation attempts to measure an asset’s market value or real value. There is no attempt to measure the change in a long-lived asset’s real value because long-lived assets are not held for resale. Another common misunderstanding is that accumulated depreciation results in the accumulation of cash to purchase or replace the long-lived asset. Accumulated depreciation represents the total cost of the asset that has been allocated to expense so far—it does not represent a cash fund.

(a) Residual value is the estimated amount that a company would currently obtain from disposing the asset if the asset were already as old as it will be and in the condition it is expected to be in at the end of its useful life. Residual value is not depreciated, since the amount is expected to be recovered at the end of the asset’s useful life. (b) Residual value is subtracted from cost to determine the depreciable amount of the asset. Residual value limits the total amount of depreciation that can be recorded for all three methods of depreciation. Depreciation will stop when the asset’s carrying amount equals its expected residual value. In the straight-line and the units-of-production methods of calculating depreciation, residual value is used in calculating the depreciable amount per year or the depreciable amount per unit. Residual value is not used in determining the amount to which the diminishing-balance depreciation rate is applied. Under all three methods carrying amount should never be reduced below residual value. In other words, depreciation stops when the asset’s carrying amount is equal to its expected residual value.

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QUESTIONS (Continued) 9. (1) Depreciation Expense

(2) Profit

(3) Accumulated Depreciation

(4) Carrying Amount

(a) Early years of an asset’s life: Straightline

Will be lower than diminishingbalance

Will be higher than diminishingbalance

Will be lower than diminishingbalance

Will be higher than diminishingbalance

Units-ofproduction

Depending on number of units, could be higher or lower than the other two methods.

Impact on profit will vary with the number of units produced

Depending on number of units, could be higher or lower than the other two methods

Diminishing Will be higher -balance than straightline

Will be lower than straightline

Will be higher than straight-line

Will be lower than straightline

All three result in the same total accumulated depreciation

All three result in the same final carrying amount

(b) Over the total life of the asset: All three result in the same total depreciation expense

All three result in the same total impact on profit

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 for specific classes of assets.

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QUESTIONS (Continued) 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.

13.

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. The revaluation model is particularly useful in countries that experience high rates of inflation or for companies in certain industries, such as real estate companies, where fair values are more relevant than cost.

14.

Factors that may contribute to an impairment loss include: obsolescence of a piece of machinery, 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. Thus in practice not many companies will write up their property, plant, and equipment for this reason.

15.

A revision of depreciation affects current and future periods but not prior periods. Depreciation is based on the best available information at the time the estimate was made. Continual restatement of prior periods would adversely affect the reader's confidence in the financial statements; thus, prior periods should not be restated if depreciation is revised.

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QUESTIONS (Continued) 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.

18.

In a sale of property, plant, or equipment, the carrying amount of the asset is compared to the proceeds received 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.

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QUESTIONS (Continued) 19.

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.

20.

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.

21.

The depreciation of natural resources is recorded as inventory and not as an expense because the resource extracted is expected to be sold. Until the resource is sold, it has a future benefit and all the costs of obtaining this resource are recorded as an asset, inventory. The cost is later expensed, as cost of goods sold, when the extracted resource is sold.

22.

Intangible assets are rights, privileges and competitive advantages that result from ownership of long-lived assets. They have a future benefit in that they contribute to future revenue; however, they lack physical existence or substance.

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QUESTIONS (Continued) 23.

The cost of an intangible asset with a finite life should be amortized over the shorter of that asset's useful life or its legal life. The useful life represents the period over which economic benefits of the asset are to be received by the company. If the useful life is shorter than legal life, this would result in an increased annual amortization charge to profit.

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 can only be sold if the entire business is sold.

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.

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QUESTIONS (Continued) 26.

The asset turnover and return on asset ratios show how effectively the company uses its long-lived assets. The asset turnover shows the amount of sales produced for each dollar invested in assets. It is calculated by dividing net sales by average total assets. The return on assets measures overall profitability. It is calculated by dividing profit by average total assets.

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

The cost of the land is $86,000 ($75,000 + $5,000 + $2,500 + $3,500). The cost of the land improvements is $3,000.

BRIEF EXERCISE 9-2 The cost of the equipment is $33,000 (invoice price $31,350 + installation $650 + testing $1,000). The payment of $2,000 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)

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

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BRIEF EXERCISE 9-4 Jan. 2

Land [$800,000 x ($255,000 ÷ $850,000)] .... 240,000 Building [$800,000 x ($510,000 ÷ $850,000)] .... 480,000 Equipment [$800,000 x ($85,000 ÷ $850,000)] ...... 80,000 Cash ................................................ Mortgage Note Payable ($800,000 − $200,000) .................

200,000 600,000

BRIEF EXERCISE 9-5 Depreciable amount is $30,000 ($33,000 − $3,000). With a 3-year useful life, annual depreciation is $10,000 ($30,000  3). Under the straight-line method, depreciation is the same each year. Thus, depreciation expense is (a) $10,000 for each year of the equipment’s life and (b) $30,000 in total over the equipment’s life.

BRIEF EXERCISE 9-6 The diminishing-balance rate is 66⅔% (13 x 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 $33,000 2011 $33,000 66⅔% $22,000 $22,000 11,000 2012 11,000 66⅔% 7,333 29,333 3,667 2013 3,667 66⅔% 667¹ 30,000 3,000 ¹Limited to the amount that reduces the carrying amount to the residual value of $3,000 (b) Total depreciation over the truck’s useful life is $30,000.

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BRIEF EXERCISE 9-7 Depreciable amount per unit: ($35,000 − $350)  525,000 km. = $0.066/km. Annual depreciation expense: 2010: 110,000 x $0.066 = $7,260 2011: 155,000 x $0.066 = $10,230

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

Depreciable Year Amount* X 2011 2012 2013 2014

$30,000 30,000 30,000 30,000

Depr. Rate

33⅓% x 10/12 33⅓% 33⅓% 33⅓% x 2/12

Depr. Expense $ 8,333 10,000 10,000 1,667

End of Year Accum. Carrying Depr. Amount $33,000 $ 8,333 24,667 18,333 14,667 28,333 4,667 30,000 3,000

*Depreciable amount = $33,000 − $3,000 (b) Total depreciation expense over the equipment’s useful life is $30,000. (See accumulated depreciation at end of 2014 above.)

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BRIEF EXERCISE 9-9 The double diminishing-balance rate is 66⅔% (33⅓% x 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 X 2011 2012 2013

$33,000 22,000 7,333

End of Year Depr. Depr. Accum. Carrying Rate = Expense Depr. Amount $33,000 66⅔% x 1/2 $ 11,000 $ 11,000 22,000 66⅔% 14,667 25,667 7,333 66⅔% 4,333¹ 30,000 3,000

¹ Limited to the amount that brings the carrying amount to the residual value of $3,000 (b) Total depreciation expense over the equipment’s useful life is $30,000. (See accumulated depreciation at end of 2013 above.)

BRIEF EXERCISE 9-10 Loss on Impairment ................................... Accumulated Depreciation—Machinery Calculation: Carrying amount ($90,000 − $54,000)..... Less: Recoverable amount .................... Impairment loss .......................................

6,000 6,000

$36,000 30,000 $ 6,000

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BRIEF EXERCISE 9-11 Depreciation expense from 2008 to 2010: [($60,000 − $4,000) ÷ 7 years = $8,000] 2008 2009 2010 Total

$ 8,000 8,000 8,000 $24,000

Carrying amount, Jan. 1, 2011 ($60,000 − $24,000) ....... $36,000 Add: Equipment up-grade ............................................. 9,000 Less: Revised residual value ........................................ (3,000) Remaining depreciable amount ..................................... 42,000 Remaining useful life (9 years − 3 years) ...................... ÷ 6 years Revised annual depreciation expense 2011 .................. $ 7,000

BRIEF EXERCISE 9-12 (a)

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

37,000

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

33,500 3,500

37,000

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

37,000 $37,000 33,500 3,500 0 $ 3,500

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BRIEF EXERCISE 9-13 (a) Sept. 30

Depreciation Expense [($72,000 − $2,000) ÷ 5 x 9/12] ........ 10,500 Accumulated Depreciation —Office Equipment .................. 10,500

(b) Sept. 30

Cash ................................................ 21,000 Accumulated Depreciation—Office Equipment¹ ..................................... 52,500 Gain on Disposal ...................... 1,500 Office Equipment ...................... 72,000

¹[($72,000 − $2,000) ÷ 60 months x 45 months] = $52,500 Cost of office equipment ......................... $72,000 Less: accumulated depreciation ............. 52,500 Carrying amount at date of disposal....... 19,500 Proceeds from sale .................................. 08, 21,000 Gain on disposal ...................................... $ 1,500 (c) Sept. 30

Cash ................................................ 15,000 Accumulated Depreciation—Office Equipment ....................................... 52,500 Loss on Disposal ............................ 4,500 Office Equipment ...................... 72,000

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

$72,000 52,500 19,500 15,000 $ 4,500

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BRIEF EXERCISE 9-14 Jan. 7

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

76,000* 78,000 3,000** 95,000 62,000

*Consideration paid cash plus market value of old asset: ($62,000 + $14,000 = $76,000) **Loss is the carrying amount less the fair market value: ($95,000 − $78,000 − $14,000 = $3,000)

BRIEF EXERCISE 9-15 (a)

Depreciable amount = $8,000,000 − $500,000 = $7,500,000 Depreciable amount per unit = $7,500,000 ÷ 25,000,000 tonnes = $0.30 per tonne Depreciation cost for ore extracted in Year 1: $0.30 per tonne x 7,000,000 tonnes = $2,100,000 Aug. 31 Inventory .................................... 2,100,000 Accumulated Depreciation—Mine 2,100,000 Depreciation to be included in cost of goods sold: $0.30 per tonne x 6,500,000 tonnes = $1,950,000 Depreciation to be included in inventory: $0.30 per tonne x 500,000 tonnes = $150,000

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BRIEF EXERCISE 9-15 (Continued) (b) CUONO MINING CO. Balance Sheet (Partial) August 31, 2011 ______________________________________________________ Assets Current assets Inventory ..................................................

$150,000*

Property, plant, and equipment Ore mine ................................................... $8,000,000 Less: Accumulated depreciation ........... 2,100,000 5,900,000 * Check ($2,100,000 − $1,950,000 = $150,000)

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BRIEF EXERCISE 9-16 (a)

2011 Jan.

2 Patents .................................... Cash....................................

180,000 180,000

(b) Dec. 31 Amortization Expense ($180,000  9) .......................... 20,000 Accumulated Amortization— Patents ............................... (c)

2012 Jan.

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

20,000

25,000

(d) Original cost of patent ................................... Less: accumulated amortization ................... Plus: Legal costs to defend ........................... Remaining cost to be amortized ................... Remaining useful life (9 years − 1 year) ....... Revised annual amortization expense 2012 .

25,000 $180,000 (20,000) 25,000 185,000 ÷ 8 years $ 23,125

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

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

(h) (i) (j) (k) (l) (m) (n)

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

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BRIEF EXERCISE 9-18 CANADIAN TIRE CORPORATION, LIMITED Balance Sheet (Partial) December 31, 2008 (in millions)

Property, plant, and equipment Land .............................................................. $ 727.9 Buildings ......................................................... $2,347.2 Less: Accumulated depreciation .................. 787.1 1,560.1 Fixtures and equipment ................................. 645.3 Less: Accumulated depreciation .................. 434.5 210.8 Leasehold improvements............................... 460.5 Less: Accumulated depreciation .................. 143.5 317.0 Other property, plant, and equipment ......................... 574.0 Total property, plant, and equipment 3,389.8 Intangible assets Marks Work Wearhouse store brands and banners . Marks Work Wearhouse franchise agreements and locations .................................................................. Total intangible assets Goodwill ..........................................................................

50.4 8.0 58.4 70.7

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BRIEF EXERCISE 9-19 ($ in US millions)

Return on assets

$1,322 [($9,818 + $5,832) ÷ 2] = 16.89%

Asset turnover

$10,268 [($9,818 + $5,832) ÷ 2] = 1.31 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 machinery 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 machinery and not just the current period. Consequently, they should be capitalized and depreciated over the machinery’s useful life.

(b) 1. Delivery Equipment (or Vehicles) 2. Delivery Equipment (or Vehicles) 3. License Expense 4. Prepaid Insurance 5. Land 6. Land 7. Land ($6,600 − $1,700 = $4,900) 8. Land 9. Plant 10. Plant 11. Land Improvements 12. Factory Machinery 13. Factory Machinery 14. Plant

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EXERCISE 9-2 (a)

Land Building Land Improvements

Appraised Value $ 720,000 420,000 60,000 $1,200,000

% of Total 60% 35% 5%

Cost Allocated $ 696,000 406,000 58,000 $1,160,000*

*Total cost $1,150,000 + $10,000 (legal fees) = $1,160,000 (b) Land ......................................................... Land Improvements ................................ Building .................................................... Cash ($350,000 + $10,000) .................. Mortgage Payable ............................... (c)

696,000 58,000 406,000 360,000 800,000

Depreciable amount for the building is $386,000 ($406,000 – $20,000). With a 40-year useful life, annual depreciation expense is $9,650 ($386,000  40). Depreciable amount for the land improvements is $58,000. With a fifteen year useful life, annual depreciation expense is $3,867 ($58,000  15).

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EXERCISE 9-3 (a)

Cost of machinery =

$75,000 + $1,000 delivery + $200 insurance in transit + $2,800 testing and installation = $79,000

(b)

April 1, 2011 because that is the date the machinery 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 machinery’s useful life.

(d)

Depreciation expense, 2011 = $79,000 ÷ 10 X 9/12 = $5,925 Depreciation expense, 2012 = $79,000 ÷ 10 = $7,900

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EXERCISE 9-4 (a) Straight-line

Depreciable Year Cost* ×

Depr. Rate

2010 2011

20% 20%

$400,000 400,000

Depr. Expense $80,000 80,000

End of Year Accum. Carrying Depr. Amount $410,000 $80,000 330,000 160,000 250,000

* $410,000 − $10,000 = $400,000 (b) Diminishing-balance using double the straight-line rate Carrying Amount Beginning Year of Year ×

Depr. Rate

2010 2011

40% 40%

(c)

$410,000 246,000

End of Year Depr. Accum. Carrying = Expense Depr. Amount $410,000 $164,000 $164,000 246,000 98,400 262,400 147,600

Units-of-Production

Units of Depr. Year Production × Cost/Unit* =

Depr. Expense

2010 2011

$35,840 48,240

44,800 60,300

$0.80 0.80

End of Year Accum. Carrying Depr. Amount $410,000 $35,840 374,160 84,080 325,920

* Depreciable amount per unit is $0.80 per kilometre: [($410,000 – $10,000) ÷ 500,000 km = $0.80] (d) The units-of-production method should be used as it best reflects the pattern over which the business’ future economic benefits are expected to be consumed.

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

Depreciable Year Amount* × 2010 2011 2012 2013 2014

$74,000 74,000 74,000 74,000 74,000

Depr. Rate

Depr. Expense

25% x 3/12 25% 25% 25% 25% x 9/12

$4,625 18,500 18,500 18,500 13,875

End of Year Accum. Carrying Depr. Amount $86,000 $4,625 81,375 23,125 62,875 41,625 44,375 60,125 25,875 74,000 12,000

* $86,000 − $12,000 = $74,000

(2)

Diminishing-balance using double the straight-line rate

Carrying Amount Beginning Year of Year × 2010 2011 2012 2013

$86,000 75,250 37,625 18,812

Depr. Rate = 50% x 3/12 50% 50% 50%

End of Year Depr. Accum. Carrying Expense Depr. Amount $86,000 $10,750* $10,750 75,250 37,625 48,375 37,625 18,813 67,188 18,812 6,812** 74,000 12,000

* $86,000 x 50% x 3/12 = $10,750 ** Limited to the amount that brings the carrying amount to the residual value of $12,000

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

Year 2010 2011 2012 2013 2014

End of Year Units of Deprec. Depr. Accum. Carrying Production × Amt/Unit* = Expense Depr. Amount $86,000 500 $7.40 $3,700 $3,700 82,300 2,800 7.40 20,720 24,420 61,580 2,900 7.40 21,460 45,880 40,120 2,600 7.40 19,240 65,120 20,880 1,300 7.40 8,880** 74,000 12,000

* Depreciation amount per unit is $7.40/hour [($86,000 – $12,000)  10,000 hours = $7.40] ** Limited to the amount that brings the carrying amount to the residual value of $12,000. (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 9-6 (a)

July

1 Equipment.................................. 500,000 Cash.......................................

500,000

Dec. 31 Depreciation Expense ............... 25,000 2007 Accumulated Depreciation— Equipment ($500,000 ÷ 10 x 6/12)

25,000

Dec. 31 Depreciation Expense ............... 50,000 2010 Accumulated Depreciation— Equipment ($500,000 ÷ 10) ...

50,000

(b) Carrying amount of the equipment—Dec. 31, 2010 [$500,000 – ($50,000 x 3.5 years)].............. $325,000 Recoverable amount .................................. 225,000 Impairment loss .......................................... $100,000 Dec. 31 Loss on Impairment .................. 100,000 2010 Accumulated Depreciation— Equipment ............................ (c)

100,000

January 1, 2011 Carrying amount is $225,000 Depreciation expense for 2011: $225,000 ÷ 6.5 years = $34,615. December 31, 2011 Carrying amount is $190,385 ($225,000 − $34,615).

(d) Carrying amount at Dec. 31, 2011 ............. Carrying amount at Dec. 31, 2011 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 9-7 (a)

Annual depreciation — 2009 Building: ($800,000 – $40,000) ÷ 20 yrs = $38,000 per year Equipment: ($120,000 – $5,000) ÷ 5 yrs = $23,000 per year Carrying amount Building Dec. 31, 2009: $382,000 [$800,000 – ($38,000 x 11)] Carrying amount Equipment Dec. 31, 2009: $97,000 ($120,000 – $23,000)

(b) Annual depreciation — 2010 Building: [($382,000 – $65,000) ÷ (25 − 11 yrs)] = $22,643 per year Equipment: [($97,000 – $3,500) ÷ (4 – 1 yrs)] = $31,167 per year Carrying amount Building Dec. 31, 2010: $359,357 ($382,000 – $22,643) Carrying amount Equipment Dec. 31, 2010: $65,833 ($97,000 – $31,167) (c)

Annual depreciation — 2011 Building: $22,643 per year as in part (b) Equipment: $31,167 per year as in part (b) Carrying amount Building Dec. 31, 2011: $336,714 ($359,357 – $22,643) Carrying amount Equipment Dec. 31, 2011: $34,666 ($65,833 – $31,167)

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EXERCISE 9-8 (a)

2010 June 30 Depreciation Expense ............... 13,000 Accumulated Depreciation —Equipment ......................... [($60,000 − $8,000) ÷ 4 years]

(b) July (c)

13,000

1 Equipment ($10,000 + $1,000)... 11,000 Cash.......................................

11,000

2011 June 30 Depreciation Expense ............... 10,400 Accumulated Depreciation —Equipment .........................

10,400

Carrying amount, July 1, 2010 ($60,000 − $13,000) Add: New part .......................................................... Less: Revised residual value ................................ Remaining depreciable amount ............................. Remaining useful life (6 − 1) ................................... Revised annual depreciation expense ...................

$47,000 11,000 58,000 6,000 $52,000 ÷ 5 years $10,400

(d) Cost ($60,000 + $11,000) ......................................... Accumulated Depreciation ($13,000 + $10,400) .... Carrying amount June 30, 2011..............................

$71,000 23,400 $47,600

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EXERCISE 9-9 (a) Jan. 2 No entry Feb. 28

Depreciation Expense ........................ Accumulated Depreciation —Machinery ................................... ($54,000 ÷ 10 years x 2/12)

900

Aug. 1 Depreciation Expense ........................ Accumulated Depreciation —Office Equipment........................ ($10,980 ÷ 3 years x 7/12)

2,135

900

2,135

Dec. 1 Depreciation Expense ........................ 2,750 Accumulated Depreciation—Truck ($30,000 − $6,000) ÷ 8 years x 11/12)

2,750

(b)

Cash

Equipment

Accum. Depr.

Total PP&E

Total Assets

Owner's Equity

Jan. 2

−$8,000

Feb. 28

−$54,000

−$49,5001

−$4,5002

−$4,500

Aug. 1

+$2,000

−$10,980

−$9,4553

−$1,5254

+$4755

+$475

Dec. 1

−$35,000

−$30,000 −$21,0007 +$33,0008 +$42,0006

−$2,0009

−$2,000

Transaction

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EXERCISE 9-9 (Continued) (b) (Continued) 1

$49,500 = ($54,000 ÷ 10 years) x (9 years + 2 months) $4,500 = $54,000 − $49,500 3 $9,455 = ($10,980 ÷ 3 years) x (2 years + 7 months) 4 $1,525 = $10,980 − $9,455 5 $475 = $2,000 − $1,525 6 $42,000 = Fair value of old truck $7,000 + cash $35,000 7 $21,000 = [($30,000 − $6,000) ÷ 8 years)] x 7 years 8 $33,000 = $42,000 – ($30,000 − $21,000) 9 $2,000 = Fair value old truck $7,000 – Carrying amount $9,000 2

8,000 8,000

Accumulated Depreciation—Machinery 49,500 Loss on Disposal................................ 4,500 Machinery ....................................... 54,000

Aug. 1 Cash .................................................... Accumulated Depreciation —Office Equipment ............................ Gain on Disposal .......................... Office Equipment ...........................

2,000 9,455

Dec. 1 Delivery Truck (New) .......................... 42,000 Accumulated Depreciation —Truck .. 21,000 Loss on Disposal................................ 2,000 Delivery Truck (Old) ....................... Cash ................................................

475 10,980

30,000 35,000

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EXERCISE 9-10 (a)

(1) (2)

Straight-line method: ($32,000 − $2,000) ÷ 4 years = $7,500 per year for 2008, 2009 and 2010. Double diminishing-balance method DDB Rate: ¼ x 2 = 50%

2008: $32,000 x 50% = $16,000 2009: ($32,000 − $16,000) x 50% = $8,000 2010: ($32,000 − $16,000 − $8,000) x 50% = $4,000 (b) (1)

Straight-line method Proceeds − Carrying amount = Gain (loss) $6,500 – [$32,000 – ($7,500 x 3)] = $6,500 – $9,500 = ($3,000) loss

(2)

Double diminishing-balance method Proceeds − Carrying amount = Gain (loss) $6,500 – [$32,000 – ($16,000 + $8,000 + $4,000)] = $6,500 – $4,000 = $2,500 gain

(c) The amount of the loss using the straight-line method is $3,000. The amount of the gain using the doublediminishing-balance method is $2,500. 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. (d) When comparing the total impact on profit over the threeyear period the amounts are identical. Using the straightline method total depreciation is $22,500 and loss on disposal is $3,000 resulting in a $25,500 decrease in profit over the three year period. Using the double-diminishingbalance method total depreciation is $28,000 and gain on disposal is $2,500 resulting in a $25,500 decrease in profit over the three year period.

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EXERCISE 9-11 (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 x 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 INC. Income Statement (Partial) Year Ended December 31, 2011 Cost of goods sold: (will include this amount plus other costs) ($1.50 x 100,000 tonnes) ............................ $150,000 PHILLIPS INC. Balance Sheet (Partial) December 31, 2011 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 value 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, and are permanent in nature.

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 until an impairment in value 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 with increases to their market value occur when the business uses the fair value model under the International Financial Accounting Standards (IFRS). This is very unlikely the case for Chin Company. As well, current market 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) Jan. 2 Patents ............................................. Cash .............................................

22,500

April 1 Franchise ......................................... Cash .............................................

250,000

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

335,000

Nov. 1 Research Expense .......................... Cash .............................................

185,000

22,500

250,000

335,000

185,000

(b) Dec. 31 Loss on Impairment—Goodwill ...... Goodwill ...................................... ($360,000 − $300,000)

60,000

31 Amortization Expense .................... 71,250 Accumulated Amortization—Patents [($225,000 ÷ 5) + ($22,500 ÷ 3)] ... Accumulated Amortization— Franchise [($250,000 ÷ 10) x 9/12]

60,000

52,500 18,750

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EXERCISE 9-14 (a) Patent Purchase price Jan. 1, 2008 Amortization 2008 (1) Amortization 2009 Amortization 2010 Balance Dec. 31, 2010 Amortization, 2011 (2) (1) (2)

Carrying Amount

$40,000 40,000 40,000 $280,000 $93,333 $186,667

($400,000 ÷ 10 years) Carrying amount ÷ (6 – 3 years) = $280,000 ÷ 3

Trademark Purchase price during 2007 Legal defence during 2010 Balance Dec. 31, 2010 Balance Dec. 31, 2011 (3) (3 )

Cost $400,000

Accum. Amort.

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 2009 Balance Dec. 31, 2010 Balance Dec. 31, 2011

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

(b) Income statement – December 31, 2011 Operating expenses: Amortization expense—Patent Impairment loss—Trademark

Carrying Amount $55,000 $55,000

$93,333 25,000

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EXERCISE 9-15 (a) Account Accumulated Depreciation – Finite-Life Intangible Assets Accumulated Depreciation – Building Accumulated Depreciation – Machinery and Equipment Accumulated Depreciation – Other Property, Plant, and Equipment Accumulated Depreciation – Satellites Accumulated Depreciation – Telecommunications Assets Depreciation and Amortization Expense Buildings

Financial Statement Balance Sheet

Section Intangibles

Balance Sheet

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

Cash and Cash Equivalents Common Shares Finite-Life Intangible Assets Goodwill Indefinite-Life Intangible Assets Land

Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet

Machinery and Equipment

Balance Sheet

Other Long-term Assets Other Property, Plant, and Equipment Plant under Construction

Balance Sheet Balance Sheet

Satellites

Balance Sheet

Telecommunications Assets

Balance Sheet

Balance Sheet Balance Sheet

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

Income Statement

Operating Expenses

Balance Sheet

Property, Plant, and Equipment Current Assets Shareholders’ Equity Intangibles Goodwill Intangibles

Balance Sheet

Property, Plant, and Equipment Property, Plant, and Equipment Long-Term Assets Property, Plant, and Equipment Property, Plant, and Equipment Property, Plant, and Equipment Property, Plant, and Equipment

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EXERCISE 9-15 (Continued) (b) BCE Inc. Balance Sheet (Partial) December 31, 2008 (in millions)

Property, plant, and equipment Land ............................................................................. Buildings ...................................................... $3,459 Less: Accumulated depreciation ................ 1,570 Plant under construction ............................ Machinery and equipment........................... $7,009 Less: Accumulated depreciation ................ 4,567 Telecommunications assets ....................... $41,131 Less: Accumulated depreciation ................ 28,264 Satellites ....................................................... $1,395 Less: Accumulated depreciation ............... 562 Other Property, plant, and equipment ........ $333 Less: Accumulated depreciation ............... 133 Total Property, plant, and equipment ................... Intangible assets Finite-life intangible assets ........................ $5,747 Less: Accumulated depreciation ............... 3,050 Indefinite-life intangible assets.................................. Total intangible assets........................................... Goodwill ........................................................................... Other Long-term assets ..................................................

77 1,889 1,099 2,442 12,867 833 200 19,407

2,697 3,697 6,394 5,659 2,625

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EXERCISE 9-16 (a) (in millions) December 31, 2008 Asset $30,089 turnover [($32,528 + $24,509) ÷ 2]

Return on assets

December 31, 2007 $18,565 [($24,509 + $18,759) ÷ 2]

= 1.055 times

= 0.86 times

$2,137 [($32,528 + $24,509) ÷ 2]

$2,983 [($24,509 + $18,759) ÷ 2]

= 7.5%

= 13.8%

(b) Suncor’s asset turnover has increased significantly from 2007 to 2008. Net Revenues have increased from $18.6 billion to $30 billion or 62% while total assets have increased from $24.5 billion to $32.5 billion or 33%. Suncor generated more revenues in the year ended December 31, 2008 as compared to the year ended December 31, 2007. Profits have not kept pace with the increase in revenues. Return on assets has decreased significantly from 13.8% to 7.5%. The increase in total assets has not generated an increase in profit. In fact, profit has fallen from $3 billion to $2.1 billion.

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SOLUTIONS TO PROBLEMS PROBLEM 9-1A (a)

Jan. 12 Land ........................................... 220,000 Cash....................................... Note Payable .........................

55,000 165,000

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

4,500

31 Land ........................................... 25,000 Cash....................................... Feb. 13 Cash ........................................... Land .......................................

7,500

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

8,000

25,000

7,500

8,000

Mar. 14 Building ...................................... 35,000 Cash.......................................

35,000

31 Building ...................................... 15,000 Cash.......................................

15,000

Apr. 22 Building ...................................... 17,000 Cash.......................................

17,000

June 15 Building ...................................... 300,000 Cash....................................... Note Payable .........................

75,000 225,000

Sept. 14 Building ...................................... 300,000 Cash....................................... Note Payable .........................

100,000 200,000

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PROBLEM 9-1A (Continued) (a) (Continued) Oct. 12 Land Improvements .................. 42,000 Cash.......................................

42,000

15 Land Improvements .................. Cash.......................................

8,000 8,000

20 Building ...................................... Cash.......................................

6,700

Dec. 31 Interest Expense ....................... Cash.......................................

2,800

6,700

2,800

(b) Date 2011 Jan. 12 16 31 Feb. 13 28

Date 2011 Mar. 14 31 Apr. 22 June 15 Sept.14 Oct. 20

Explanation

Land Ref.

Debit

Credit Balance

220,000 4,500 25,000 8,000

220,000 224,500 249,500 242,000 250,000

Debit

Credit Balance

35,000 15,000 17,000 300,000 300,000 6,700

35,000 50,000 67,000 367,000 667,000 673,700

7,500

Explanation

Building Ref.

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PROBLEM 9-1A (Continued) (b) (Continued)

Date 2011 Oct. 12 15

Land Improvements Explanation Ref. Debit

Credit Balance

42,000 8,000

42,000 50,000

The costs that will appear on Kadlec’s December 31, 2011 balance sheet will be: Land $250,000 Building 673,700 Land Improvements 50,000 Taking It Further: Property, plant, and equipment assets should be depreciated (except land) when the assets are ready for use. In the case of Kadlec, the building was ready for use on October 20, 2011 and land improvements were completed on October 15, 2011 and so depreciation should be calculated from those dates.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-2A (a)

Year

Calculation

Accumulated Depreciation Dec. 31

MACHINE 1 2008 2009 2010 2011

$384,000* x 10%** x 10/12 = $32,000 $384,000 x 10% = $38,400 $384,000 x 10% = $38,400 $384,000 x 10% = $38,400

$ 32,000 70,400 108,800 147,200

*$392,000 − $8,000 = $384,000 **1/10 years = 10% MACHINE 2 2010 2011

$120,000 x 12.5%* x 2/12 = $2,500 ($120,000 – $2,500) x 12.5% = $14,688

$2,500 17,188

*1/8 years = 12.5% (b)

Year

Calculation

Accumulated Depreciation Dec. 31

MACHINE 1 2008 2009 2010 2011

$384,000* x 10%** x 6/12 = $19,200 $384,000 x 10% = $38,400 $384,000 x 10% = $38,400 $384,000 x 10% = $38,400

$ 19,200 57,600 96,000 134,400

*$392,000 − $8,000 = $384,000 **1/10 years = 10%

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-2A (Continued) (b) (Continued) MACHINE 2 2010 2011

$120,000 x 12.5%* x 6/12 = $7,500 ($120,000 − $7,500) x 12.5% = $14,063

$ 7,500 21,563

*1/8 years = 12.5%

(c)

It really doesn’t matter which policy Flatboard chooses in terms of recording depreciation in the year of acquisition, as long as it follows the policy consistently. The same total depreciation will be recorded whether depreciation is recorded monthly, or semi-annually. Depreciation is only an estimate, in any case.

Taking It Further: Flatboard should not consider recording depreciation to the nearest day. Depreciation is an estimate. The additional cost of recording it to the nearest day is not warranted and it implies an accuracy that does not exist.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3A (a)

Invoice price $204,000 Delivery cost 10,400 Installation and testing 8,600 Cost of the machine $223,000 The $1,975 insurance policy is an annual operating expenditure and not included in the cost of the asset.

(b) 1. STRAIGHT-LINE DEPRECIATION End of Year Depreciable Depr. Depr. Accum. Carrying Year Amount × Rate = Expense Depr. Amount $223,000 2009 $210,000* 25%** x 3/12*** $ 13,125 $ 13,125 209,875 2010 210,000 25% 52,500 65,625 157,375 2011 210,000 25% 52,500 118,125 104,875 2012 210,000 25% 52,500 170,625 52,375 2013 210,000 25% x 9/12 39,375 210,000 13,000 * ** ***

$223,000 − $13,000 = $210,000 1/4 years = 25% Machine was ready for use on October 1, 2009

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3A (Continued) (b) (Continued) 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year × 2009 2010 2011 2012 2013

$223,000 195,125 97,562 48,781 24,390

Depr. Rate

50%* x 3/12 50% 50% 50% 50%

End of Year Depr. Accum. Carrying Expense Depr. Amount $223,000 $27,875 $27,875 195,125 97,563 125,438 97,562 48,781 174,219 48,781 24,391 198,610 24,390 11,390** 210,000 13,000

* 1/4 years = 25% x 2 = 50% ** Limited to the amount that brings carrying amount to the residual value of $13,000 3. UNITS-OF-PRODUCTION End of Year Units of Depr. Depr. Accum. Carrying Year Production × Amt/Unit* = Expense Depr. Amount $223,000 2009 6,000 $2.33* $ 13,980 $ 13,980 209,020 2010 27,450 2.33 63,958 77,938 145,062 2011 22,950 2.33 53,474 131,412 91,588 2012 20,100 2.33 46,833 178,245 44,755 2013 13,500 2.33 31,755** 210,000 13,000 * Depreciable amount per unit is $2.33 per unit [($223,000 – $13,000)  90,000 = $2.33] ** Equal to the amount that brings the carrying amount to the residual value of $13,000 (difference is due to rounding the depreciation per unit amount)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3A (Continued) (c)

Straight-line depreciation provides the lowest amount of depreciation expense for 2009 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 2009 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 machine at the end of its useful life is an asset retirement cost and the amount must be estimated and added to the cost the machine — 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).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-4A (a) Transaction

Land

Building

Equip. ment

Accum. Depr.

Jan. 12 NE NE NE NE Feb. 24 NE +$75,000 NE NE Mar. 6 NE NE NE NE May 17 NE NE NE NE July 19 NE NE NE NE Aug. 21 NE NE +$26,000 NE Sept. 20 NE NE NE NE Oct. 25 NE NE +$20,000 NE Nov. 9 NE NE NE NE Dec. 31 +$75,000 NE NE NE Dec. 31 NE NE NE +$37,500

(b) Jan. 12 Maintenance Expense ............... Cash.......................................

Total PP&E

Profit

NE −$2,200 +$75,000 NE NE −$5,400 NE −$3,100 NE −$5,900 +$26,000 NE NE −$2,700 +$20,000 NE NE −$1,200 +$75,000 +$75,000 −$37,500 −$37,500

2,200 2,200

Feb. 24 Building ...................................... 75,000 Cash....................................... 75,000 Note: Possibly add to equipment depending on the type of system. Mar.

6 Maintenance Expense ............... Cash......................................

5,400

May. 17 Training Expense ...................... Cash.......................................

3,100

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

5,900

5,400

3,100

5,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

26,000

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

2,700

Oct. 25 Machinery .................................. 20,000 Cash....................................... Nov.

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

20,000

1,200

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

1,200

75,000

Dec. 31 Loss on Impairment .................. 37,500 Accumulated Depreciation— Equipment ............................ [($150,000 − $62,500) − $50,000]

37,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-4A (Continued) Taking It Further: Given that the engine has to be replaced frequently, consideration should be given to depreciating this component of the machine using a four year useful life and the remainder of the machine the twelve year useful life. The major difficulty with this is determining how much of the cost of the machine 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 machine.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-5A (a) Depreciable Year Amount × 2006 2007 2008 2009 2010

$1,100,000* 1,100,000 1,100,000 1,100,000 1,100,000

End of Year Depr. Depr. Accum. Carrying Rate** = Expense Depr. Amount $1,200,000 10% $110,000$110,0001,090,000 10% 110,000 220,000 980,000 10% 110,000 330,000 870,000 10% 110,000 440,000 760,000 10% 110,000 550,000 650,000

* Depreciable amount = $1,200,000 − $100,000 = $1,100,000 ** 1 ÷ 10 years = 10% (b)

(c)

Dec. 31

Loss on Impairment 250,000 Accumulated Depreciation— Equipment ............................ ($650,000 − $400,000)

250,000

The depreciation expense will decrease. The impairment recorded is larger than the original residual value, causing an overall decrease in the depreciable amount.

(d) Depreciable Year Amount ×

Depr. Rate

2011 2012 2013 2014 2015

20%** 20% 20% 20% 20%

$400,000 400,000 400,000 400,000 400,000

End of Year Depr. Accum. Carrying Expense Depr. Amount $800,000* $400,000 $80,000 880,000 320,000 80,000 960,000 240,000 80,000 1,040,000 160,000 80,000 1,120,000 80,000 80,000 1,200,000 0

* Accumulated Depreciation = $550,000 end of year before Loss on impairment + $250,000 loss on impairment ** 1 ÷ 5 years remaining (10 – 5 years) = 20%

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-5A (Continued) (e)

Accumulated depreciation at the end of this equipment’s useful life will be $1,200,000. Carrying amount at the end of this equipment’s useful life will be the amount of residual value which is $0.

Taking It Further: The recoverable amount of equipment could decline for the following factors: 1. Competitive factors cause the product being produced by the equipment to be overpriced. 2. Technological obsolescence causing pressure on pricing on resale or on the pricing of the product manufactured. 3. Environmental factors causing unforeseen costs to dispose to the equipment at the end of its useful life. 4. Equipment is no longer manufactured and repair parts may no longer be available. 5. Bankruptcy of the manufacturer of the equipment.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6A (a) 2009 May

1 Land ........................................... 150,000 Building ...................................... 235,000 Cash....................................... Note 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) 2010 Feb. 17 Maintenance Expense ............... Cash.......................................

115,000 270,000

6,267

9,000

225 225

Dec. 31 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—Land............ 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)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6A (Continued) (a) (Continued) 2011 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 Note 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, have been permanently shelved.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 value 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. 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 market value of the land. 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-7A (a)

1. STRAIGHT-LINE DEPRECIATION

Depreciable Year Amount X

Depr. Rate

2009 2010 2011 2012 2013

20%** 20% 20% 20% 20%

$84,000* 84,000 84,000 84,000 84,000

Depr. Expense $16,800 16,800 16,800 16,800 16,800

End of Year Accum. Carrying Depr. Amount $91,500 $16,800 74,700 33,600 57,900 50,400 41,100 67,200 24,300 84,000 7,500

* $91,500 − $7,500 = $84,000 ** 1 ÷ 5 years = 20% 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year ×

Depr. Rate

2009 2010 2011 2012 2013

40%* 40% 40% 40% 40%

$91,500 54,900 32,940 19,764 11,858

Depr. Expense $36,600 21,960 13,176 7,906 **4,358

End of Year Accum. Carrying Depr. Amount $91,500 $36,600 54,900 58,560 32,940 71,736 19,764 79,642 11,858 84,000 7,500

* (1 ÷ 5 years) × 2 = 20% x 2 ** Amount that makes carrying amount equal to residual value

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-7A (Continued) (b) 1. (b) (a) DiminishingStraight-Line Balance Cost ................................................. Accumulated depreciation. ............ Carrying amount............................. Cash proceeds ............................... Loss (Gain) on sale ........................

$91,500 67,200 24,300 15,000 $ 9,300

$91,500 79,642 11,858 15,000 $(3,142)

Depreciation expense .................... Add: (Deduct) Loss (Gain) on sale Net expense ....................................

$67,200 9,300 $76,500

$79,642 (3,142) $76,500

Equipment’s purchase price ....... Proceeds from sale of bus........... Amount expensed ........................

$91,500 15,000 $76,500

In total the effect on profit is the same under both methods. This is because the method of depreciation selected only affects the timing of the expense recognition. Over the life of the asset, the total expense recognized is the same $76,500. Taking It Further: When selecting a depreciation method, management should choose the method that best matches the estimated pattern in which the asset’s future economic benefits are expected to be consumed.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-8A (a)

2009 Mar.

1 Delivery Equipment ................... 65,000 Accounts Payable .................

65,000

(b) 2009 Aug. 31 Depreciation Expense ............... 6,000 Accumulated Depreciation —Delivery Equipment ........... 6,000 [($65,000 − $5,000) ÷ 5 years] x 6/12 months = $6,000 2010 Aug. 31 Depreciation Expense ............... 12,000 Accumulated Depreciation —Delivery Equipment ........... ($65,000 − $5,000) ÷ 5 years = $12,000 2011 Aug. 31 Depreciation Expense ............... 12,000 Accumulated Depreciation —Delivery Equipment ........... (c)

12,000

2011 Sept. 30 Depreciation Expense ............... 1,000 Accumulated Depreciation —Delivery Equipment ........... 1,000 [($65,000 − $5,000) ÷ 5 years] x 1/12 months = $1,000 Accumulated Depreciation at September 30, 2011: ($65,000 − $5,000) x 31/60 months = $31,000 Or add annual depreciation expense in above journal entries: ($6,000 + $12,000 + $12,000 + $1,000 = $31,000) Carrying Amount at September 30, 2011: Cost – Accumulated Depreciation $34,000 = $65,000 − $31,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

Sept. 30 Accumulated Depreciation —Delivery Equipment ............... 31,000 Loss on Disposal* ..................... 34,000 Delivery Equipment ..............

65,000

*Proceeds – Carrying Amount = Gain (loss) $0 − $34,000 = $(34,000) 2.

Sept. 30 Cash ........................................... 30,000 Loss on Disposal** .................... 4,000 Accumulated Depreciation —Delivery Equipment ............... 31,000 Delivery Equipment .............. ** $30,000 − $34,000 = $(4,000) Sept. 30 Cash ........................................... 40,000 Accumulated Depreciation —Delivery Equipment ............... 31,000 Gain on Disposal*** .............. Delivery Equipment .............. *** $40,000 − $34,000 = $6,000 Sept. 30 Delivery Equipment ($28,000 + $55,000) .................... 83,000 Accumulated Depreciation —Delivery Equipment ............... 31,000 Loss on Disposal**** ................ 6,000 Cash ($87,000 − $32,000) ...... Delivery Equipment .............. **** $28,000 − $34,000 = $(6,000)

65,000

6,000 65,000

55,000 65,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-9A (a)

April

1 Land ...........................................2,200,000 Cash....................................... 550,000 Note 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 Note 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 ............... Accumulated Depreciation —Equipment ($500,000 ÷ 10)

50,000 50,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

74,250

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

39,375

74,250

39,375

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-9A (Continued) (c) HAMSMITH CORPORATION Balance Sheet (Partial) December 31, 2011 _______________________________________________________ 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, 2011 April 1, 2011

10,000,000 June 1, 2011 2,200,000

700,000

Dec. 31, 2011Bal. 11,500,000

Buildings Jan. 1, 2011

48,700,000

Dec. 31, 2011 Bal. 48,700,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-9A (Continued) (c) (Continued) Equipment Jan. 1, 2011 July 1, 2011

75,000,000 1,100,000

May 1, 2011 Dec. 31, 2011

1,400,000 500,000

Dec. 31, 2011Bal. 74,200,000

Accumulated Depreciation—Buildings Jan. 1, 2011 Dec. 31, 2011

31,100,000 974,000

Dec. 31, 2011 Bal. 32,074,000

Accumulated Depreciation—Equipment May 1, 2011 Dec. 31, 2011

1,166,667 500,000

Jan. 1, 2011 May 1, 2011 Dec. 31, 2011 Dec. 31, 2011

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

Dec. 31, 2011 Bal. 32,795,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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, 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-10A 1.

Research Expense ($160,000 x 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) x 6/12 = $5,000

5,000

88,000

5,867

5,000

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

12,500

Gain on License Market Value ................... 50,000 License ................................................... Recovery of Impairment Loss–License

10,000 40,000

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 are expensed as incurred.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-11A (a)

Jan.

2 Patent #1 .................................... 22,400 Cash ........................................... June 30 Research Expense .................... 220,000 Cash....................................... 30 Patent #2 (Development Costs) 60,000 Cash ........................................... Sept. 1 Advertising Expense ................. 21,000 Cash ........................................... Oct. 1 Copyright #2 .............................. 16,000 Cash ...........................................

22,400 220,000 60,000 21,000 16,000

Dec. 31 No entry: Reversals of impairments of goodwill may not be recorded. (b) Dec. 31 Amortization Expense ............... 9,800 Accumulated Amortization— Patent #1................................ 9,800 [($70,000 x 1/10) + ($22,400 x 1/8*)] * At Jan. 1, 2011 Patent # 1 has been amortized 2 years ($14,000 ÷ $70,000 = 2/10) — remaining period to amortize is 8 years. 31 Amortization Expense ............... 5,300 Accumulated Amortization— Copyright #1 .......................... 4,800 Accumulated Amortization— Copyright #2 .......................... 500 [($48,000 x 1/10) + ($16,000 x 1/8 x 3/12)]

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-11A (Continued) (b) (Continued) Dec. 31 Amortization Expense ............... 1,500 Accumulated Amortization— Patent #2................................ [($60,000 ÷ 20 years) x 6/12 = $1,500]

1,500

Assets Intangible assets Patents1 ................................................ Less: Accumulated amortization2...... Copyrights3 .......................................... Less: Accumulated amortization4...... Total intangible assets ........................ Goodwill ....................................................

$152,400 25,300 64,000 34,100

$127,100 29,900 $157,000 $210,000

Cost: Patent #1 ($70,000 + $22,400) + Patent #2 ($60,000) = $152,400 2 Accumulated Amortization: Patent #1 ($14,000 + $7,000 + $2,800) + Patent #2 ($1,500) = $25,300 3 Cost: Copyright #1 ($48,000) + Copyright #2 ($16,000) = $64,000 4 Accumulated Amortization: Copyright #1 ($28,800 + $4,800) + Copyright #2 ($500) = $34,100

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-12A (a)

2010 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 x 120,000 t = $570,000 Dec. 31 Cost of Goods Sold ................ Inventory .......................... 2011 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 x 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, 2011 ______________________________________________________ Cost of goods sold ........................................

$380,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-12A (Continued) (b) (Continued) YOUNT MINING COMPANY (Partial) Balance Sheet December 31, 2011 ______________________________________________________ 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 in 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 to inventory.

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Accounting Principles, Fifth Canadian Edition

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

Asset turnover

Return on assets

Andruski Company

Brar Company

$449.0 [($589.6 + $561.9) ÷ 2]

$1,464.1 [($1,288.5 + $1,324.4) ÷2]

= 0.78 to 1

= 1.12 to 1

$15.5 [($589.6 + $561.9) ÷ 2]

$84.8 [($1,288.5 + $1,324.4) ÷2]

= 2.69%

= 6.49%

(b) Brar Company is far more efficient in using its assets to generate sales–its assets turnover of 1.12 times is higher than 0.78 times for Andruski Company. Brar is also more efficient in using assets to produce profit–with a return on assets of 6.49% compared to 2.69% for Andruski Company. Taking It Further: In order to make better comparisons between Brar and Andruski, it would be beneficial to look at more detailed information contained in both their balances sheets and income statements. It appears that Brar has economies of scale which benefit them in generating profits far greater than Andruski. It is possible, for example that one business cannot afford to purchase some property, plant, and equipment and has to rent the necessary assets. If that is the case, the return on assets ratio is not truly comparable.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-1B (a)

Feb.

7 Land ........................................... 275,000 Cash....................................... Note Payable ......................... 9 Land ........................................... Cash......................................

Mar.

75,000 200,000

5,500 5,500

15 Land ........................................... 11,000 Cash.......................................

11,000

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

4,000 4,000

25 Land ........................................... Cash.......................................

9,000 9,000

2 Building ...................................... 18,000 Cash.......................................

18,000

15 Building ...................................... 15,000 Cash.......................................

15,000

Aug. 31 Building ...................................... 650,000 Cash....................................... Note Payable .........................

170,000 480,000

Sept. 3 Land Improvements .................. 12,000 Cash.......................................

12,000

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

2,500 2,500

11 Building ...................................... Cash.......................................

6,500 6,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-1B (Continued) (a)

(Continued) Dec. 31 Interest Expense ....................... 17,500 Cash.......................................

17,500

(b) Date 2011 Feb. 7 9 15 17 25

Date 2011 Mar. 2 15 Aug. 31 Sept.11

Date 2011 Sept. 3

Explanation

Land Ref.

Debit

Credit Balance

275,000 5,500 11,000 9,000

275,000 280,500 291,500 287,500 296,500

Debit

Credit Balance

18,000 15,000 650,000 6,500

18,000 33,000 683,000 689,500

Land Improvements Explanation Ref. Debit

Credit Balance

12,000

4,000

Explanation

Building Ref.

The costs that will appear on Weisman’s December 31, 2011 balance sheet will be: Land $296,500 Building 689,500 Land Improvements 12,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-1B (Continued) Taking It Further: Property, plant, and equipment assets should be depreciated (except land) when the assets are ready for use. In the case of Weisman, the building was ready for use on September 10, 2011 and land improvements were completed on September 3, 2011 and so depreciation should be calculated starting from those dates.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-2B (a)

Year

Calculation

Accumulated Depreciation Dec. 31

MACHINE 1 – Straight-line Depreciation 2009 2010 2011

($89,880* ÷ 7) x 11/12 = $11,770 $89,880 ÷ 7 = $12,840 $89,880 ÷ 7 = $12,840

$ 11,770 24,610 37,450

* $97,880 − $8,000 = $89,880 MACHINE 2 – Diminishing-balance Depreciation 2010 2011

$168,000 x 20%* x 3/12 = $8,400 ($168,000 − $8,400) x 20% = $31,920

$ 8,400 40,320

* 1 ÷ 10 years = 10% x 2 = 20%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-2B (Continued) (b)

Year

Calculation

Accumulated Depreciation Dec. 31

MACHINE 1 2009 2010 2011

($89,880* ÷ 7) x 1/2 = $6,420 $89,880 ÷ 7 = $12,840 $89,880 ÷ 7 = $12,840

$ 6,420 19,260 32,100

* $97,880 − $8,000 = $89,880

MACHINE 2 2010 2011

$168,000 x 20%* x 1/2 = $16,800 ($168,000 − $16,800) x 20% = $30,240

$ 16,800 47,040

* 1 ÷ 10 years = 10% x 2 = 20% (c)

It really doesn’t matter which policy Tarcher chooses in terms of recording depreciation in the year of acquisition, as long as it follows the policy consistently. The same total depreciation will be recorded whether depreciation is recorded monthly, or semi-annually. Depreciation is only an estimate, in any case.

Taking It Further: The choice of the method to prorate depreciation in the period of acquisition will not affect depreciation expense if the unitsof-production method is used. Under this method, depreciation is a function of the units produced not the time the machine is owned.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3B (a)

Cost: Cash price Delivery costs Installation and testing Total cost

$360,000 2,000 6,400 $368,400

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 × 2009 2010 2011 2012 2013 2014

$345,400* 345,400 345,400 345,400 345,400 345,400

Depr. Rate

20%** x 8/12 20% 20% 20% 20% 20% x 4/12

End of Year Depr. Accum. Carrying Expense Depr. Amount $368,400 $46,053 $ 46,053 322,347 69,080 115,133 253,267 69,080 184,213 184,187 69,080 253,293 115,107 69,080 322,373 46,027 23,027 345,400 23,000

* Depreciable amount = $368,400 − $23,000 = $345,400 ** 1 ÷ 5 years = 20%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3B (Continued) (b) (Continued) 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying Amount Beginning Year Of Year × 2009 2010 2011 2012 2013 2014

$368,400 270,160 162,096 97,258 58,355 35,031

Depr. Rate

40%* x 8/12 40% 40% 40% 40% 40%

End of Year Depr. Accum. Carrying Expense Depr. Amount $368,400 $98,240 $98,240 270,160 108,064 206,304 162,096 64,838 271,142 97,258 38,903 310,045 58,355 23,342 333,387 35,013 12,013** 345,400 23,000

* 1 ÷ 5 years = 20% x 2 = 40% **Equal to the amount that makes carrying amount equal to residual value 3. UNITS-OF-PRODUCTION DEPRECIATION

Units of Depr. Year Production × Amt./Unit* = 2009 2010 2011 2012 2013 2014

25,500 36,000 34,500 31,500 28,500 9,000

$2.09* 2.09 2.09 2.09 2.09 2.09

End of Year Depr. Accum. Carrying Expense Depr. Amount $368,400 $53,295 $ 53,295 315,105 75,240 128,535 239,865 72,105 200,640 167,760 65,835 266,475 101,925 59,565 326,040 42,360 19,360** 345,400 23,000

* Depreciation amount per unit: ($368,400 − $23,000) ÷ 165,000 units = $2.09 ** Use the amount that makes carrying amount equal to residual value

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-3B (Continued) (c)

Double diminishing-balance depreciation provides the highest amount of depreciation expense for 2009, thus resulting in the lowest 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 2009 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 machine at the end of its useful life is an asset retirement cost which must added to the cost of the machine — 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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Accounting Principles, Fifth Canadian Edition

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 −$15,500 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 Nov. 6 NE +$120,000 NE NE +$120,000 NE Nov. 28 NE NE NE NE NE −$5,000 Dec. 31 NE NE NE +$35,000* −$35,000 −$35,000 Dec. 31 +$95,000 NE NE NE +$95,000 +$95,000

*$35,000 = [($200,000 − $75,000) − $90,000] (b) Jan. 22 Maintenance Expense ............... Accounts Payable .................

4,600 4,600

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

95,000

6 Maintenance Expense ............... 15,500 Accounts Payable ................

15,500

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

10,000

Aug.

7 Machinery .................................. 35,000 Accounts Payable .................

35,000

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

1,900

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-4B (Continued) (b) (Continued) Nov.

6 Building ...................................... 120,000 Accounts Payable ................. 28 Maintenance Expense ............... Accounts Payable .................

120,000

5,000 5,000

Dec. 31 Loss on Impairment .................. 35,000 Accumulated Depreciation— Equipment .............................

35,000

Dec. 31 Land ........................................... 95,000 Recovery of Impairment Loss

95,000

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 $95,000 ($575,000 − $480,000). Since the current recoverable amount of $620,000 is greater than the original cost of the land, before impairment was recorded, the recovery entry is limited to $95,000. Taking It Further: Given that the engine has to be replaced frequently, consideration should be given to depreciating this component of the machine using a five year useful life and the remainder of the machine the fifteen year useful life. If the original machine 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 machine.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

Depr. Rate

2007 2008 2009 2010

10% 10% 10% 10%

$360,000* 360,000 360,000 360,000

End of Year Depr. Accum. Carrying Expense Depr. Amount $375,000 $36,000 $ 36,000 339,000 36,000 72,000 303,000 36,000 108,000 267,000 36,000 144,000 231,000

* Depreciable amount = $375,000 − $15,000 = $360,000 ** 1 ÷ 10 years = 10% (b) Dec. 31 Loss on Impairment 76,000 Accumulated Depreciation— Equipment ............................ ($231,000 − $155,000) (c)

76,000

It is difficult to predict. The impairment loss decreases the depreciable amount, but the shorter service life will increase the percentage written off each year.

(d) Depreciable Year Amount X 2011 2012 2013

$140,0002 140,000 140,000

Depr. Rate 33⅓%3 33⅓% 33⅓%

End of Year Depr. Accum. Carrying Expense Depr. Amount $220,000¹ $155,000 $46,667 266,667 108,333 46,667 313,334 61,666 46,666 360,000 15,000

¹ Accumulated Depreciation = $144,000 end of year before loss on impairment + $76,000 Loss on Impairment 2 Depreciable amount = Recoverable amount at date of impairment less revised residual value of $15,000 3 1 ÷ 3 years (7 – 4 years) remaining = 33⅓%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-5B (Continued) (e) Accumulated depreciation at the end of this equipment’s useful life will be $360,000. The carrying amount at the end of this equipment’s useful life will be the amount of residual value which is $15,000. Taking It Further: The recoverable amount of equipment could decline for the following factors: 1. Competitive factors cause the product being produced by the equipment to be overpriced. 2. Technological obsolescence causing pressure on pricing on resale or on the pricing of the product manufactured. 3. Environmental factors causing unforeseen costs to dispose of the equipment at the end of its useful life. 4. Equipment is no longer manufactured and repair parts may no longer be available. 5. Bankruptcy of the manufacturer of the equipment.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6B (a)

2009 Aug.

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

200,000 395,000

Dec. 31 Depreciation Expense .............. 2,500 Accumulated Depreciation—Building 2,500 [($255,000 − $15,000) ÷ 40] x 5/12 = $2,500 31 Interest Expense ....................... 8,229 Cash ...................................... ($395,000 × 5% × 5/12 = $8,229) 2010 May 21 Repairs Expense ...................... Cash ......................................

8,229

2,000 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—Land ........... 60,000 Land ....................................... ($280,000 − $340,000 = − $60,000)

60,000

Building - no entry as carrying amount = $246,500 ($255,000 − $2,500 − $6,000) and recoverable amount of $249,000 is greater.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6B (Continued) (a) (Continued) 2011 Mar. 31 Depreciation Expense ............... 1,500 Accumulated Depreciation—Building [($255,000 − $15,000) ÷ 40] x 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 Note 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 shelved.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6B (Continued) (c)

Nov. 30 Depreciation Expense ............... 5,500 Accumulated Depreciation—Building 5,500 [($255,000 − $15,000) ÷ 40] x 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 comparisons of what would be obtained on sale. 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.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-6B (Continued) Taking It Further: (Continued) When considering impairment of the land, on its own, there might be conditions that have been 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 market value of the land. 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 9-7B (a)

1. STRAIGHT-LINE DEPRECIATION End of Year

Depreciable Depr. Year Amount × Rate (1/3) = 2010 2011 2012

$214,000* 214,000 214,000

1/3 1/3 1/3

Annual Depr. Expense

Accum. Depr.

Carrying Amount $254,000 $71,333 $71,333 182,667 71,333 142,666 111,334 71,334** 214,000 40,000

* $254,000 − $40,000 = $214,000 ** rounding 2. UNITS-OF-PRODUCTION DEPRECIATION End of Year

Year

Annual Units of Depr. Depr. 1 Production × Amt./Unit = Expense

2010 2011 2012

175,000 152,000 123,000

$0.4756 0.4756 0.4756

$83,230 72,291 58,479*

Accum. Depr.

Carrying Amount $254,000 $83,230 170,770 155,521 98,479 214,000 40,000

Depreciable amount per unit: ($254,000 − $40,000) ÷ 450,000 km = $0.4756 per kilometre * rounding of $20

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-7B (Continued) (b) 1.

(a) Straight (b) Units-Line of-Production Cost ............................................... $254,000 $254,000 Accumulated depreciation. .......... 142,666 155,521 Carrying amount........................... 111,334 98,479 Cash proceeds ............................. 100,000 100,000 Loss (Gain) on sale ...................... $ 11,334 $ (1,521) 2. Depreciation expense .................. $ 142,666 Add (Deduct): Loss (Gain) on sale 11,334 Net expense .................................. $154,000

$155,521 (1,521) $154,000

Bus purchase price ...................... $254,000 Proceeds from sale of equipment 100,000 Amount expensed ........................ $154,000 In total the effect on net earnings is the same under both methods. This is because the method of depreciation selected only affects the timing of the expense recognition. In total over the life of the asset the expense recognized is the same: $154,000. Taking It Further: When selecting a depreciation method, management should choose the method that best matches the estimated pattern in which the asset’s future economic benefits are expected to be consumed. In the case of the bus purchased by Rapid Transportation Ltd. the units-of-production method provides the fairest technique in achieving this goal. Buses are not consumed in operation as a function of time, but as a function of use.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-8B (a)

2009 Feb.

1 Office Equipment....................... 85,000 Accounts Payable .................

(b) 2009 Sept. 30 Depreciation Expense ............... 11,200 Accumulated Depreciation —Office Equipment .............. [($85,000 − $1,000) ÷ 5 years] x 8/12 months 2010 Sept. 30 Depreciation Expense ............... 16,800 Accumulated Depreciation —Office Equipment .............. ($85,000 − $1,000) ÷ 5 years 2011 Sept. 30 Depreciation Expense ............... 16,800 Accumulated Depreciation —Office Equipment .............. (c)

2011 Oct. 26 Depreciation Expense ............... Accumulated Depreciation —Office Equipment .............. [($85,000 − $1,000) ÷ 5 years] x 1/12

85,000

11,200

16,800

1,400 1,400

Accumulated Depreciation at October 26, 2011: ¹ $11,200 + $16,800 + $16,800 + $1,400 = $46,200 Carrying Amount at October 26, 2011: Cost – Accumulated Depreciation $38,800 = $85,000 − $46,200

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Accounting Principles, Fifth Canadian Edition

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

(2)

(3)

(4)

Oct. 26 Accumulated Depreciation— Office Equipment....................... 46,200 Loss on Disposal* ..................... 38,800 Office Equipment .................. * $0 − $38,800 = ($38,800)

Oct. 26 Cash ........................................... 50,000 Accumulated Depreciation— Office Equipment....................... 46,200 Gain on Disposal** ................ Office Equipment .................. ** $50,000 − $38,800 = $11,200 Oct. 26 Cash ........................................... 40,000 Accumulated Depreciation— Office Equipment....................... 46,200 Gain on Disposal*** .............. Office Equipment .................. *** $40,000 − $38,800 = $1,200 Oct. 26 Office Equipment ($38,000 + $68,000) .................... 106,000 Accumulated Depreciation— Office Equipment....................... 46,200 Loss on Disposal**** ................. 800 Cash ($113,000 − $45,000) .... Office Equipment .................. **** $38,000 − $38,800 = ($800)

85,000

11,200 85,000

1,200 85,000

68,000 85,000

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-9B

(a)

April

1 Land ...........................................1,900,000 Cash....................................... 475,000 Note 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 [($750,000 ÷ 10) × 7 + $25,000)] 550,000 Carrying amount 200,000 Cash proceeds 350,000 Gain on disposal $150,000 June 1 Cash ........................................... 380,000 Note Receivable ........................ 820,000 Land ....................................... Gain on Disposal .................. July

300,000 900,000

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

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

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Accounting Principles, Fifth Canadian Edition

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— Buildings ($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 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-9B (Continued) (c)

JAINA COMPANY Balance Sheet (Partial) December 31, 2011 ______________________________________________________ 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 following for balances Land Jan. 1, 2011 April 1, 2011

4,000,000 1,900,000

June 1, 2011

300,000

Dec. 31, 2011 Bal. 5,600,000 Buildings Jan. 1, 2011

28,500,000

Dec. 31, 2011 Bal. 28,500,000 Equipment Jan. 1, 2011 July 1, 2011

48,000,000 1,000,000

May 1, 2011 Dec. 31, 2011

750,000 470,000

Dec. 31, 2011Bal. 47,780,000

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PROBLEM 9-9B (Continued) (c) (Continued) Accumulated Depreciation—Buildings Jan. 1, 2011 Dec. 31, 2011

12,100,000 570,000

Dec. 31, 2011 Bal. 12,670,000

Accumulated Depreciation—Equipment May 1, 2011 Dec. 31, 2011

550,000 470,000

Jan. 1, 2011 May 1, 2011 Dec. 31, 2011 Dec. 31, 2011

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

Dec. 31, 2011 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, 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-10B 1.

Research Expense ..................................... 70,000 Patent .....................................................

70,000

Patent .......................................................... 21,000 Legal Fees Expense ..............................

21,000

Patent .......................................................... 38,000 Legal Fees Expense ..............................

38,000

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

No entry needed: Recoverable amount is greater than carrying amount: Balance Patent 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 9-11B (a)

Jan.

July

Aug.

Oct.

2 Trademark ................................ 0. 7,000 Cash.....................................

7,000

1 Research Expense .................. 210,000 Cash.....................................

210,000

1 Patent (Development Costs) ... Cash.....................................

50,000 50,000

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

60,000 60,000

1 Copyright #2 ............................ 180,000 Cash.....................................

180,000

Dec. 31 Impairment Loss—Goodwill ... 35,000 Goodwill ($125,000 − $90,000)

35,000

Trademark – no impairment: Balance Jan. 1, 2011 ............... $54,000 Addition Jan. 2, 2011 ............... 7,000 Carrying amount ..................... $61,000 Recoverable amount ............... $65,000 Recoverable amount exceeds carrying amount (b) Dec. 31 Amortization Expense ............. 1,250 Accumulated Amortization— Patent ................................. [($50,000 ÷ 20) x 6/12] = $1,250]

1,250

31 Amortization Expense ............. 27,000 Accumulated Amortization— Copyright............................. 27,000 [($36,000 x 1/3) + ($180,000 x 1/3 x 3/12)]

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

60,000 60,000

Assets Intangible assets Patents ................................................. $ 50,000 Less: Accumulated amortization ....... 1,250 $ 48,750 1 Copyrights .......................................... $216,000 Less: Accumulated amortization ....... 51,000 165,000 2 Trademark .................................................................. 61,000 Total intangible assets........................................... $274,750 Goodwill ........................................................................... $ 90,000 1

Copyright: Cost $36,000 + $180,000 = $216,000 Copyright: Amortization $24,000 + $27,000 = $51,000 2 Trademark: $54,000 + $7,000 = $61,000 Taking It Further: Although intangible assets do not have physical substance, they have common characteristics 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)

2010 June 7 Timber Land........................ 50,000,000 Cash................................ 10,000,000 Mortgage Payable .......... 40,000,000 26 Weighing 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 = $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 —Weighing 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) 2011 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 —Weighing 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, 2011 ______________________________________________________ Cost of goods sold .................................

$11,520,000

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

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

$ 2,240,000

28,000

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PROBLEM 9-12B (Continued) (b) (Continued) CYPRESS TIMBER COMPANY (Partial) Balance Sheet December 31, 2011 ______________________________________________________ Property, plant, and equipment Timber tract ......................................... $50,000,000 Less: Accumulated depreciation1...... 16,800,000 $33,200,000 Weighing 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 (2010) + $28,000 (2011) = $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 in 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 millions)

Asset turnover

Return on assets

STAD Company

STHN Company

$341.7 [($264.5 + $234.0) ÷ 2]

$9,411.5 [($4,429.9 + $5,343.9) ÷ 2]

= 1.37 to 1

= 1.93 to 1

$12.8 [($264.5 + $234.0) ÷ 2]

$672.6 [($4,429.9 + $5,343.9) ÷ 2]

= 5.14%

= 13.76%

(b) STHN Company is more efficient in using its assets to generate sales–its assets turnover of 1.93 times is higher than 1.37 for STAD Company. It is also much more efficient in using assets to produce profit–with a return on assets of 13.76% compared to 5.14% for STAD Company. Taking it Further: Since the two companies are of vastly different sizes, it makes it more complicated to make comparisons between the two companies. Although the ratios try to eliminate the effect of different sizes, there are economies of scale which affect the comparability of the absolute amounts used in the ratio calculations. The amount of information provided is very limited.

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CONTINUING COOKIE CHRONICLE (a)

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

$27,200 2,500 1,500 $31,200

(b) 1. STRAIGHT-LINE DEPRECIATION Depreciable Year Amount × 2011 2012 2013 2014 2015 2016 Total

$24,600* 24,600 24,600 24,600 24,600 24,600

Depr. Rate

20% × 4/12 20% 20% 20% 20% 20% × 8/12

Depr. Expense $ 1,640 4,920 4,920 4,920 4,920 3,280 $24,600

End of Year Accum. Carrying Depr. Amount $31,200 $ 1,640 29,560 6,560 24,640 11,480 19,720 16,400 14,800 21,320 9,880 24,600 6,600

* ($31,200 − $6,600 = $24,600) 2. DOUBLE DIMINISHING-BALANCE DEPRECIATION Carrying End of Year Amount (Beg. Depr. Depr. Accum. Carrying Year of Year × Rate = Expense Depr. Amount $31,200 2011 $31,200 40%* × 4/12 $ 4,160 $ 4,160 27,040 2012 27,040 40% 10,816 14,976 16,224 2013 16,224 40% 6,490 21,466 9,734 2014 9,734 40% 3,134** 24,600 6,600 $24,600 * 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 DEPRECIATION End of Year Units of Depreciable Depr. Accum. Carrying Year Production × Cost/Unit = Expense Depr. Amount $31,200 2011 15,000 $0.123* $ 1,845 $ 1,845 29,355 2012 45,000 0.123 5,535 7,380 23,820 2013 50,000 0.123 6,150 13,530 17,670 2014 45,000 0.123 5,535 19,065 12,135 2015 35,000 0.123 4,305 23,370 7,830 2016 10,000 0.123 1,230 24,600 6,600 $24,600 * $24,600 ÷ 200,000 km = $0.123 per km (c)

As indicated in the three different schedules prepared in part (b), the carrying value on the balance sheet at December 31, 2011 will be different depending on which method is selected for recording depreciation on the van.

Impact on Cookie Creation's balance sheet and income statement in 2011: Double DiminishingUnits-ofStraight-Line Balance Production Cost of asset $31,200 $31,200 $31,200 Accumulated depreciation 1,640 4,160 1,845 Carrying amount $29,560 $27,040 $29,355 Depreciation expense

$ 1,640

$ 4,160

$ 1,845

The double diminishing-balance method of depreciation will result in the lowest amount of profit reported, the lowest amount of owner's equity reported and the lowest carrying amount of the asset reported at December 31, 2011.

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CONTINUING COOKIE CHRONICLE (Continued) (c)

(Continued) The straight-line method of depreciation will result in the greatest amount of profit reported, the greatest amount of owner's equity reported and the greatest carrying amount of the asset reported at December 31, 2011.

(d) Over the van’s 5-year useful life, the total depreciation will be $24,600 under each of the methods. The depreciation method chosen will affect the timing of the depreciation expense recognized each year only. (e)

The units-of-production 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. As long as Natalie is willing to track the number of kilometres driven over the course of the year, then this would be the method recommended.

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BYP 9-1 FINANCIAL REPORTING PROBLEM (a)

(in thousands)

Capital Assets Goodwill Other Intangibles Other Assets

Cost $546,307 61,162 36,359 11,257 $655,085

Accumulated Carrying Depreciation Amount $349,542 $196,765 1,178 59,984 4,862 31,497 7,443 3,814 $363,025 $292,060

(b) The amount used to buy capital assets during the 2009 fiscal year was $52,139,000. (c)

Building on leased land, furniture, fixtures, equipment, software, automotive and leasehold improvements are depreciated using the straight-line basis. The building is depreciated on the diminishing-balance method. (See Note 2) The amount of depreciation expense reported in the statement of operations for fiscal 2009 was $47,613,000.

(d) The expected useful life for calculating depreciation on the “furniture, fixtures, equipment, software and automotive” was 3 to 8 years. (See Note 2) (e)

Intangible assets comprise Goodwill, Trademarks and Trade names and Non-competition agreements.

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BYP 9-1 (Continued) (f)

There was no loss for impairment related to capital assets recorded by Forzani during the 2009 fiscal year. The carrying amount of long-lived assets is reviewed at least annually by Forzani or whenever events indicate a potential impairment has occurred. An impairment loss is recorded if and when a long-lived asset’s carrying amount exceeds its recoverable amount. The impairment loss is measured as the amount by which the carrying amount exceeds its recoverable amount.

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BYP 9-2 INTERPRETING FINANCIAL STATEMENTS (a)

Additions to property and equipment at the Brandon, Manitoba pork processing plant should be treated as capital expenditures. The expansion will result in the creation of assets that will have long lives and the cost will be recorded as an expense against the revenue it helped generate, through annual depreciation charges.

(b) Maple Leaf Foods could use the straight-line, the diminishing-balance method or the units-of-production method to depreciate its pork processing facilities. The straight-line method is simple to use and, if the assets are used at a consistent level, will allocate costs against revenue in the same consistent way. Diminishingbalance is appropriate in cases where the benefits are greater in the early years of an asset’s life. The units-ofproduction method would be the most appropriate in this case as the levels of production can be easily measured (production capacity or number of hogs processed per week) and the levels of production can change from one week to the next. The units-ofproduction method is recommended as it best reflects the rate at which the asset is being consumed to produce economic benefits. (c)

Yes. My recommendation would still be the units-ofproduction method. Depreciation expense would increase proportionately as a result of the change to triple-shift from double-shift because the number of units being processed would increase at the same rate.

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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:

Loss on Impairment 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 is greater than 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. Loss on impairment 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 reasonably be 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 of the original estimate. 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 maintenance 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.

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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)

A copyright is the exclusive right to copy a creative work or allow someone else to do so. It includes the sole right to publish, produce or reproduce, to perform in public, to communicate a work to the public by telecommunication, to translate a work, and in some cases, to rent the work. Copyright applies to all original literary, dramatic, musical, and artistic works. These include books, other writings, music, sculptures, paintings, photographs, films, plays, television and radio programs, and computer programs. Copyright also applies to other subject matter including sound recordings (such as records, cassettes, 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. Since you automatically obtain copyright the law automatically protects you. You do not have to register your copyright in order to be protected. (c)

It is a good idea to register your copyright because it indicates notice of copyright on your works. Registration gives the registrant a certificate that states his or her ownership of the copyright. This certificate can be used in court to establish ownership.

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

The fee is $50.

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BYP 9-6 (Continued) (f)

The fee paid for registering a copyright can be capitalized (recorded as an asset) if the copyright registered will provide benefit to the business in the future. Because the amount paid is small, some businesses might decide to expense the fee it when incurred.

(g) Copyright infringement refers to unlawful use of copyright material. Plagiarism—passing off someone else's work as your own—is a form of infringement. (h) The responsibility for policing a copyright rests with the person who owns the copyright.

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Legal Notice 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, 12

1, 2, 3, 4, 14

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

1, 2, 3

2. Account for estimated liabilities.

7, 8, 9, 10, 5, 6, 7, 8, 11, 12 14

6, 7, 8, 9, 13

1, 3, 4, 5

3. Account for contingencies.

12, 13, 14, 9, 10, 14 15, 16, 17

9, 10, 13

1, 6, 7

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

18, 19, 20, 11, 12, 13, 11, 12, 13, 1, 3, 8, 9 21, 22, 23 14, *18 *15

1, 3, 8, 9

24, 25, 26, 14, 15 27

5, 14

1, 2, 3, 6, 7, 10

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

*28, *29

*15, *16

*11

*16, *17, *18

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number 1A

Description Identify liabilities.

Difficulty Level Simple

Time Allotted (min.) 10-15

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 contingent liabilities and assets.

Moderate

15-25

Discuss reporting of contingent liability and asset.

Simple

10-15

Prepare payroll register and record payroll.

Moderate

25-35

Record and post payroll transactions.

Moderate

25-35

10A

Prepare current liabilities section; calculate and comment on ratios.

Moderate

15-25

*11A

Calculate payroll deductions.

Moderate

25-35

Identify liabilities.

Simple

10-15

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 contingent liabilities and assets.

Moderate

15-25

Discuss reporting of contingent asset.

Simple

10-15

Prepare payroll register and record payroll.

Moderate

25-35

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number 9B

Description Record and post payroll transactions.

Difficulty Level Moderate

Time Allotted (min.) 25-35

10B

Prepare current liabilities section; calculate and comment on ratios.

Moderate

15-25

*11B

Calculate payroll deductions.

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

1. Account for determinable or certain current liabilities.

Q10-1 Q10-2 Q10-3 Q10-12 BE10-14

Q10-4 Q10-5 Q10-6 E10-9

2. Account for estimated liabilities.

Q10-12 BE10-14

Q10-7 Q10-8 Q10-9 Q10-10 Q10-11 E10-9

3. Account for contingencies.

Q10-12 BE10-14

4. Determine payroll costs and record payroll transactions.

Q10-21 Q10-23 BE10-14

Q10-13 Q10-14 Q10-15 Q10-16 Q10-17 BE10-9 E10-9 Q10-18 Q10-19 Q10-20 Q10-22

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

Q10-24 Q10-25 Q10-26 Q10-27 BE10-14

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

*Q10-28 *Q10-29

Broadening Your Perspective

Application BE10-1 BE10-2 BE10-3 BE10-4 E10-1 E10-2 E10-3 E10-4 BE10-5 BE10-6 BE10-7 BE10-8 E10-6 E10-7 E10-8 E10-13 BE10-10 E10-10 E10-13 P10-1A P10-6A P10-7A

Analysis

Synthesi s

BYP10-1

BYP10-2 BYP10-5 BYP10-6

E10-5 E10-13 P10-1A P10-2A P10-3A P10-1B P10-2B P10-3B P10-1A P10-3A P10-4A P10-5A P10-1B P10-3B P10-4B P10-5B P10-1B P10-6B P10-7B

BE10-11 P10-3A BE10-12 P10-8A BE10-13 P10-9A *BE10-18 P10-1B E10-11 P10-3B E10-12 P10-8B E10-13 P10-9B *E10-15 P10-1A BE10-15 P10-1B E10-5 P10-2B E10-14 P10-3B P10-1A P10-6B P10-2A P10-7B P10-3A P10-10B P10-6A P10-7A P10-10A *BE10-16 *P10-11A *BE10-17 *P10-11B *BE10-18 *E10-15 *E10-16 Continuing Cookie Chronicle Cumulative Coverage Chapters 3 – 10 BYP10-3 BYP10-4

Evaluation

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ANSWERS TO QUESTIONS 1.

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.

(a) Notes payable differ from accounts payable in that notes have written legal documentation that make collection easier if legal action is necessary. In addition, most notes are interest bearing. Notes also can extend for longer periods of time than accounts payable. Accounts payable and notes payable are similar in that they are both promises to pay an amount in the future. Accounts payable and notes payable that result from purchase transactions are also known as trade payables. (b) A note is different than an operating line of credit in that a note is for a fixed amount and is repayable on a specific date. An operating line of credit is a pre-authorized loan from the bank that can be drawn down and repaid as required. Both lines of credit and notes payable may require collateral. Both are obligations to pay an amount in the future.

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.

Disagree. The company only serves as a collection agent for the taxing authority. It does not report sales taxes as revenue; it reports sales taxes as a current liability because it must forward the amount paid by the customer to the government.

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QUESTIONS (Continued) 5.

The property tax bill for the calendar year is usually not known until the spring. If a company has a year-end 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.

Estimated warranty liability is the estimated cost of servicing a product’s warranty. Actual warranty costs incurred are costs for the repair or replacement of defective units. In most cases the estimated liability will not be the same amount as the actual expenditure incurred. The warranty liability is carried forward from year to year; each year it is increased by the amount of estimated expense and decreased by the amount of actual costs. Each year end the liability will have to be reviewed and the estimated expense will have to be increased if the actual costs have exceeded the previous estimated expense and decreased if the previous estimated expense has exceeded the actual costs. Companies will not make an adjustment to previous years’ estimates.

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QUESTIONS (Continued) 9.

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.

10.

The cost of product warranties represents future costs for the repair or replacement of defective units sold and therefore should be recorded as an expense of the period. Rewards are incurred in order to promote sales. When rewards result in a reduced selling price, it should be recorded as a reduction in sales or a decrease in revenues.

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 GAAP for Private Enterprises, 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 it is not probable that the company will have to settle, or obligations for which the amount cannot be reliably measured.

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QUESTIONS (Continued) 13. Under GAAP for Private Enterprises, a contingent liability is defined as a possible obligation that will be confirmed by the occurrence or nonoccurrence of an uncertain future event. A contingent liability may be recognized as a liability if it is likely that a present obligation exists and the amount can be reliably estimated. If these criteria are not satisfied, then note disclosure is appropriate (unless it is unlikely that an obligation exists). 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. This includes a possible obligation that it is not probable that the company will have to settle, or a present obligation for which the amount cannot be reliably measured. 14.

Under GAAP for Private Enterprises, 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. 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 likely a present obligation exists and that the amount can be reliably estimated.

15.

A debt guarantee or loan guarantee is a guarantee that a loan will be repaid. A loan guarantee is provided by an individual or a company other than the company who has obtained a loan from a lending institution. A loan guarantee is provided as collateral or protection to the lender in case the company who borrowed is unable to repay the loan. A debt guarantee is an example of a contingent liability because the liability is dependent on a future event, the lender honouring or not honouring their commitment to repay the loan.

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QUESTIONS (Continued) 16.

A contingent liability is an existing situation involving uncertainty as to a possible obligation, which will be resolved when one or more future events occur or fail to occur. An example of a contingent liability is a lawsuit that a company expects to lose but cannot estimate the amount of the judgement. Under IFRS, a contingent liability 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. A contingent asset is an existing situation involving uncertainly that will only be resolved when one or more future events occur or fail to occur. This event will confirm the existence of an asset. An example of a contingent asset is a lawsuit that could favour the company.

17.

Under GAAP for Private Enterprises, the accounting treatment for a contingent liability when it is likely and can be reasonably estimated is to accrue for the liability. The accounting treatment for a contingent asset when it is likely and reasonably estimable is to disclose the asset and the related gain. The asset and related gain will be recorded only when the asset and gain have been fully realized. The rationale behind this inconsistency is conservatism, where the goal is to be sure that any negative effect on investors and creditors is fully disclosed. Under IFRS, a contingent liability 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. IFRS also allows for the recognition of a contingent asset if it is virtually certain that a gain will occur.

18.

Salaries are specific amounts paid to employees per week, per month or per year. Wages are amounts paid to employees on an hourly basis or on a piece work basis. However, the terms salaries and wages are often used interchangeably.

19.

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. The deductions are recorded as a liability and paid to the appropriate party rather than to the employee.

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QUESTIONS (Continued) 20.

Employee payroll deductions are the amount of payroll deductions deducted from an employee’s gross 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.

21.

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.

22.

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.

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QUESTIONS (Continued) 23.

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 postemployment benefits are accounted for using the accrual basis.

24.

Current liabilities are usually listed in order of their liquidity, by maturity date. They are also often listed in order of magnitude with the largest items listed first.

25.

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.

26.

Employee payroll deductions should be reported as a current liability. Employer payroll costs should be reported on the income statement as an operating expense.

27.

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) *28. 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 (currently $46,300). 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 1.73%) of insurable earnings, to a maximum earnings ceiling (currently $42,300). In most cases, insured earnings are gross earnings plus any taxable benefits. *29. The amount deducted from an employee’s wages 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 wages 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) 2010 July 1 Cash ............................................... Notes Payable ........................... (b) Aug. 1 Interest Expense ($60,000 × 6% × 1/12) ..................... Cash ........................................... (c) Dec. 31 Interest Expense ($60,000 × 6% × 1/12) ..................... Interest Payable ........................ (d) 2011 Apr. 1 Interest Expense ($60,000 × 6% × 1/12) ..................... Notes Payable ................................ Cash ...........................................

60,000 60,000

300 300

300 60,000 60,300

BRIEF EXERCISE 10-2 (a) Mar. 16 Cash .................................................... 13,024 Sales ............................................... HST Payable ($11,526 × 13%) ........

11,526 1,498

(b) Calculation of sales: Sales = $11,526 ÷ 1.13 = $10,200 Calculation of sales tax payable: HST payable = $10,200 × 13% = $1,326

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BRIEF EXERCISE 10-2 (Continued) (b) (Continued) Mar. 16 Cash .................................................... 11,526 Sales ............................................... HST Payable ...................................

10,200 1,326

BRIEF EXERCISE 10-3 (a)

Calculation of sales tax collected: GST: $8,200 × 5% = PST: ($8,200 + ($8,200 × 5%)) × 10% = Total taxes collected

$410 861 $1,271

(b) Total amount collected = $8,200 + $1,271 = $9,471 (c) Combined sales tax rate = 5% + [10% × (1 + 5%)] = 15.5%

BRIEF EXERCISE 10-4 Feb. 28

Property Tax Expense ($7,620 × 2/12) Property Tax Payable ....................

1,270

May 31 Property Tax Payable ......................... Property Tax Expense ($7,620 × 3/12) Prepaid Property Tax ($7,620 × 7/12) Cash ................................................

1,270 1,905 4,445

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

4,445

1,270

7,620

4,445

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BRIEF EXERCISE 10-5 (a)

Dec. 31 Warranty Expense ..................... 4,200 Warranty Liability.................. [(1,000 units × 6%) × $70/unit]

(b) Following year: Warranty Liability ...................... Repair Parts Inventory..........

4,200

3,800 3,800

BRIEF EXERCISE 10-6 July 3 One-Stop Money Liability .................. Cash ($150 - $20) ................................ Sales ............................................... July 3 Sales Discounts for One-Stop Money Issued ($150 × 2%) .................. One-Stop Money Liability ..............

20 130 150

3 3

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

BRIEF EXERCISE 10-7 Sep. 30 Sales Discount for Rebate Rewards Issued .................................. 60,000 Rebate Liability .............................. [(100,000 × 15%) × $4] As redeemed in October: Rebate Liability ................................... Cash (2,000 × $4)............................

60,000

8,000 8,000

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BRIEF EXERCISE 10-8 Dec. 2010 Cash .................................................. Unearned Gift Card Revenue .....

4,200

Jan. 2011 Unearned Gift Card Revenue .......... Sales ............................................

2,950

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

1,325

4,200

2,950 1,325

BRIEF EXERCISE 10-9 (a)

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 Canadian GAAP for Private Enterprises.

(b)

Recorded: This liability is likely and can be reasonably estimated. The treatment would be the same under both IFRS and Canadian GAAP for Private Enterprises.

(c)

Disclosed: This asset/gain is likely and should be disclosed. The treatment would be the same under both IFRS and Canadian GAAP for Private Enterprises.

(d)

Disclosed: Even though this contingent liability is unlikely—the chance of occurrence is small—it should still be disclosed. The treatment would be the same under both IFRS and Canadian GAAP for Private Enterprises.

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BRIEF EXERCISE 10-10 Loss due to Environmental Lawsuit ................. 50,000 Liability for Clean Up .....................................

50,000

The arguments for recording this liability are that the outcome is likely 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. The argument against recording it is that it is not known for sure yet if a liability exists and the amount is uncertain. Management may be reluctant to disclose this information 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 × $16) ....................................... $640.00 Overtime pay (3 × $24) ....................................... 72.00

$712.00

Less: CPP contributions................................... $31.91 EI premiums ............................................ 12.32 Income tax withheld ................................ 104.65 Net pay .............................................................................

148.88 $563.12

(b) Employer costs: CPP contributions .............................................. $31.91 EI premiums ($12.32 × 1.4) ................................ 17.25

$49.16

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

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BRIEF EXERCISE 10-12 Jan.

Jan.

5 Wages Expense ......................... 712.00 CPP Payable.......................... EI Payable.............................. Income Tax Payable ............. Wages Payable .....................

31.91 12.32 104.65 563.12

5 Wages Payable .......................... 563.12 Cash.......................................

563.12

5 Employee Benefits Expense ..... CPP Payable.......................... EI Payable ($12.32 × 1.4) ......

31.91 17.25

49.16

BRIEF EXERCISE 10-13 Aug. 22 Salaries and Wages Expense ............ 70,000 CPP Payable ................................... EI Payable....................................... Income Tax Payable....................... Salaries and Wages Payable ......... ($70,000 - $3,330 - $1,211 - $19,360 = $46,099)

3,330 1,211 19,360 46,099

22 Salaries and Wages Payable ............. 46,099 Cash ................................................

46,099

22 Employee Benefits Expense .............. CPP Payable ................................... EI Payable ($1,211 × 1.4)................

3,330 1,695

5,025

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BRIEF EXERCISE 10-14 1. 2. 3. 4. 5. 6. 7.

Current liability Current liability Current liability Current liability Current liability Current asset Disclosed in the notes to the financial statements as a contingent liability 8. Current liability 9. Current asset 10. Current liability ($5,000) and long-term liability ($70,000)

BRIEF EXERCISE 10-15 (a) SUNCOR ENERGY INC. (Partial) Balance Sheet December 31, 2008 (in millions)

Liabilities Current liabilities Accounts payable and accrued liabilities ................. Income taxes payable ................................................. Sales taxes payable .................................................... Short term debt ........................................................... Total current liabilities ...........................................

$ 3,229 192 97 11 $3,529

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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BRIEF EXERCISE 10-15 (Continued) (b) Current Ratio = Current Assets ÷ Current Liabilities $3,237* ÷ $3,529 = 0.92 to 1 * $660 + $1,580 + $88 + $909 = $3,237 Acid-Test Ratio = (Cash + AR + Income Tax Recoverable) ÷ Current Liabilities ($660 + $1,580 + $88) ÷ $3,529 = 0.66 to 1

*BRIEF EXERCISE 10-16 Monthly Pay = ($55,200/year ÷ 12 months) = $4,600 (a)

January 2009: CPP deduction = ($4,600 - [$3,500 ÷ 12]) × 4.95% = $213.26 EI deduction = $4,600 × 1.73% = $79.58

(b) December 2009: No deductions for CPP or EI. The cumulative salary up to November 2009 is $50,600 ($4,600 × 12). The cumulative salary exceeds the annual maximum pensionable earnings of $46,300 and maximum insurable earnings of $42,300.

*BRIEF EXERCISE 10-17 Gross salary for the week = $1,090 CPP [($1,090.00 − $67.30) ×4.95%] EI ($1,090 × 1.73%) Federal income tax (claim code 1) Ontario income tax (claim code 1) Total deductions

$50.62 18.86 143.20 75.10 $287.78

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*BRIEF EXERCISE 10-18 (a) Gross earnings: Regular pay......................................................... $720.00 Overtime pay ([$720 ÷ 40] × 1.5 × 10 hours) ..... 270.00

$990.00

(b) CPP ($990 - [$3,500 ÷ 52]) × 4.95% ............. $45.67 EI (1.73% × $990) ......................................... 17.13 (c) Federal income tax (claim code 3) ............ 112.20 Ontario income tax (claim code 3) ............ 63.15 Total deductions ..................................... (d) Net pay........................................................................

$238.15 $751.85

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SOLUTIONS TO EXERCISES EXERCISE 10-1 (a)

Briffet Construction 2010 Oct. 1 Cash ........................................... 200,000 Notes Payable ....................... Nov.

2011 Aug.

1 Interest Expense ....................... Cash....................................... ($200,000 × 6% × 1/12)

200,000

1,000 1,000

1 Notes Payable............................ 200,000 Interest Expense ....................... 1,000 Cash.......................................

201,000

(b) TD Bank 2010 Oct. 1 Notes Receivable....................... 200,000 Cash.......................................

200,000

Nov.

2011 Aug.

1 Cash ........................................... Interest Revenue ................... ($200,000 × 6% × 1/12)

1,000

1 Cash ........................................... 201,000 Interest Revenue ................... Notes Receivable ..................

1,000

1,000 200,000

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EXERCISE 10-2 (a)

Tundra Trees Mar. 1 Equipment.................................. 20,000 Accounts Payable .................

20,000

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

20,000

July 31 Interest Expense ....................... Interest Payable .................... ($20,000 × 8% × 4/12)

533 533

Oct. 31 Interest Expense* ...................... 400 Interest Payable ......................... 533 Notes Payable............................ 20,000 Cash....................................... * ($20,000 × 8% × 3/12)

20,933

(b) Edworthy Equipment Mar. 1 Accounts Receivable ................ 20,000 Sales ......................................

20,000

Cost of Goods Sold ................... 12,000 Inventory ...............................

12,000

Mar. 31 Notes Receivable....................... 20,000 Accounts Receivable ............

20,000

May 31 Interest Receivable.................... Interest Revenue ................... ($20,000 × 8% × 2/12)

267

Oct. 31 Cash ........................................... 20,933 Interest Receivable ............... Interest Revenue* ................. Notes Receivable .................. * ($20,000 × 8% × 5/12)

267

267 666 20,000

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EXERCISE 10-3 1.

Sainsbury Company Apr. 10 Cash ........................................... 29,945 Sales ...................................... HST Payable ($26,500 × 13%)

Hockenstein Company Apr. 15 Cash ........................................... 33,674 Sales ($33,674 ÷ 1.13) ........... HST Payable ($29,800 × 13%)

26,500 3,445

29,800 3,874

Montgomery Company Apr. 21 Cash ........................................... 34,650 Sales ...................................... GST Payable ($30,000 × 5%) PST Payable ($31,500 × 10%)

30,000 1,500 3,150

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EXERCISE 10-4 2010 (a) Oct. 31 Cash .................................................... 288,000 Unearned Subscription Revenue 288,000 (6,000 × $48) (b) Dec. 31 Unearned Subscription Revenue ...... 48,000 Subscription Revenue ................. ($288,000 × 2/12)

48,000

2011 (c) Mar. 31 Unearned Subscription Revenue ...... 72,000 Subscription Revenue .............. ($288,000 × 3/12)

72,000

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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 2010 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, 2011 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, 2011 (Partial) Operating expenses Property tax expense .............................................. $18,660

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EXERCISE 10-5 (Continued) (b) (Continued) Prepaid Property Taxes Date Explanation Ref. Debit Jul. 31 7,775 Aug. 31 Sep. 30 Oct. 31 Nov. 30 Dec. 31

Credit Balance 7,775 1,555 6,220 1,555 4,665 1,555 3,110 1,555 1,555 1,555 0

Property Tax Expense Explanation Ref. Debit 1,475 1,475 1,475 1,475 320 1,555 1,555 1,555 1,555 1,555 1,555 1,555 1,555

Credit Balance 1,475 2,950 4,425 5,900 6,220 7,775 9,330 10,885 12,440 13,995 15,550 17,105 18,660

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

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EXERCISE 10-6 (a)

Estimated warranties outstanding:

Month November December Total

Estimate of Defective Actual Units Units Defective 45,000 × 3% = 1,350 450 48,000 × 3% = 1,440 930 2,790 1,380

Dec. 31 Estimated warranty liability: (2,790 – 1,380) × $15 = $21,150 (b) Dec. 31 Warranty Expense (2,790 × $15) ..... 41,850 Warranty Liability....................

41,850

31 Warranty Liability ............................. 20,700 Repair Parts Inventory, Wages Payable, Cash, Etc .....

20,700

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EXERCISE 10-7 (a)

Warranty expense: 2009: (2,000 × 10 × 2 × $60) = $2,400,000 2010: (2,200 × 10 × 2 × $60) = $2,640,000 2011: (2,400 × 10 × 2 × $60) = $2,880,000

(b) Warranty liability at the end of the year: Estimated warranty expense for 2009: Less: Cost incurred in 2009 (20,000 × $60): Warranty liability at end of 2009:

$2,400,000 (1,200,000) 1,200,000

Add: Estimated warranty expense for 2010: Less: Cost incurred 2010 (40,000 × $60): Warranty liability at end of 2010:

2,640,000 (2,400,000) 1,440,000

Add: Estimated warranty expense for 2011: Less: Cost incurred 2011 (50,000 × $60) Warranty liability at end of 2011:

2,880,000 (3,000,000) $1,320,000

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EXERCISE 10-8 (a)

2010: 600,000 × 15% × $0.01 = $900 2011: 800,000 × 15% × $0.01 = $1,200

(b) 2010: 50,000 × $0.01 = $500 2011: 80,000 × $0.01 = $800 (c)

2010: $900 - $500 = $400 2011: $400 + $1,200 - $800 = $800

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

XXX XXX

Dr) Cost of Goods Sold Cr) Inventory

XXX

The points reduce the amount of cash required to complete the sales transaction. The sale also triggers the issuance of new points: Dr) Sales Discount for Redemptions Rewards Issued XXX Cr) 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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EXERCISE 10-9 (1)

(2)

(3)

(a)

Estimable. The amount and timing with respect to brake replacement is uncertain. The existence of the liability to replace the brakes is certain.

(b)

Under IFRS, the liability is estimated because is it probable and the amount can be reasonably estimated and should be recorded in the financial statements. Under Canadian GAAP for Private Enterprises, the liability is contingent on a future event, the possible future problem with the brakes. However, the likelihood of loss is likely because of the recall and the amount can be reasonably estimated. The liability should be recorded in the financial statements.

(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)

Under both IFRS and Canadian GAAP for Private Enterprises, the liability is estimated because it is probable and the amount can be reasonably estimated. The liability should be recorded in the financial statements.

Same as (2) above.

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EXERCISE 10-9 (Continued) (4)

(5)

(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 is certain.

(b)

Under both IFRS and Canadian GAAP for Private Enterprises, the liability is determinable because it is probable and the amount can be reasonably estimated. The liability should be recorded in the financial statements.

(a)

Contingent Liability under both IFRS and Canadian GAAP for Private Enterprises. The contingent liability is neither likely nor unlikely and the amount cannot be reasonably estimated.

(b)

Under both IFRS and Canadian GAAP for Private Enterprises, 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, Fifth 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 very 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 probability 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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EXERCISE 10-11 (a) Aug. 31 Salaries and Wages Expense ............ 41,500 CPP Payable ................................... EI Payable....................................... Income Tax Payable....................... Cash ................................................ (b) Aug. 31 Employee Benefits Expense .............. 4,940 CPP Payable ................................... EI Payable ($718 × 1.4)................... Workers’ Compensation Payable ($41,500 × 1%) .......................... Vacation Pay Payable ($41,500 × 4%) (c) Sept.15 CPP Payable ($1,860 + $1,860) .......... EI Payable ($718 + $1,005) ................. Income Tax Payable ........................... Cash ...............................................

1,860 718 8,025 30,897

1,860 1,005 415 1,660

3,720 1,723 8,025 13,468

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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

46 42 45

$ 440.00 520.00 560.00 $1,520.00

Gross Pay

$ 99.00 $ 539.00 39.00 559.00 105.00 665.00 $243.00 $1,763.00

Deductions CPP

Income Health Tax Insurance

$23.35 $ 9.32 $ 81.00 24.34 9.67 87.00 29.59 11.50 107.00 $77.28 $30.49 $275.00

Total

$10.00 $123.67 $ 415.33 15.00 136.01 422.99 15.00 163.09 501.91 $40.00 $422.77 $1,340.23

(b) May 31 Wages Expense ........................................................... 1,763.00 CPP Payable ............................................................ EI Payable................................................................ Income Tax Payable ............................................... Health Insurance Payable ...................................... Wages Payable .......................................................

77.28 30.49 275.00 40.00 1,340.23

31 Employee Benefits Expense ....................................... CPP Payable ($77.28 × 1) ....................................... EI Payable ($30.49 × 1.4) ........................................ Workers’ Compensation Payable ($1,763 × 2%) ... Vacation Pay Payable ($1,763 × 4%)...................... Health Insurance Payable ......................................

77.28 42.69 35.26 70.52 40.00

10-35

Net Pay

265.75

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EXERCISE 10-13

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

Assets

Liabilities

+ NE NE + $9,040 $25,000 NE NE NE NE -

+ NE + + $1,040 + $10,000 + + NE + -

Owner’s Equity NE NE + $8,000 $35,000 NE NE

Revenues Expenses NE NE NE + $8,000 NE NE NE NE NE NE

NE NE + NE + $35,000 + + NE + NE

Profit NE NE + $8,000 $35,000 NE NE

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EXERCISE 10-14 (a) LARKIN COMPANY (Partial) Balance Sheet August 31, 2011

Current liabilities Accounts payable ....................................................... $ 72,000 Bank indebtedness ..................................................... 50,000 Income tax payable ..................................................... 28,000 Unearned revenue ...................................................... 24,000 Warranty liability ......................................................... 18,000 HST payable ................................................................ 12,000 Mortgage payable—current portion .......................... 10,000 Interest payable .......................................................... 8,000 Property taxes payable............................................... 8,000 CPP payable ................................................................ 6,000 Customer loyalty liability ........................................... 4,000 EI payable .................................................................... 3,000 Workers’ compensation payable ............................... 1,000 Total current liabilities ........................................... $244,000 (b) Current ratio = ($145,000 + $220,000 + $10,000) ÷ $244,000 = 1.5:1 Acid-test ratio = $145,000 ÷ $244,000 = 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 × $20.50) + (4 hours × [$20.50 × 1.5]) = $820.00 + $123.00 = $943.00 Deductions ((Using Illustration 10A-3): CPP [$943 – ($3,500 ÷ 52) × 4.95%] EI ($943 × 1.73%) Federal income tax (claim code 1) Ontario income tax (claim code 1) Total deductions

$43.35 16.31 110.20 62.10 $231.96

(b) Sep. 16 Wages Expense ......................... 943.00 CPP Payable.......................... 43.35 EI Payable.............................. 16.31 Income Tax Payable ($110.20 + $62.10) 172.30 Cash....................................... 711.04 (c)

Sep. 16 Employee Benefits Expense ..... CPP Payable.......................... EI Payable ($16.31 × 1.4) ......

66.18 43.35 22.83

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*EXERCISE 10-16

Month

Gross Salary

Jan. – Aug. September October November December Totals

$32,000.00 4,000.00 4,000.00 4,000.00 4,000.00 $48,000.00

Cumulative Salary

CPP 4.95%

$32,000.00 $ 1,468.50 2 36,000.00 183.56 1 40,000.00 183.56 44,000.00 183.56 48,000.00 99.41 3 $2,118.59

EI 1.73% $553.60 5 69.20 4 69.20 6 39.79 0 $731.79

1. CPP = ($4,000 – [$3,500 ÷ 12]) × 4.95% = $183.56 2. CPP = $183.56/month × 8 months = $1,468.50 3. CPP = ([$46,300 maximum pensionable earnings - $44,000] – [$3,500 ÷ 12]) × 4.95% = $99.41 4. EI = $4,000 × 1.73% = $69.20 5. EI = $69.20/month × 8 months = $553.60 6. EI = ($42,300 maximum insurable earnings - $40,000) × 1.73% = $39.79

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 10-1A (a) 1. Current liabilities section 2. Current liabilities section

3. 4.

5. 6. 7.

Accounts payable $120,000 Salaries payable $22,8001 CPP payable 3,6002 EI payable 1,4403 Income tax payable 10,8004 Contingent liability Disclosed in notes; not on balance sheet 0 Current liabilities section Interest payable $2,5005 Note payable —current portion $100,000 Long-term liabilities section Note payable $400,000 Current liabilities section Unearned revenue $25,000 Current liabilities section Redemption rewards liability $6006 Not included in current liabilities section. No money is owed on the company’s operating line of credit.

Calculations: 1 ($60,000 - $3,000 - $1,000 - $18,000) × 3/5 = $22,800 2 ($3,000 × 2) × 3/5 = $3,600 3 ($1,000 × 2.4) × 3/5 = $1,440 4 $18,000 × 3/5 = $10,800 5 $500,000 × 6% × 1/12 = $2,500 6 (4,500 × 25% × $4) - $3,900 = $600

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PROBLEM 10-1A (Continued) Taking It Further: The notes should disclose information on the contingent liability–the lawsuit, including the estimated loss and the fact that the likelihood of the loss cannot be determined. Information on the Note Payable should include the interest rate, repayment terms and payments required in each of the next five years. Information on the operating line of credit should include the availability of $100,000 of overdraft protection.

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PROBLEM 10-2A (a)

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

20,000

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

20,000

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

83 83

Mar. 31 Notes Payable-Tanner ............... 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-McCoy ............... 20,000 Interest Expense ($20,000 × 5% × 1/12)................. 83 Cash....................................... Aug.

14,735

20,083

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

11,000 30,000

Sept. 30 Cash ........................................... 100,000 Notes Payable-FI Bank .........

100,000

Dec. 31

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

1,250 1,250

PROBLEM 10-2A (Continued)

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(a) (Continued) Dec. 31

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

750 750

(b) LEARNSTREAM COMPANY (Partial) Balance Sheet December 31, 2011

Current liabilities Notes payable ............................................................. Current portion of long-term notes payable ............. Interest payable ..........................................................

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

Long-term liabilities Notes payable .......................................... $100,000 Less current portion ................................ ( 10,000 ) $90,000 (c) LEARNSTREAM COMPANY (Partial) Income Statement Year Ended December 31, 2011 Other expense Interest expense .........................................................

$2,494

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PROBLEM 10-2A (Continued) (b) (Continued) Date Explanation Dec. 31 Jan. 31 Mar. 31 Apr. 30 Aug. 1 Sept. 30

Date Feb. 28 Mar. 31 Mar. 31 Apr. 30 Dec. 31 Dec. 31

Notes Payable Ref. Debit ✓

Credit Balance 14,000 20,000 34,000 14,000 20,000 20,000 0 30,000 30,000 100,000 130,000

Interest Expense Explanation Ref. Debit 83 245 83 83 1,250 750

Credit Balance 83 328 411 494 1,744 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 current maturity of 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 Note 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

12 Unearned Service Revenue ........... Service Revenue ......................

8,500

4,600

8,500

14 HST Payable ................................... 11,400 Cash ..........................................

11,400

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

4,957

1,340 702 2,915

17 Accounts Payable .......................... 20,000 Cash ..........................................

20,000

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 Customer Loyalty Program 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. 31

Salaries Expense...................... 16,000 CPP Payable.......................... EI Payable ............................. Income Tax Payable ............. Salaries Payable ...................

720 277 3,215 11,788

Salaries Payable ....................... 11,788 Cash.......................................

11,788

(b) (1)

(2)

(3)

(4)

Jan. 31

Interest Expense ...................... Interest Payable .................... ($50,000 × 7% × 1/12) Warranty Expense (500 × 9% × $10) ....................... Warranty Liability ................. Employee Benefits Expense ... CPP Payable.......................... EI Payable ............................. Vacation Pay Payable ........... Property Tax Expense ($7,560 ÷ 12).............................. Property Tax Payable ...........

292 292

450 450 1,748 720 388 640

630 630

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PROBLEM 10-3A (Continued) (c) SHUMWAY SOFTWARE COMPANY (Partial) Balance Sheet January 31, 2011

Current liabilities Note payable ............................................................... $ 50,000 Accounts payable ($42,500 − $20,000) ...................... 22,500 Unearned service revenue ($15,000 - $8,500) ........... 6,500 HST payable ($11,400 + $1,144 - $11,400 + $3,575 + $265) ........ 4,984 Income tax payable ($2,915 - $2,915 + $3,215) .......... 3,215 Customer loyalty program liability ($4,500 - $2,300) 2,200 CPP payable ($1,340 - $1,340 + $720 + $720) ............ 1,440 EI payable ($702 - $702 + $277 + $388) ...................... 665 Vacation pay payable ($7,680 + $640) ....................... 8,320 Property tax payable .................................................. 630 Warranty liability ......................................................... 450 Interest payable .......................................................... 292 Total current liabilities ........................................... $101,196

Taking It Further: Most companies require employees 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.

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PROBLEM 10-4A (a)

Warranty expense 2009 – (1,500 × 5% × $30) = $2,250 2010 – (1,700 × 5% × $30) = $2,550 2011 – (1,800 × 5% × $30) = $2,700 Warranty liability at year end 2009 – ($0 - $2,250 + $2,250) = $0 2010 – ($0 - $2,400 + $2,550) = $150 2011 – ($150 - $2,640 + $2,700) = $210

Note: See analysis of warranty liability account in (b) below. (b) 2009

2010

2011

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

2,250

2,400

2,550

2,640

2,700

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

Date 2009 During Dec. 31 2010 During Dec. 31 2011 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 2009 75 2010 90 2011 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 2009 $2,250 2010 2,400 2011 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 2011 only. The January 1, 2011 opening balance in the Warranty Liability account remains at $150. The revised warranty expense for 2011 is calculated as follows: Warranty expense 2011: 1,800 x 7% x $27 = $3,402 Warranty liability at December 31, 2011: $150 - $2,640 + $3,402 = $912

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PROBLEM 10-5A (a)

1. 2. 3. 4.

Reduces revenues and profit No effect on revenues, expenses and profit No effect on revenues, expenses and profit Increases revenues, expenses (cost of good sold) and profit

(b) 2010: 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 2011: 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 Gift Card Revenue .......

75,000

Unearned Gift Card Revenue .............. Sales ..............................................

45,400

75,000

45,400

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PROBLEM 10-5A (Continued) (c) Date 2010 During Dec. 31 2011 During Dec. 31

Date 2011 During Dec. 31

Redemption Rewards Liability Explanation Ref. Debit Credit Balance 122,500

122,500 77,500

148,750

226,250 173,750

45,000

52,500

Unearned Gift Card Revenue Explanation Ref. Debit Credit Balance 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. (b) 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. 2. (b) Note disclosure: Since the amount of the liability cannot be reliably measured, the lawsuit should be disclosed. 3. (a) or (c) Since it is now January 31, 2012, 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, 2011 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. 4. (c) The situation did not exist at year end and would not be disclosed in the notes to the financial statements. 5. (b) Note disclosure: The amount of the liability still can not be reliably measured, even though a portion will be paid by Mega’s insurance company. Taking It Further: Accounting for contingencies under IFRS considers liabilities contingent where there is too high a degree of uncertainty to record the liability. In the situations above, items 1, 2 and 5 would be considered contingent liabilities. Item 3, if recorded would be considered an estimated liability. The threshold for recognition is “probable” rather than “likely”. Under Canadian GAAP for Private Enterprises, items 1, 2, 3 and 5 would all be considered contingent liabilities.

PROBLEM 10-7A

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(a)

Accounting Principles, Fifth Canadian Edition

The Government of Ontario should record the contingent liability on its financial statements. It would appear that the contingency is likely (The Atom Construction Company has never missed a deadline and has a history of completing projects on budget) and the amount can be reasonably estimated. The Government of Ontario is not subject to IFRS since it is not a public company.

(b)

If Atom Construction Company is not a public company, it cannot record the contingent gain on its financial statements until the gain has been realized. This would occur when the construction project is complete, at the end of year three. Atom, however, should note disclose the contingent gain identifying that the amount is likely and the amount can be reasonably estimated. If Atom is a public company and the likelihood of the gain is virtually certain, the receivable and gain would be recognized in the financial statements.

Taking It Further: Accounting for contingent assets is substantially more restrictive in order to avoid overstating assets. For companies subject to GAAP for Private Enterprises, contingent liabilities are recorded when the loss is considered likely and can be reasonably estimated. Contingent assets are only recorded when the contingency is resolved and the asset is realized. For public companies and other companies using IFRS, liabilities are recorded when they are probable and can be reasonably estimated, and assets are recorded when they are virtually certain to be realized.

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PROBLEM 10-8A (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

600.00 0 600.00 45.00 580.00 87.00 580.00 130.50 2,360.00 262.50

Gross Pay

Deductions

CPP

Income United Tax Way

600.00 26.37 10.38 645.00 28.60 11.16 667.00 30.68 11.54 710.50 32.83 12.29 2,622.50 118.48 45.37

10-55

89.70 99.35 108.00 122.75 419.80

7.50 8.00 5.00 10.00 30.50

Total

Store Office Wages Wages Net Pay Expense Expense

133.95 466.05 600.00 147.11 497.89 645.00 155.22 511.78 667.00 177.87 532.63 710.50 614.15 2,008.35 1,912.00 710.50

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PROBLEM 10-8A (Continued) (b) Mar. 14 Store Wages Expense ............... 1,912.00 Office Wages Expense .............. 710.50 CPP Payable ......................... 118.48 EI Payable ............................. 45.37 Income Tax Payable ............. 419.80 United Way Contributions Payable 30.50 Wages Payable ..................... 2,008.35 14 Employee Benefits Expense ..... CPP Payable ($118.48 × 1) ... EI Payable ($45.37 × 1.4) ......

182.00 118.48 63.52

(c) Mar. 14 Wages Payable .......................... 2,008.35 Cash ...................................... 2,008.35 (d) Apr. 15 CPP Payable ($118.48 + $118.48) .................... 236.96 EI Payable ($45.37 + $63.52) ..... 108.89 Income Tax Payable .................. 419.80 United Way Contributions Payable 30.50 Cash ......................................

796.15

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PROBLEM 10-8A (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 earnings for EI purposes, so no EI is deducted from business profit or drawings. 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 10-9A (a) and (b)

Date Jan. 1 12 31 31

Date Jan. 1 12 31

Date Jan. 1 20 31

Canada Pension Plan Payable Explanation Ref. Debit Credit Balance Balance

✓ 5,454 2,845 2,845

5,454 0 2,845 5,690

Employment Insurance Payable Explanation Ref. Debit Credit Balance Balance

✓ 3,050 1,095 1,533

Income Tax Payable Explanation Ref. Debit Balance

3,050 0 1,095 2,628

Credit Balance

✓ 16,800 15,620

16,800 0 15,620

Workers’ Compensation Payable Explanation Ref. Debit Credit Balance Balance

✓ 5,263 3,165

5,263 0 3,165

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PROBLEM 10-9A (Continued) (a) and (b) (Continued)

Date Jan. 1 10 31

Date Jan. 1 11 31

Date Jan. 1 31

Date Jan. 1 8 31

Date Jan. 31 31

Union Dues Payable Explanation Ref. Debit Balance

Credit Balance

✓ 1,250 950

1,250 0 950

Canada Savings Bonds Payable Explanation Ref. Debit Credit Balance Balance

✓ 2,500 1,200

Vacation Pay Payable Explanation Ref. Debit Balance

2,500 0 1,200

Credit Balance

✓ 2,532

6,450 8,982

Disability Insurance Payable Explanation Ref. Debit Credit Balance Balance

✓ 1,050 1,100

1,050 0 1,100

Salaries and Wages Payable Explanation Ref. Debit Credit Balance ✓

40,490 40,490

40,490 0

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PROBLEM 10-9A (Continued) (b) (Continued) Jan. 8 Disability Insurance Payable ............. Cash................................................

1,050 1,050

10 Union Dues Payable ........................... Cash................................................

1,250

11 Canada Savings Bonds Payable ....... Cash................................................

2,500

1,250

2,500

12 CPP Payable ....................................... 5,454 EI Payable ........................................... 3,050 Income Tax Payable ........................... 16,800 Cash................................................

25,304

20 Workers’ Compensation Payable ...... Cash................................................

5,263

31 Office Salaries Expense ..................... 24,600 Store Wages Expense ........................ 38,700 CPP Payable ................................... EI Payable....................................... Income Tax Payable ...................... Union Dues Payable ...................... Canada Savings Bonds Payable... Disability Insurance Payable ........ Salaries and Wages Payable .........

2,845 1,095 15,620 950 1,200 1,100 40,490

31 Salaries and Wages Payable ............. 40,490 Cash................................................

40,490

31 Employee Benefits Expense .............. 10,075 CPP Payable ................................... EI Payable ($1,095 × 1.4) ............... Workers’ Compensation Payable ([$24,600 + $38,700] × 5%) ............. Vacation Benefits Payable ($63,300 × 4%) PROBLEM 10-9A (Continued)

2,845 1,533 3,165 2,532

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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 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.

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PROBLEM 10-10A (a) KANGAROO MEDIA INC. (Partial) Balance Sheet December 31, 2008 (in thousands)

Current liabilities Accounts payable and accrued liabilities ............... Deferred revenues .................................................... Current portion of long-term debt ........................... Total current liabilities .........................................

$1,993 211 3,199 $5,403

(b) Current ratio: $10,579 ÷ $5,403 = 1.96:1 Current assets = $897 + $9,266 + $160 + $128 + $128 = $10,579 Acid-test ratio: ($897 + $9,266 + $160) ÷ $5,403 = 1.91:1 (c)

Current ratio Dec. 31/07: $27,177 ÷ $6,813 = 3.99:1 Acid-test ratio Dec. 31/07: $25,662 ÷ $6,813 = 3.77:1 Both the current and acid-test ratios weakened during 2008.

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PROBLEM 10-10A (Continued) Taking It Further: In assessing solvency, 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 Kangaroo Media 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 10-11A (a) WESTERN ELECTRIC COMPANY Payroll Register Week Ending June 5, 2009

Employee C. Tam T. Ng O. Stavtech A. Mandell Totals

Gross Pay 945.00 1,135.00 1,135.00 1,067.00 4,282.00

CPP 43.45 52.85 52.85 49.48 198.63

1 2 2 3

Deductions Federal Ontario Total EI Income Tax Income Tax Deductions 4 16.35 109.10 61.00 229.90 5 19.64 139.50 73.95 285.94 5 19.64 153.75 79.50 305.74 6 18.46 137.90 74.00 279.84 74.08 540.25 288.45 1,101.42

1. CPP = ($945.00 – [$3,500 ÷ 52]) × 4.95% = $43.45 2. CPP = ($1,135.00 – [$3,500 ÷ 52]) × 4.95% = $52.85 3. CPP = ($1,067.00 – [$3,500 ÷ 52]) × 4.95% = $49.48 4. EI = $945.00 × 1.73% = $16.35 5. EI = $1,135.00 × 1.73% = $19.64 6. EI = $1,067.00 × 1.73% = $18.46

10-64

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Net Pay 715.10 849.06 829.26 787.16 3,180.58

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*PROBLEM 10-11A (Continued) (b) Semi-monthly Payroll Ending June 15, 2009:

Employee

Gross Salary

Gross Pay

CPP 4.95%

EI 1.73%

S. Goodspeed M. Giancarlo H. Radley

$40,840 60,760 70,480

$1,701.67 2,531.67 2,936.67

$ 77.01 1 118.10 2 138.15 3

$29.44 4 43.80 5 50.80 6

1. CPP = ($1,701.67 – [$3,500 ÷ 24]) × 4.95% = $77.01 2. CPP = ($2,531.67 – [$3,500 ÷ 24]) × 4.95% = $118.10 3. CPP = ($2,936.67 – [$3,500 ÷ 24]) × 4.95% = $138.15 4. EI = $1,701.67 × 1.73% = $29.44 5. EI = $2,531.67 × 1.73% = $43.80 6. EI = $2,936.67 × 1.73% = $50.80 (c) Pay period in which CPP maximum is reached = Maximum annual employee CPP contribution ÷ 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 ÷ 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 2009. M. Giancarlo: Pay period in which CPP maximum is reached = $2,118.60 ÷ $118.10 = 17.94; rounded up to pay period 18 (September 30th).

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*PROBLEM 10-11A (Continued) (c) (Continued) Pay period in which EI maximum is reached = $731.79 ÷ $43.80 = 16.71; rounded up to pay period 17 (September 15th). H. Radley: Pay period in which CPP maximum is reached = $2,118.60 ÷ $138.15 = 15.34; rounded up to pay period 16 (August 31st). Pay period in which EI maximum is reached = $731.79 ÷ $50.80 = 14.40; rounded up to pay period 15 (August 15th). 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 amount of CPP, EI and income tax to be deducted are all dependent on the length of the pay period, thus different tables are required.

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PROBLEM 10-1B (a)1. Not on balance sheet

FOB destination and arrived after year-end 2. Current liabilities section Salaries payable $45,6001 CPP payable 7,2002 EI payable 2,8803 Income tax payable 21,6004 3. Current liabilities section Property tax payable 40,000 4. Current liabilities section Note payable 35,000 Interest payable 1465 5. Current liabilities section Warranty liability 18,0006 6. Current liabilities section Mortgage payable 9,250 Long-term liabilities section Mortgage payable 215,750 7. Current liabilities section Environmental 250,0007 liability Calculations: 1 $90,000 - $27,000 − $4,500 - $1,500) × 4/5 = $45,600 2 $4,500 × 4/5 × 2 = $7,200 3 $1,500 × 4/5 × 2.4 = $2,880 4 $27,000 × 4/5 = $21,600 5 $35,000 × 5% × 1/12 = $146 6 [(10,000 × 5%) - 100] × $45 = $18,000 7 Note: Because this likelihood of loss is likely and estimable, it should be recorded in the accounts

Taking It Further: The notes should disclose information on the lawsuit, including the estimated loss and that a provision has been made for the estimated loss. The interest rate and repayment terms on both the note payable and the mortgage payable should also be disclosed.

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PROBLEM 10-2B (a)

2010: Dec. 1 Interest Expense ($15,000 × 6% × 1/12)................. 75 Interest Payable ......................... 375 Note Payable.............................. 15,000 Cash....................................... 2011: Apr. 1 Land ........................................... 75,000 Notes Payable —Mountain Real Estate ........ Apr. 30 Equipment.................................. Accounts Payable .................

8,000

May 31 Accounts Payable ..................... Notes Payable—Mongoose ..

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-Mongoose ........... Cash....................................... Oct.

Oct.

1 Interest Expense ($75,000 × 7% × 3/12)................ Cash.......................................

15,450

75,000 8,000 8,000

1,313 160 8,000 8,160 1,313 1,313

1 Cash ........................................... 90,000 Notes Payable—Western Bank

90,000

31 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, 2011 Current liabilities Notes payable ............................................................. Current portion of long-term notes payable ............. Interest payable .......................................................... Total current liabilities ........................................... Long-term liabilities Notes payable .......................................... Less current portion ................................

$75,000 18,000 888 $93,888

$90,000 ( 18,000 ) $72,000

(c) MILEHI MOUNTAIN BIKES (Partial) Income Statement Year ended October 31, 2011 Other expenses Interest expense .........................................................

$3,749*

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PROBLM 10-2B (Continued) (c) (Continued)

Date Dec. 1 July 31 Aug. 31 Oct. 1 Oct. 31

Date Nov. 1 Dec. 1 Apr. 1 May 31 Aug. 31 Oct. 1

Interest Expense Explanation Ref. Debit 75 1,313 160 1,313 888

Explanation

Notes Payable Ref. Debit ✓ 15,000 8,000 90,000

Credit Balance 75 1,388 1,548 2,861 3,749

Credit Balance 15,000 0 75,000 75,000 8,000 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 represents the amount that must be settled within one year and 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 Service Revenue.......... Service Revenue .....................

7,000

14 HST Payable .................................. 11,390 Cash .........................................

11,390

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

7,395

1,905 850 4,640

16 Cash............................................... 18,000 Notes Payable—HSBC Bank ..

18,000

17 Accounts Payable ......................... 32,000 Cash .........................................

32,000

20 Accounts Receivable.................... 33,900 Sales (500 × $60) ..................... HST Payable ($30,000 × 13%) .

30,000 3,900

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

12,500

30 Customer Loyalty Program Liability 1,750 HST Payable ($1,750 × 13/113) Service Revenue ($1,750 × 100/113)

201 1,549

31 Sales Discount for Redemptions Reward Issued .............................. 5,000 Customer Loyalty Program Liability (50,000 × 10% × $1)

5,000

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PROBLEM 10-3B (Continued) (a) (Continued) Jan. 31 Warranty Liability ...................... Parts Inventory .....................

875 875

31 Salaries Expense....................... 22,500 CPP Payable.......................... EI Payable ............................. Income Tax Payable ............. Salaries Payable ...................

1,027 289 5,135 16,049

31 Salaries Payable ........................ 16,049 Cash.......................................

16,049

(b) Jan. 31 Interest Expense ....................... Interest Payable .................... [($18,000 × 6% × 1/12) × 1/2]

31 Warranty Expense ..................... Warranty Liability ................. (500 × 6% × $10)

300

31 Employee Benefits Expense..... CPP Payable.......................... EI Payable ............................ Vacation Pay Payable ...........

2,332

300

1,027 405 900

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PROBLEM 10-3B (Continued) (c) ZAUR COMPANY (Partial) Balance Sheet January 31, 2011 Liabilities Current liabilities Accounts payable ($52,000 - $32,000) ....................... Notes payable ............................................................. Vacation pay liability .................................................. Unearned service revenue ($16,000 - $7,000) ........... HST payable ($11,390 + $2,054 - $11,390 + $3,900 + $201)..................................................................... Customer loyalty program liability ($2,150 - 1,750 + $5,000) .................................................................. Warranty liability ($5,750 - $875 + $300) .................... Income taxes payable ($4,640 - $4,640 + $5,135) ...... CPP payable ($1,905 - $1,905 + $1,027 + $1,027) ...... EI payable ($850 - $850 + $289 + $405) ...................... Interest payable .......................................................... Total current liabilities ...........................................

$20,000 18,000 10,020 9,000 6,155 5,400 5,175 5,135 2,054 694 45 $81,678

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PROBLEM 10-4B (a)

Warranty expense 2009 – (1,200 × 5% × $25) = $1,500 2010 – (1,320 × 5% × $25) = $1,650 2011 – (1,420 × 5% × $25) = $1,775 Warranty liability at year end 2009 – ($0 - $1,275 + $1,500) = $225 2010 – ($225 - $1,600 + $1,650) = $275 2011 – ($275 - $1,960 + $1,775) = $90

Note: See analysis of warranty liability account in (b) below. (b) 2009 Warranty Liability ................................ Repair Parts Inventory...................

1,275

Dec. 31 Warranty Expense (1,200 × 5% × $25) Warranty Liability ...........................

1,500

1,275

1,500

2010 Warranty Liability ................................ Repair Parts Inventory...................

1,600

Dec. 31 Warranty Expense (1,320 × 5% × $25) Warranty Liability ...........................

1,650

1,600

1,650

2011 Warranty Liability ................................ Repair Parts Inventory...................

1,960

Dec. 31 Warranty Expense (1,420 × 5% × $25) Warranty Liability ...........................

1,775

1,960

1,775

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

Date 2009 During Dec. 31 2010 During Dec. 31 2011 During Dec. 31 (c)

Warranty Liability Explanation Ref. Debit

Credit

Balance

1,500

1,275 Dr 225

1,650

1,375 Dr 275

1,775

1,685 Dr 90

1,275

1,600

1,960

Percentage of units returned for repair = Number of units returned ÷ Number of units sold Returned 2009 60 2010 70 2011 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

2009 2010 2011

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 2011 only. The January 1, 2011 opening balance in the Warranty Liability account remains at $275. The revised warranty expense for 2011 is calculated as follows: Warranty expense 2011: 1,420 x 7% x $25 = $2,485 Warranty liability at December 31, 2011: $275 - $1,960 + $2,485 = $800

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PROBLEM 10-5B (a)

1. 2. 3. 4.

Reduces revenues and profit No effect on revenues, expenses and profit No effect on revenues, expenses and profit Increases revenues, expenses (cost of goods sold) and profit

(b) 2010: 1 Sales Discount for Redemption Rewards Issued (750,000 × $0.025) . Redemption Rewards Liability ..... 2

18,750 18,750

Cash ...................................................... Redemption Rewards Liability ............ Sales .............................................. 2011: 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 Gift Card Revenue .......

3,950

Unearned Gift Card Revenue .............. Sales ..............................................

1,500

23,800

20,250 20,250

30,230

3,950

1,500

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PROBLEM 10-5B (Continued) (c) Date 2010 During Dec. 31 2011 During Dec. 31

Date 2011 During Dec. 31

Redemption Rewards Liability Explanation Ref. Debit Credit Balance 18,750

18,750 12,800

20,250

33,050 23,550

5,950

9,500

Unearned Gift Card Revenue Explanation Ref. Debit Credit Balance 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.

(b) Note disclosure: It does not appear that it is likely that the company will have an obligation for its customer’s bank loan.

(b) Note disclosure: Since the amount of the liability cannot be reliably measured, the lawsuit cannot be recorded, but it should be disclosed.

(c) 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 of the lawsuit could have a substantial negative effect on the company’s financial position, then note disclosure is still desirable.

(b) Part of the disclosure concerning the lawsuit should include the fact that insurance coverage exists.

(b) Note disclosure: The situation arose after year end and a liability did not exist at December 31, 2011, therefore an accrual is not required. The situation may have a significant effect, in a subsequent period, on the assets and liabilities or future operations of the company and disclosure could be important to users in their interpretation of the financial statements. Disclosure of this event would be required.

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PROBLEM 10-6B (Continued) Taking It Further: Accounting for contingencies under IFRS considers liabilities contingent where there is too high a degree of uncertainty to record the liability. In the situations above, all of the items would be considered contingent liabilities. The threshold for recognition is “probable” rather than “likely”. Situations that result in an accrual (probable likelihood of loss and the amount can be reasonably estimated) are considered estimated liabilities.

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PROBLEM 10-7B The College of Learning is not a public company and would not be required to follow IFRS. (a)

The contingent asset is likely and the amount is estimable. As a result, this contingent asset can be disclosed in the March 31 financial statements. The amount cannot be recorded until the insurance claim has been settled.

(b)

In this case there is no contingent asset. The insurance claim is unlikely to be successful. No asset can to be recorded or disclosed in the March 31 financial statements.

(c)

In this case the insurance claim is no longer a contingent asset because written confirmation has been received from the insurance company. As a result of the written confirmation, the insurance claim should be recorded as an account receivable in the March 31 financial statements. Since this is no longer a contingent asset the accounting rules about contingent assets are not applicable.

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PROBLEM 10-7B (Continued) Taking It Further: Accounting for contingent assets is substantially more restrictive in order to avoid overstating assets. For companies subject to GAAP for Private Enterprises, contingent liabilities are recorded when the loss is considered likely and can be reasonably estimated. Contingent assets are only recorded when the contingency is resolved and the asset is realized. For public companies and other companies using IFRS, liabilities are recorded when they are probable and can be reasonably estimated, and assets are recorded when they are virtually certain to be realized.

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PROBLEM 10-8B (a) SCOOT SCOOTERS Payroll Register Week Ending February 15, 2011

Earnings

Deductions Gross Income United Employee Hours Regular Overtime Pay CPP EI Tax Way P. Kilchyk 40 510.00 0 510.00 21.91 8.82 66.20 5.00 B. Quon 42 560.00 42.00 602.00 26.47 10.41 81.95 7.25 C. Pospisil 40 610.00 0 610.00 26.86 10.55 83.55 5.50 B. Verwey 44 540.00 81.00 621.00 27.41 10.74 85.10 8.25 Totals 2,220.00 123.00 2,343.00 102.65 40.52 316.80 26.00

10-83

Total Net Pay 101.93 408.07 126.08 475.92 126.46 483.54 131.50 489.50 485.97 1,857.03

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PROBLEM 10-8B (Continued) (b) Feb. 15 Wages Expense ............................2,343.00 CPP Payable.......................... 102.65 EI Payable.............................. 40.52 Income Tax Payable ............. 316.80 United Way Contributions Payable 26.00 Wages Payable ..................... 1,857.03 15 Employee Benefits Expense ........ 159.38 CPP Payable.......................... EI Payable ($40.52 × 1.4) ......

102.65 56.73

(c) Feb. 15 Wages Payable .............................1,857.03 Cash....................................... 1,857.03 (d) Mar. 15 CPP Payable ($102.65 + $102.65). 205.30 EI Payable ($40.52 + $56.73) ........ 97.25 Income Tax Payable ..................... 316.80 United Way Contributions Payable .......................................... 26.00 Cash.......................................

645.35

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PROBLEM 10-8B (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 10-9B (a), and (b)

Date Jan. 1 12 31 31

Date Jan. 1 12 31

Date Jan. 1 12 31 31

Date Jan. 1 20 31

Canada Pension Plan Payable Explanation Ref. Debit Credit Balance Balance

✓ 8,878 4,168 4,168

Income Tax Payable Explanation Ref. Debit Balance

8,878 0 4,168 8,336

Credit Balance

✓ 22,500 21,700

22,500 0 21,700

Employment Insurance Payable Explanation Ref. Debit Credit Balance Balance

✓ 3,723 1,583 2,216

3,723 0 1,583 3,799

Workers’ Compensation Payable Explanation Ref. Debit Credit Balance Balance

✓ 5,676 6,405

5,676 0 6,405

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PROBLEM 10-9B (Continued) (a) and (b) (Continued)

Date Jan. 1 10 31

Date Jan. 1 17 31

Date Jan. 1 31

Date Jan. 1 7 31

Date Jan. 1 31 31

Union Dues Payable Explanation Ref. Debit Balance

Credit Balance

✓ 1,200 1,250

1,200 0 1,250

Canada Savings Bonds Payable Explanation Ref. Debit Credit Balance Balance

✓ 2,420 1,210

Vacation Pay Payable Explanation Ref. Debit Balance

2,420 0 1,210

Credit Balance

✓ 3,660

10,704 14,364

United Way Contributions Payable Explanation Ref. Debit Credit Balance Balance

✓ 750 750

750 0 750

Salaries and Wages Payable Explanation Ref. Debit Credit Balance Balance

✓ 60,839 60,839

0 60,839 0

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PROBLEM 10-9B (Continued) (b) (Continued) Jan. 7 United Way Contributions Payable Cash .......................................... 10 Union Dues Payable ..................... Cash ..........................................

750 750 1,200 1,200

12 CPP Payable.................................. 8,878 EI Payable ..................................... 3,723 Income Tax Payable ..................... 22,500 Cash ..........................................

35,101

17 Canada Savings Bonds Payable.. Cash ..........................................

2,420 2,420

20 Workers’ Compensation Payable Cash ..........................................

5,676 5,676

31 Office Salaries Expense ............... 41,200 Store Wages Expense .................. 50,300 CPP Payable ............................. EI Payable ................................. Income Tax Payable ................. Union Dues Payable ................. United Way Contributions Payable Canada Savings Bonds Payable Wages Payable .........................

4,168 1,583 21,700 1,250 750 1,210 60,839

31 Wages Payable ............................. 60,839 Cash ..........................................

60,839

31 Employee Benefits Expense ........ 16,449 CPP Payable ($4,168 × 1) ......... EI Payable ($1,583 × 1.4) .......... Workers’ Compensation Payable ($91,500 × 7%) .......................... Vacation Pay Payable ($91,500 × 4%) PROBLEM 10-9B (Continued)

4,168 2,216 6,405 3,660

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Taking It Further: The employer is required to keep some personal information for the employee, such as name, social insurance number, address and start date of employment. The employee’s personnel record also records the employee’s pay rate or salary. For each pay period, the employer must keep track of gross pay and individual deductions, such as CPP, EI and income taxes. This information is also accumulated on an annual basis in order to prepare CRA filings such as the T4 slip.

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PROBLEM 10-10B (a) SHOPPERS DRUG MART CORPORATION (Partial) Balance Sheet January 3, 2009

Current liabilities Accounts payable and accrued liabilities ............ Bank indebtedness ................................................ Short-term debt ...................................................... Dividends payable ................................................. Total current liabilities ...................................... (b)

$1,018,505 240,844 197,845 46,709 $1,503,903

Current ratio: $2,724,421 ÷ $1,503,903 = 1.81:1 Current assets: $448,476 + $36,567 + $339,957 + $83,279 + $8,835 + $1,743,253 + $64,054 Acid-test ratio: ($36,567 + $448,476 + $8,835 + $339,957) ÷ $1,503,903 = 0.55:1

(c)

Current ratio Dec. 29/07: $2,150,137 ÷ $2,158,320 = 1.00:1 Acid-test ratio Dec. 29/07: $399,894 ÷ $2,158,320 = 0.19:1 Both the current and acid-test ratios improved during 2008.

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PROBLEM 10-10B (Continued) Taking It Further: In assessing solvency, 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 Shoppers Drug Mart Corporation the acid-test and current ratios are substantially different 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 10-11B (a) SLOVAK PLUMBING COMPANY Payroll Register Week Ending May 8, 2009

Employee D. Quinn K. Holub A. Lowhorn I. Kostra Totals

Gross Pay 995.00 1,030.00 1,074.00 940.00 4,039.00

CPP 45.92 1 47.65 2 49.83 3 43.20 4 186.60

Deductions Federal Ontario Total EI Income Tax Income Tax Deductions 5 17.21 122.50 67.25 252.88 6 17.82 121.45 66.30 253.22 7 18.58 140.55 74.00 282.96 8 16.26 95.95 56.55 211.96 69.87 480.45 264.10 1,001.02

1. CPP = ($995.00 – [$3,500 ÷ 52]) × 4.95% = $45.92 2. CPP = ($1,030.00 – [$3,500 ÷ 52]) × 4.95% = $47.65 3. CPP = ($1,074.00 – [$3,500 ÷ 52]) × 4.95% = $49.83 4. CPP = ($940.00 – [$3,500 ÷ 52]) × 4.95% = $43.20 5. EI = $995.00 × 1.73% = $17.21 6. EI = $1,030.00 × 1.73% = $17.82 7. EI = $1,074.00 × 1.73% = $18.58 8. EI = $940.00 × 1.73% = $16.26

10-92

Chapter 10 Unauthorized copying, distribution, or transmission of this page is prohibited.

Net Pay 742.12 776.78 791.04 728.04 3,037.98

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*PROBLEM 10-11B (Continued) (b) Semi-monthly Payroll Ending May 15, 2009:

Employee B. Dolina H. Koleno A. Krneta

Gross Salary

Gross Pay

CPP 4.95%

$75,760 64,980 41,180

$3,156.67 $149.04 1 2,707.50 126.80 2 1,715.83 77.72 3

EI 1.73% $54.61 4 46.84 5 29.68 6

1. CPP = ($3,156.67 – [$3,500 ÷ 24]) × 4.95% = $149.04 2. CPP = ($2,707.50 – [$3,500 ÷ 24]) × 4.95% = $126.80 3. CPP = ($1,715.83 – [$3,500 ÷ 24]) × 4.95% = $77.72 4. EI = $3,156.67 × 1.73% = $54.61 5. EI = $2,707.50 × 1.73% = $46.84 6. EI = $1,715.83 × 1.73% = $29.68 (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 = $2,118.60 ÷ $149.04 = 14.22; rounded up to pay period 15 (August 15th). Pay period in which EI maximum is reached = $731.79 ÷ $54.61 = 13.40; rounded up to pay period 14 (July 31st).

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*PROBLEM 10-11B (Continued) (c) (Continued) H. Koleno: Pay period in which CPP maximum is reached = $2,118.60 ÷ $126.80 = 16.71; rounded up to pay period 17 (September 15th). Pay period in which EI maximum is reached = $731.79 ÷ $46.84 = 15.62; rounded up to pay period 16 (August 31st). 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 2009. 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 differ, depending on the length of the pay period, thus different tables are necessary.

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CONTINUING COOKIE CHRONICLE (a)

Total interest expense in 2010 was calculated in Chapter 4 as $2,000 × 3% × 1.5/12 = $8 Total interest over the term of the loan: $2,000 × 3% Less: portion incurred in 2010 Portion of interest incurred in 2011

(b) Total interest over the term of the loan: $2,000 × 3% Interest incurred from November 16, 2010 to August 31, 2011 ($2,000 × 3% × 9.5/12) Interest (cash) savings (c)

$60 (8) $52

$60 (48) $12

Advantages: • Results in cash savings on the interest charge. • Allows her to make additional borrowings from other sources since she will have less debt outstanding. • Reduces her interest expense for the 2011 year; this will improve her profitability. Disadvantages: • If Natalie can generate profits at a higher rate of return than the borrowing rate on the $2,000, then the borrowing is generating additional profits for Natalie’s company. • Natalie has to make sure that she has sufficient cash on hand to meet outstanding debt and that she doesn’t incur higher interest costs because of a cash shortfall.

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CONTINUING COOKIE CHRONICLE (Continued) (d) 2011 Aug. 31 Interest Expense ......................... 35 Interest Payable ........................... 13 Note Payable................................ 2,000 Cash......................................... Accrue interest from Feb. 1 to Aug. 31, 2011: $2,000 × 3% × 7/12 ............................. Interest accrued in November, 2010 ........... Interest accrued in December, 2010 ........... Interest accrued in January, 2011 ............... Total interest $48

2,048

$35 $3 5 5

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CUMULATIVE COVERAGE: CHAPTERS 3 TO 10 (a) 1.

July 31 Operating Expenses .................. Accounts Receivable ................ Cash.......................................

45 650 695

31 Bad Debt Expense ..................... 1,850 Allowance for Doubtful Accounts [($38,500 × 10%) − $2,000] .... 31 Interest Receivable.................... Interest Revenue ($10,000 × 8% × 1/12 months)

31 Cost of Goods Sold ................... Merchandise Inventory ($40,900 − $39,200) ...............

1,700

31 Operating Expenses .................. Prepaid Expenses .................

5,500

1,850

1,700

5,500

31 Depreciation Expense ($5,600 + $5,120) ........................ 10,720 Amortization Expense ............... 15,000 Accumulated Depreciation —Building.............................. 5,600 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 × 7% × 1/12) ..........

725

31 Operating Expenses .................. Salaries Payable ...................

1,975

725

1,975

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CUMULATIVE COVERAGE (Continued) (b) LEBRUN COMPANY Adjusted Trial Balance July 31, 2011 ______________________________________________________

Cash .......................................................... Petty cash ................................................. Accounts receivable ................................ Allowance for doubtful accounts ........... Notes receivable ...................................... Interest receivable ................................... Merchandise inventory ........................... Prepaid expenses .................................... Land ......................................................... Building .................................................... Accumulated depreciation—building ..... Equipment ................................................ Accumulated depreciation—equipment . Patent ....................................................... Accumulated amortization—patent ........ Accounts payable .................................... Interest payable ....................................... Salaries payable ....................................... Mortgage 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 ......................................................... See the following page for calculations.

Debit $ 16,705 200 39,150

Credit

$ 3,850 10,000 67 39,200 10,500 50,000 155,000 16,400 25,000 17,320 75,000 30,000 78,900 725 1,975 124,200 127,690 54,000 750,000 451,700 1,850 188,740 15,000 10,720 467 8,695 _________ $1,151,527 $1,151,527

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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 Notes receivable Interest receivable Merchandise inventory Prepaid expenses Land Building Accumulated depreciation —building Equipment Accumulated depreciation —equipment Patent Accumulated amortization —patent Accounts payable

Unadjusted Trial Balance Dr. Cr. 17,400 200 38,500

Adjustments Dr

Cr. (1) 695

(1) 650

2,000

Adjusted Trial Balance Dr. Cr. 16,705 200 39,150

(2) 1,850

10,000

3,850 10,000

(3) 67

40,900

(4) 1,700

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

78,900

30,000 78,900

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CUMULATIVE COVERAGE (Continued) (b) (Continued) Account Interest payable Salaries payable Mortgage 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

Unadjusted Trial Balance Dr. Cr.

Adjusted Trial Balance Dr. Cr.

Adjustments Dr. Cr. (7) 725

725

(8) 1,975

1,975

124,200

127,690

54,000

54,000 750,000

450,000

181,220

750,000 (4) 1,700

451,700

(2) 1,850 (5) 5,500 (8) 1,975 (1) 45

1,850

188,740

(6)15,000

15,000

(6)10,720

10,720

400

(3)

467

7,970 (7) 725 1,121,190 1,121,190 38,232

8,695 38,232 1,151,527 1,151,527

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CUMULATIVE COVERAGE (Continued) (c) LEBRUN COMPANY Income Statement Year Ended July 31, 2011 Sales revenues Sales ............................................................................ $750,000 Cost of goods sold ..................................................... 451,700 Gross profit ................................................................. 298,300 Operating and other expenses Operating expenses ................................... $188,740 Amortization expense................................. 15,000 Depreciation expense ................................. 10,720 Bad debt expense ....................................... 1,850 Total expenses ....................................................... 0 216,310 Profit from operations ..................................................... 81,990 Other revenues Interest revenue .......................................... $ 467 Other expenses Interest expense ........................................ 8,695 8,228 Profit................................................................................. $73,762

LEBRUN COMPANY Statement of Owner’s Equity Year Ended July 31, 2011 S. LeBrun, capital, August 1, 2010 ................................. $127,690 Add: Profit........................................................................ 73,762 201,452 Less: Drawings ................................................................ 54,000 S. LeBrun, capital, July 31, 2011 .................................... $147,452

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CUMULATIVE COVERAGE (Continued) (c) (Continued) LEBRUN COMPANY Balance Sheet July 31, 2011 Assets Current assets Cash ($16,705 + $200)................................................. $ 16,905 Accounts receivable ................................... $39,150 Less: Allowance for doubtful accounts .... 3,850 35,300 Notes receivable ......................................................... 10,000 Interest receivable ...................................................... 67 Merchandise inventory ............................................... 39,200 Prepaid expenses ....................................................... 10,500 Total current assets ............................................... 111,972 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 .......................................................... Less: Accumulated amortization ...............

45,000

$75,000 30,000

Total assets ..................................................................... $353,252

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CUMULATIVE COVERAGE (Continued) (c) (Continued) LEBRUN COMPANY Balance Sheet (Continued) July 31, 2011 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................... Interest payable .......................................................... Salaries payable.......................................................... Current portion of mortgage payable ........................ Total current liabilities ...........................................

$ 78,900 725 1,975 1,680 83,280

Long-term liabilities Mortgage payable ($124,200 − $1,680) ...................... Total liabilities ........................................................

122,520 205,800

Owner’s equity S. LeBrun, capital ....................................................... 147,452 Total liabilities and owner’s equity ....................... $353,252

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BYP10-1 FINANCIAL REPORTING PROBLEM (a)

Total current liabilities at February 1, 2009, were $302,451,000. There was a $29,322,000 decrease from the previous year ($302,451,000 – $331,773,000), which was equivalent to a 9% decrease ($29,322,000 ÷ $331,773,000).

(b) The components of total current liabilities on February 1, 2009 were indebtedness under revolving credit facility, accounts payable and accrued liabilities, and current portion of long-tem debt. (c)

Current ratio: 2009 $382,253,000 ÷ $302,451,000 = 1.26:1 Current ratio: 2008 $456,936,000 ÷ $331,773,000 = 1.38:1 Acid-test ratio: 2009 ($3,474,000 + $84,455,000) ÷ $302,451,000 = 0.29:1 Acid-test ratio: 2008 ($47,484,000 + $75,506,000) ÷ $331,773,000 = 0.37:1 Receivables turnover: 2009 $1,346,758,000 ÷ [($84,455,000 + $75,506,000) ÷ 2] = 16.84 Receivables turnover: 2008 $1,331,009,000 ÷ [($75,506,000 + $65,543,000) ÷ 2] = 18.87 Inventory turnover: 2009 $863,239,000 ÷ [($291,497,000 + $319,445,000) ÷ 2] = 2.83 Inventory turnover: 2008 $852,608,000 ÷ [($319,445,000 + $302,207,000) ÷ 2] = 2.74

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BYP 10-1 (Continued) Operating cycle: 2009 (365 ÷ 16.84) + (365 ÷ 2.83) = 150.7 days Operating cycle: 2008 (365 ÷ 18.87) + (365 ÷ 2.74) = 152.6 days

Ratio: Current ratio Acid-test ratio Receivables turnover Inventory turnover Operating cycle

Summary 2009 1.26:1 0.29:1 16.84 2.83 150.7 days

2008 1.38:1 0.37:1 18.87 2.74 152.6 days

Forzani’s overall liquidity has decreased in 2009. Its current ratio and acid test ratios have both decreased. Its receivables turnover has also decreased indicating a slowdown in the time it takes to collect outstanding receivables from 19.3 days (365 ÷ 18.87) to 21.7 days (365 ÷ 16.84). The inventory turnover has increased slightly from 2008. The decrease indicates a slight improvement in the time it takes to sell the merchandise from 133.2 days (365 ÷ 2.74) to 129 days (365 ÷ 2.83). As the number of days to sell inventory has decreased by more than the increase in the number of days to collect receivables, the overall operating cycle has improved from 152.6 days to 150.7 days. (d) Forzani reports contingent liabilities in note 15 to its financial statements. Contingencies include; a guarantee to franchisees’ banks to buy back inventory of franchisees (the maximum exposure was $43,707,000), indemnification of liabilities incurred in the normal course of business, and claims and lawsuits incurred in the normal course of business. In the opinion of management, all such claims are not expected to have a material affect on the financial statements.

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BYP 10-2 INTERPRETING FINANCIAL STATEMENTS (a)

Saputo does not accrue guarantees and claims, as they are not expected to have a material impact on the reported results. It does not accrue the indemnification liabilities as they cannot be reasonably estimated.

(b) The legal costs to date should be recorded on the income statement as an expense. These costs have no future benefit and therefore cannot be recorded as an asset. (c)

Saputo is disclosing guarantees on certain leases whereby the company may have to make up a shortfall in the guaranteed residual value at the end of the leases. The market value of the leased assets may decline significantly if the product line is discontinued or if the equipment becomes obsolete due to changes in the market or due to technological changes.

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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 MEMORANDUM TO: FROM: DATE: SUBJECT:

Show Time Movie Theatre, Owner Student Accounting for Gift Certificates

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, 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 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: CPP Contribution $134.06 EI Contribution 51.90 Income taxes 429.84 Cash received (net pay)

$3,000.00

615.80 $2,384.20

The total amount of cash received in a year: Annual salary ($3,000 × 12) Less deductions: CPP Contribution ($134.06 × 12) EI Contribution ($51.90 × 12) Income tax ($429.84 × 12) Cash received (net pay)

$36,000.00 1,608.72 622.80 5,158.08 $28,610.40

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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 2009 maximum pensionable earnings of $46,300, the employee will not reach the maximum annual contribution. The total EI paid in the year will be $51.90 × 12 = $622.80. The employee’s annual salary is less than the 2009 maximum insurable earnings of $42,300, 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 $622.80.

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BYP 10-6 (Continued) (e)

(f)

Consulting revenue ($3,000 × 12) Less deductions: Income tax ($429.84 × 12) CPP Contribution ($134.06 × 12 × 2) Net Pay

$36,000.00 5,158.08 3,217.44 $27,624.48

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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Legal Notice Copyright

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CHAPTER 11 Financial Reporting Concepts ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief Exercises

Problems Set A

Problems Set B

1. Explain the importance of having a conceptual framework of accounting, and list the components.

1, 2

2. Identify and apply the objective of financial reporting and the underlying assumptions used by accountants.

3, 4, 5

2, 3, 6

1, 2, 4, 5, 6

1, 2, 4, 5

3. Describe the 6, 7, 8, 9, fundamental and 10, 12 enhancing qualitative characteristic of financial reporting.

4, 6

2, 3, 4, 5

1, 2, 3

4. Identify and apply 11, 12, 13, the constraints on 14 financial reporting.

5, 6, 7

5, 6

3, 4

5. Identify and apply the basic recognition and measurement concepts of accounting.

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

4, 5, 6, 7, 8, 9, 10, 11

Solutions Manual

15, 16, 17, 18, 19, 20, 21, 22, 23

11-1

Exercises

Chapter 11

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Comment on objective of financial reporting, relevance, and faithful representation.

Moderate

15-20

Assumptions and concepts – going concern, full disclosure.

Moderate

15-25

Comment on objective of financial reporting, qualitative characteristics, and constraints.

Moderate

15-20

Identify concept or assumption violated and prepare entries.

Moderate

20-30

Identify assumption or concepts and correct entries.

Moderate

15-25

Identify point of revenue and expense recognition.

Moderate

15-20

Calculate revenue at various points of recognition.

Moderate

20-30

Calculate revenue, expense, and gross profit – percentage-of-completion and zero profit methods.

Moderate

15-25

Revise revenue, expense, and gross profit – percentage-of-completion.

Complex

15-25

10A

Calculate revenue, expense, and gross profit – percentage-of-completion method.

Moderate

20-30

11A

Revenue recognition criteria – sale of goods.

Complex

20-30

Comment on relevance and faithful representation.

Simple

10-15

Comment on the application of accounting assumptions and concepts.

Moderate

15-25

Comment on objective of financial reporting, qualitative characteristics, and constraints.

Moderate

15-20

Identify elements, assumptions, constraints, and recognition and measurement criteria.

Moderate

20-30

Identify assumptions and concepts and correct entries.

Moderate

15-25

Identify point of revenue and expense recognition.

Moderate

15-20

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Problem Number

Accounting Principles, Fifth Canadian Edition

Description

Difficulty Level

Time Allotted (min.)

Calculate revenue at various points of recognition.

Moderate

20-30

Calculate revenue, expense, and gross profit – percentage-of-completion and zero profit methods.

Moderate

15-25

Revise revenue, expense, and gross profit – percentage-of-completion method.

Complex

15-25

10B

Calculate revenue, expense, and gross profit – percentage-of-completion method.

Moderate

20-30

11B

Determine when to recognize revenue when revenues are uncertain.

Complex

20-30

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Chapter 11

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objectives 1. Explain the importance of having a conceptual framework of accounting, and list the components.

Knowledge

Comprehension

BE11-1

Q11-1 Q11-2 P11-3A P11-3B

Application

Identify and apply the objective of financial reporting and the underlying assumptions used by accountants.

Q11-3 BE11-3

Q11-4 Q11-5 BE11-2 BE11-6 E11-2 E11-4 P11-1A P11-1B

E11-1 E11-5 P11-2A P11-2B

Describe the fundamental and enhancing qualitative characteristic of financial reporting.

Q11-6 Q11-7 Q11-9 BE11-4

E11-5 P11-2A P11-2B

Identify and apply the constraints on financial reporting.

Q11-8 Q11-10 Q11-12 BE11-6 E11-2 E11-3 E11-4 P11-1A P11-3A P11-1B P11-3B Q11-11 Q11-12 Q11-13 Q11-14 BE11-6 BE11-7

Identify and apply the basic recognition and measurement concepts of accounting.

Broadening Your Perspective

Solutions Manual

Q11-16 Q11-17 Q11-18 Q11-22

Q11-15 Q11-19 Q11-20 Q11-23 BE11-6 BE11-7 E11-4 E11-7

Analysis

BE11-5 E11-5

E11-6 P11-4A P11-4B

E11-8 P11-6A P11-6B

Q11-21 E11-11 BE11-5 P11-7A BE11-8 P11-8A BE11-9 P11-9A BE11-10 P11-10A BE11-11 P11-11A BE11-12 P11-7B BE11-13 P11-8B E11-5 P11-9B E11-9 P11-10B E11-10 P11-11B BYP11-4 Continuing Cookie Chronicle

E11-6 P11-4A P11-5A P11-4B P11-5B

11-4

Evaluation

E11-6 P11-4A P11-5A P11-4B P11-5B

P11-3A P11-3B

BYP11-3

Synthesis

BYP11-1 BYP11-2 BYP11-6

BYP11-5

Chapter 11

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 1.

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.

It is impractical and impossible to make a rule for every situation. Because Canadian standards and IFRS are based on principles, accountants can then use their professional judgement to apply the framework to any situation. In a rules-based situation, accountants often focus on avoiding the rules, rather than adhering to the intent of the standard.

The basic 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.

(a)

Accrual Accounting: Transactions are recorded in the period when the transaction occurs and not when cash is received or paid.

(b)

Going Concern: The company will continue operating for the foreseeable future – long enough to achieve its goals and respect its commitments.

(a)

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. Also, the current/noncurrent classification of assets and liabilities would lose much of its significance. Labelling anything as fixed or long-term would be difficult to justify.

(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.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 6.

The fundamental 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 the 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.

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. 8.

Comparability results when different companies use the same accounting principles. Consistency means using the same accounting treatment for similar events from year to year within the same company.

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.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 10.

The full disclosure principle requires disclosure of circumstances and events that are useful for decisions. Full disclosure is reflected in the information presented in the body of the financial statements as well as the accompanying notes.

11.

The two constraints are materiality and cost-benefit. The materiality constraint 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 $10 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. The cost-benefit constraint means that the costs of the accounting information should not exceed the benefits derived from it. A 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.

12.

The full disclosure principle requires disclosure to be as complete as possible. However, the cost of providing some of the disclosures may be greater than the benefit. In Canada, this issue is a significant one for private enterprises and has been addressed through the development of Canadian GAAP for Private Enterprises.

13.

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 sense of false accuracy that is simply not the case in financial statements where estimates and other judgements are made.

14.

I disagree. The costs of applying GAAP to small or non-publicly traded companies exceed the benefits. As a result, a simplified version of GAAP has been developed for these companies.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 15. The revenue recognition critieria 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. 16. 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. 17. 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. For example, for the sale of goods: • 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. 18.

Revenue from long-term service and construction contracts using the percentage-completion method must meet the following conditions: • the amount of revenue can be measured; • it is probable the company will collect the cash (receive the economic benefits); • the stage of completion of the contract can be reliably measured; • the costs to complete can be reliably measured.

19. The advantage of using the percentage-of-completion method is that it allows a company to better match the revenues and gross profits to the periods in which the actual efforts are incurred rather than having to wait until a project is complete. 20. Changes in estimates are recognized prospectively, and not retrospectively. Each period after the revision of the estimate, the cost incurred-to-date is divided by the most recent estimate of total costs to determine the percentage completed-to-date. This percentage is multiplied by total revenue to determine the revenue-to-date. Revenue previously recognized is then subtracted from the revenue-to-date to determine the revenue to be recognized in the current period.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 21.

(a) The percentage-of-completion method is not appropriate if the revenues and costs on a long-term construction contract cannot be reliably measured. (b) Under IFRS, the company would use the zero profit method. Each year, the company would recognize revenue equal to the costs incurred. In the final year of the contract, all of the gross profit would be recognized. Companies using Canadian GAAP for private companies would use the completed contract method. In this case, revenue and gross profit is recognized only when the contract is completed.

22.

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.

23.

For some assets, fair value presents information that is more relevant to users’ needs by providing information about the company’s liquidity and solvency. One criticism of the cost principle is that cost is irrelevant for predicting the value of an asset. Fair value can move substantially away from the cost. For assets such as trading securities securities, fair value is more important than cost. As a result, these assets are now carried at fair value.

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Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 (a) (b) (c) (d) (e) (f) (g)

No Yes Yes Yes No Yes No

BRIEF EXERCISE 11-2 (a) 2

(b) 1

BRIEF EXERCISE 11-3 (a) (b) (c) (d) (e) (f)

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

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Revenues Liabilities Assets Expenses Owner’s equity Assets

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 11-4 (a) (b) (c) (d) (e) (f) (g) (h) (i)

4 7 2 5 1 3 6 9 8

BRIEF EXERCISE 11-5 (a) (b) (c) (d) (e)

Cost-Benefit constraint None. Materiality constraint Expense recognition criteria; matching Materiality constraint. However, if a large quantity of small tools is owned, the company may want to record them as long-lived assets and depreciate them.

BRIEF EXERCISE 11-6 (a) (b) (c) (d) (e) (f)

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

Going concern Reporting entity Full disclosure Materiality Matching Cost

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 11-7 (a) (b) (c) (d) (e) (f) (g)

3. Full disclosure 5. Expense recognition 1. Revenue recognition 6. Fair value 4. Cost 1. and 2. Revenue recognition and Matching 2. Matching

BRIEF EXERCISE 11-8 Revenue of $400,000; the value of the work completed in March. Salaries expense of $100,000.

BRIEF EXERCISE 11-9 The company should recognize the full $350,000 of sales for the month of September. All of the merchandise is sold FOB shipping point which means that ownership has been transferred at the point of shipping. None of the merchandise in transit was owned by Mullen. Uncollectible sales are recognized using Bad Debts Expense. The company is using the percentage of sales as the basis of recognition. The expense would be 1% of sales = 1% X $350,000 = $3,500. Sales Returns can be estimated at 2% of sales (2% X $350,000 = $7,000). If sales returns are material, they should be estimated and recorded 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.

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Chapter 11

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 11-10 Sales ($275,000 - $35,000) Cost of goods sold ($150,000 - $19,000) Gross profit

$240,000 131,000 $109,000

The company can only recognize the sale when the ownership is transferred. For the goods in transit, since the shipping terms are FOB destination, Abbotsford Ltd. still owns the merchandise. Under the matching principle, the cost of goods is recognized on the income statement in the same year as the related sale. The cost of goods in transit would remain on the balance sheet as part of inventory.

BRIEF EXERCISE 11-11 Year 2009 2010 2011

Costs Incurred $ 840,000 1,120,000 840,000 $2,800,000

Year 2009 2010 2011

Solutions Manual



Total Estimated Cost

Percentage = Complete X

Total Revenue

30% 40% 30%

$4,200,000 4,200,000 4,200,000

$2,800,000 2,800,000 2,800,000

Revenue Recognized $1,260,000 1,680,000 1,260,000 $4,200,000

Costs Incurred $ 840,000 1,120,000 840,000 $2,800,000

11-13

Revenue = Recognized $1,260,000 1,680,000 1,260,000 $4,200,000

Gross Profit $ 420,000 560,000 420,000 $1,400,000

Chapter 11

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 11-12

Year 2009 2010 2011

Costs Incurred (To Date) ÷ $ 840,000 2,100,000 3,100,000

Revised Revenue $ 1,260,000 2,845,161 4,200,000

Total Estimated Cost = $2,800,000 3,100,000 3,100,000

Percentage Complete (To Date) X 30.00% 67.74% 100.00%

Revenue Recognized (Current = Period) $ 1,260,000 $ 1,260,000 1,585,161 2,845,161 1,354,839 $4,200,000

Revenue Recognized Previously

Total Revised Revenue = Revenue $4,200,000 $ 1,260,000 4,200,000 2,845,161 4,200,000 4,200,000

Costs Incurred (Current Period) = $ 840,000 1,260,000 1,000,000 $3,100,000

BRIEF EXERCISE 11-13 2009

2010

2011

Revenue

$ 840,000

$ 1,120,000

$2,240,000

Expenses

840,000

1,120,000

840,000

Gross profit

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11-14

$1,400,000

Chapter 11

Gross Profit (Current Period) $ 420,000 325,161 354,839 $1,100,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 11-1 (a) (b) (c) (d) (e) (f)

(g)

Relates to both and should be allocated Relates to both and should be allocated Recorded by Skate Shop Recorded by Ride Snowboards Personal expense Likely personal but may be considered a business expense for Ride Snowboard if she used her membership at the ski hill to promote her business Personal expense

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Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

EXERCISE 11-2 (a) If a manager’s remuneration is tied to achieving a certain profit, there is a temptation to manipulate profit in order to achieve the target. (b) Management could choose to use straight-line depreciation as opposed to double declining-balance. In the early years of an asset’s useful life, this would lead to a lower depreciation expense and higher profit. In years of rising prices, management could choose to account for inventories using the average cost as its inventory cost formula rather than FIFO as its cost flow formula. The use of the average cost would cause the cost of goods sold to be higher and therefore profit to be lower. (c) The behaviour would not meet the prime objective of financial reporting, which is to provide useful information for decision making. Users would be misled by the distorted profit figures. (d) In past years, as many of the recent accounting scandals have shown, this type of behaviour was likely. Today, with improved scrutiny and corporate governance on management and their estimates and judgements, it is unlikely that manipulation of profits could occur—at least to the extent we have seen in past.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-3 (a) (b) (c) (d) (e) (f) (g) (h)

3 4 6 7 2 8 1 5

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-4 (a) (b) (c) (d) (e) (f) (g)

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

Economic Entity Cost-benefit Full disclosure Going concern Materiality Matching Cost

EXERCISE 11-5 1. 2. 3. 4. 5. 6. 7. 8. 9.

Revenue recognition criteria Full disclosure concept Expense recognition criteria Going concern assumption; full disclosure principle No violation (lower of cost and net realizable value) Timeliness characteristic Cost measurement criteria Economic entity concept Cost-benefit constraint

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Chapter 11

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-6 1.

This is a violation of the cost measurement concept, because the equipment was recorded at its estimated fair value and not its cost. The correct journal entry is: Equipment .............................................. Cash ................................................

85,000 85,000

This is a violation of the economic entity concept. The treatment of the transaction treats Evan Ellis and Ellis Co. 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 truck. 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.

There is no violation of generally accepted accounting principles if the sale and write-off occurred within the same period. However, this could be a violation of the matching concept, if the sale and write-off occurred in different periods. Bad Debts Expense should be recorded in the period of the sale as follows, in order to match against revenues:

Bad Debts Expense ............................... Allowance for Doubtful Accounts .

5,000

Allowance for Doubtful Accounts ........ Accounts Receivable .....................

5,000

This is a violation of the cost measurement concept. The inventory was written up to its fair value when it should have remained at cost. Thus, no journal entry should have been made.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-6 (Continued)

This is a question of matching, materiality and cost-benefit. In theory, the pencil sharpener should be depreciated to match the expense with revenue, since the pencil sharpener has an estimated useful life of 5 years. However, because the cost of the pencil sharpener is not material, the cost of accounting for it as a long-lived asset will exceed any benefits from doing so. Office Expense ....................................... Cash ...............................................

50 50

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 Flight Revenue .............

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EXERCISE 11-7 (a) 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. (b) 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 Leon 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. (c) Revenue should be recognized on a per game basis over the season from April to October. (d) 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. (e) 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. (f) 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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Chapter 11

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-8 March sales = 250 x $540 = $135,000 for services performed from May-September (5 months) June sales = 300 x $600 = 180,000 for services performed from June-September (4 months) July sales = 150 x $600 = 90,000 for services performed from July-September (3 months) Total sales $405,000 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 $135,000 $180,000 $90,000 Total

Solutions Manual

May June July August Sept. $27,000 $27,000 $27,000 $27,000 $27,000 45,000 45,000 45,000 45,000 000000 000000 30,000 30,000 30,000 $27,000 $72,000 $102,000 $102,000 $102,000

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EXERCISE 11-9 (a)

$2,000 x 4 = $8,000. By applying the revenue recognition criteria, one can determine that 4 months of rent should be recognized as revenue in 2009, while the remainder is revenue in 2010.

(b)

$0. Ownership of the property transfers at January 3, 2010 because the terms are FOB destination. Thus, a sale has not occurred in 2009 and revenue should not be recognized until 2010.

(c)

$1,600,000 x ($300,000 ÷ $1,200,000) = $400,000. If one fourth of the costs have been incurred, then one fourth of the revenue should be recognized, using the percentageof-completion method.

(d)

$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.

(e)

$6,000 x 5% x 5/12 = $125. Interest revenue should be recognized for the five months the note was outstanding in 2009.

(f)

$0. Even though collection is assured, the revenue has not been earned. The ownership of the product is not transferred until 2010.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-10 (a) Costs Incurred

Year 2009 2010 2011



$ 25,000,000 55,000,000 20,000,000 $100,000,000

Total Estimated Cost

2009 2010 2011

Percentage Complete X

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

Actual Cost Incurred

$ 37,500,000 82,500,000 30,000,000 $150,000,000

$ 25,000,000 55,000,000 20,000,000 $100,000,000

Gross Profit Recognized $12,500,000 27,500,000 10,000,000 $50,000,000

(b)

Year 2009 2010 2011

Costs Total Incurred Estimated (To Date) ÷ Cost = $ 25,000,000 $ 100,000,000 80,000,000 105,000,000 105,000,000 105,000,000

Revised Revenue $ 37,500,000 114,285,714 150,000,000

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Percentage Complete (To Date) X 25.00% 76.19% 100.00%

Revenue Revenue Recognized Recognized (Current Previously = Period) $ 0 $ 37,500,000 37,500,000 76,785,714 114,285,714 35,714,286 $150,000,000

11-24

Total Revised Revenue = Revenue $150,000,000 $ 37,500,000 150,000,000 114,285,714 150,000,000 150,000,000 Costs Gross Incurred Profit (Current (Current Period) = Period) $ 25,000,000 $ 12,500,000 55,000,000 21,785,714 25,000,000 10,714,286 $105,000,000 $45,000,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 11-11 2009 2010 2011 Revenue $25,000,000 $55,000,000 $70,000,000 Expenses 25,000,000 55,000,000 20,000,000 Gross profit $ 0 $ 0 $50,000,000

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 11-1A The objective of financial reporting is to provide useful information for decision-making. The major user groups of Forzani Group Ltd. 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. Taking It Further: Forzani Group Ltd. also discloses future cash payments for principal repayment on long-term debt.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-2A (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) The company has developed a viability plan under which it will have to restructure its operations. It acknowledges that many factors remain outside its control and that it may not be able to continue as a going concern. Although the company has continued to apply the going concern assumption, the remarks in the notes to the financial statements are 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. In General Motors’ case, it seems that there is some possibility that the company may survive its economic difficulties, as evidenced by the viability plan it has entered into with the U.S. government. 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

11-27

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-3A Producing information for financial disclosure comes at a cost for companies. The International Financial Reporting Standards violate the cost-benefit constraint for most private enterprises. Most private companies have few users and their information needs are usually simpler. They 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.

Solutions Manual

11-28

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 X (100%  5 X 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 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 .....................................................

Solutions Manual

11-29

36,000 36,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

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.

Solutions Manual

11-30

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 2011. Therefore the revenue has not been earned in 2010 and it would be inappropriate for the company to record any revenue in 2010. No entry is necessary in 2010.

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.

Solutions Manual

11-31

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-5A

(a) and (b) 1.

It appears from the information that 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 measurement criteria indicate that assets and liabilities are to be accounted for on the basis of cost at acquisition. 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 not taken place. Correcting entry required: Gain on Acquisition of Equipment ............ Equipment ..........................................

Solutions Manual

11-32

65,000 65,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-5A (Continued) (a) and (b) (Continued)

At the present time, accountants do not recognize pricelevel adjustments in the accounts. Hence, it is inappropriate to deviate from the cost measurement criteria. It should also be noted that depreciation is not so much a matter of valuation as it is a means of cost allocation. Assets are not depreciated on the basis of a decline in their fair value, but are depreciated on the basis of systematic charges of expired costs against revenues. Correcting entry required: Depreciation Expense ................................ Accumulated Depreciation .................

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. 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 ............................

Solutions Manual

11-33

78,000 78,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-5A (Continued) (a) and (b) (Continued)

A loss should not be recognized at this point under the cost measurement criteria. In some circumstances, land may be written down if it is considered impaired. Correcting entry required: Land ........................................................... Loss on Decline in Value of Land ......

30,000 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.

Solutions Manual

11-34

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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.

Solutions Manual

11-35

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-7A (a) 1.

The percentage-of-completion method of revenue recognition is used on long-term projects, usually construction. To apply it, the following conditions must exist: • • • •

the amount of revenue can be measured; this is usually evidenced by a firm contract price; it is probable that cash will be collected; a reasonably accurate estimate of costs (and therefore of gross profit); and a way to reasonably estimate the extent of progress to completion of the project.

Revenue is recognized in proportion to the work completed. Normally, the proportion or percentage of work completed is measured by dividing the actual costs incurred in the current period by the estimated total costs. This percentage is applied to total revenue to determine the revenue to be recognized for the period. This revenue is then matched against the costs of the current period to determine gross profit. This method is in accordance with generally accepted accounting principles for long-term projects when estimates are dependable as it accomplishes proper matching of revenues and expenses.

Solutions Manual

11-36

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-7A (Continued) (a) (Continued)

(b) 1.

Under IFRS, if the percentage completion cannot be reliably estimated, the zero-profit method is applied. Under this method, revenues are recognized in amount equal to the costs, but do not trigger gross profit. The gross profit is deferred to the last year of the contract. Under Canadian GAAP for Private Enterprises, the completed-contract method is used when the conditions required for the percentage-ofcompletion method are not met. Revenues and costs are recognized only when the contract is complete. In such circumstances, even though this method distorts gross profit in each period of the contract, it is in accordance with GAAP and the matching concept. This is because both revenues and costs are deferred and matched in the final period. $2,400,000 ($1,800,000  $4,500,000 x $6,000,000) $0 under Canadian GAAP for Private Enterprises. Under IFRS, revenue of $1,800,000 would be recognized, equal to the costs incurred, for a gross profit of $0.

Taking It Further: Security Equipment should use the percentage-of-completion method. It is a long-term contract and reasonable estimates of progress can be made.

Solutions Manual

11-37

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-8A (a)

Year

Costs Incurred

2009 2010 2011 2012 Totals

$06,000,000 18,000,000 10,000,000 6,000,000 $40,000,000



Total Estimated Cost

2009 2010 2011 2012 Totals

Percentage Complete X

$40,000,000 40,000,000 40,000,000 40,000,000

Revenue Recognized

Year

–

$ 8,400,000 25,200,000 14,000,000 8,400,000 $56,000,000

Total Revenue

15% 45% 25% 15%

$56,000,000 56,000,000 56,000,000 56,000,000

Actual Cost Incurred

$06,000,000 0018,000,000 0 10,000,000 006,000,000 $40,000,000

Revenue = Recognized $08,400,000 025,200,000 014,000,000 8,400,000 $56,000,000

Gross Profit Recognized $02,400,000 007,200,000 004,000,000 002,400,000 $16,000,000

Note that the cash collections are not relevant in the percentage-of-completion method. (b) Revenue Recognized

Year 2009 2010 2011 2012 Totals

Actual Cost Incurred

–

$ 6,000,000 18,000,000 10,000,000 22,000,000 $56,000,000

Solutions Manual

$06,000,000 0018,000,000 0 10,000,000 006,000,000 $40,000,000

11-38

Gross Profit Recognized $020 000 000 016,000,000 $16,000,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-8A (Continued) (b)

(Continued)

If Cosky Construction used the zero profit method, revenues would be recognized equal to the costs incurred for the first three years. In the last year, the remaining revenue is recognized to add up to the contract price of $56,000,000. Taking It Further: The revenue recognition criteria states that revenue should be recognized at the same time that an increase in an asset is recognized. This usually implies that collectability of the amount for services rendered is reasonably assured, such that the receivable can be recognized as an asset. If Cosky is unsure that the customer will be able to pay, the company would have to delay recognition of revenue until collectability again becomes reasonably assured.

Solutions Manual

11-39

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-9A Total gross profit will fall by $8,000,000, which represents the additional $4 million in costs in each of 2011 and 2012.

Year 2009 2010 2011 2012

Costs Incurred (To Date) ÷ $ 6,000,000 24,000,000 38,000,000 48,000,000

Revised Revenue $ 8,400,000 33,600,000 44,335,200 56,000,000

Total Estimated Cost = $40,000,000 40,000,000 48,000,000 48,000,000

Percentage Complete Total Revised (To Date) X Revenue = Revenue 15.00% $56,000,000 $ 8,400,000 60.00% 56,000,000 33,600,000 79.17% 56,000,000 44,335,200 100.00% 56,000,000 56,000,000

Revenue Cost Recognized Incurred (Current (Current = Period) Period) = $ 8,400,000 $ 6,000,000 $ 8,400,000 25,200,000 18,000,000 33,600,000 10,735,200 14,000,000 44,335,200 11,664,800 10,000,000 $56,000,000 $48,000,000

Revenue Recognized Previously

Taking It Further: The recognition of revenue using the percentage-of-completion method is based on being to reliably estimate remaining and total costs to complete the contract. When these costs cannot be reliably estimated, the company should adopt the zero-profit method if the company is applying IFRS or the completedcontract method if reporting under Canadian GAAP for Private Enterprises. This change represents a change in estimate and would be applied prospectively. Revenues and costs recognized in 2009 would not be adjusted retrospectively.

Solutions Manual

11-40

Chapter 11

Gross Profit (Current Period) $2,400,000 7,200,000 (3,264,800) 1,664,800 $8,000,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-10A

Costs Incurred

Year 2009 2010 2011



$ 1,120,000 980,000 700,000 00$2,800,000

Total Estimated Cost

2009 2010 2011

Percentage Complete X

$2,800,000 2,800,000 2,800,000

Revenue Recognized

Year

Total Revenue

40% 35% 25%

$5,000,000 5,000,000 5,000,000

Actual Cost Incurred

–

$2,000,000 1,750,000 0 1,250,000 0$5,000,000

$1,120,000 980,000 700,000 $2,800,000

Revenue Recognized $2,000,000 1,750,000 1,250,000 0$5,000,000

Gross Profit Recognized $0 880,000 770,000 00 550,000 00$2,200,000

Taking It Further: The receipt of cash is not factored into the calculation, unless not receiving cash is an indication of collectability problems. Under the accrual accounting assumption, revenue is recognized when it is earned, not when cash is received. Cash received in excess of revenue is considered to be unearned.

Solutions Manual

11-41

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-11A

(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.

Solutions Manual

11-42

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-11A (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 2010.

Taking It Further: Yes. The amount of revenue that Dave’s should recognize in 2009 would be $60,000. This is the amount of revenue for furniture delivered before year-end and that has already been collected in full. A thorough credit check is a critical factor since it provides support that cash will be collected. Since Dave’s opened for business in 2009, they do not have any prior experience to determine collectability on its credit sales.

Solutions Manual

11-43

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-1B Forzani’s 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 event have some level of uncertainty with respect to the amount or their ultimate resolution. In order to provide faithful representation and complete information of Forzani’s 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 may be sacrificed if the estimates differ materially from actual results. Faithful representation involves completeness 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.

Solutions Manual

11-44

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-2B (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 measurement of assets would be done on a liquidation, or net realizable value basis rather than on their carrying amounts. (b) Air Canada is not into bankruptcy, so not following the going concern assumption is premature. The company is facing financial difficulty and risk, although it does not appear that its dissolution is imminent. 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.

Solutions Manual

11-45

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-3B This new requirement will improve financial statements by providing additional information. It will enhance comparability of Canadian financial statements with those of other countries. It also provides a more faithful representation of the nature of the various expenses and a more complete picture of the revenue generating ability of the company. Under the previous GAAP, many companies included cost of goods sold with other expenses or disclosed net earnings only. For companies selling merchandise, cost of goods sold is a major expense. Its disclosure allows users to better measure the quality of earnings and to calculate earnings from various sources. It also provides information about trends in profitability. Taking It Further: Companies have been reluctant to disclose this information because it reveals their gross profit and pricing structure. Many companies feel that this information may place them at a competitive disadvantage.

Solutions Manual

11-46

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 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:

Solutions Manual

11-47

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-4B (Continued) (a) and (b) (Continued) 4. (Continued) Equipment ................................................... Cash .....................................................

54,000

Depreciation Expense ($54,000  6) .......... 9,000 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 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 its fair value is expected to recover, the loss will not be realized. No entry is necessary.

Expense recognition criteria (matching concept). The marketing plan will be designed and implemented in 2011. 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 2011. No entry necessary.

Revenue recognition criteria. Desktop will not transfer ownership of the merchandise until January 2011. Therefore the revenue has not been earned in 2010 and it would be inappropriate for the company to record any revenue in 2010. No entry is necessary in 2010.

Solutions Manual

11-48

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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, as long as the revaluations are made with sufficient regularity. Under this approach, the current years revaluation surplus would be recognized in Other Comprehensive Income and the accumulated surplus will appear in Accumulated Other Comprehensive Income.

Solutions Manual

11-49

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-5B (a) and (b) 1.

A gain should not be recognized until the inventory is sold. Accountants use the cost basis and write-ups of assets are not permitted. It should also be noted that the revenue recognition criteria indicates that revenue (or a gain) should not be recognized until it is earned. Correcting entry required: Gain on Inventory ....................................... Merchandise Inventory .......................

15,000 15,000

2. It appears from the information that 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 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 .......................... Deposit Liability ..................................

Solutions Manual

11-50

35,000 30,000 5,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 Acquisition of Equipment ............ Equipment ...........................................

Solutions Manual

11-51

75,000 75,000

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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. Usually utilities are not a material amount and the financial statements will not be materially misstated by omitting the expense and liability.

Solutions Manual

11-52

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-6B

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.

Solutions Manual

11-53

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-7B

(a) 1.

The percentage-of-completion method of revenue recognition is used on long-term projects, usually construction. To apply it, the following conditions must exist: • • • •

Solutions Manual

11-54

Chapter 11

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 11-7B (Continued) (a) (Continued)

(b) 1.

Under IFRS, if the percentage completion cannot be reliably estimated, the zero-profit method is applied. Under this method, revenues are recognized in amount equal to the costs, but do not trigger gross profit. The gross profit is deferred to the last year of the contract. Under Canadian GAAP for Private Enterprises, the completed-contract method is used when the conditions required for the percentage-ofcompletion method are not met. Revenue and costs are recognized only when the contract is complete. In such circumstances, even though this method distorts gross profit in each period of the contract, it is in accordance with GAAP and the matching concept. This is because both revenues and costs are deferred and matched in the final period. $16,200,000 ($13,500,000  $50,000,000 = 27% x $60,000,000) $0 under Canadian GAAP for Private Enterprises. Under IFRS, revenue of $13,500,000 would be recognized, equal to the costs incurred for a gross profit of $0.

Taking It Further: Devany Construction should use the percentage-of-completion method. The contract is a long-term contract and reasonable estimates of progress can be made.

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PROBLEM 11-8B (a)

Year

Costs Incurred

2009 2010 2011 2012 Totals

$ 9,000,000 12,000,000 24,000,000 15,000,000 $60,000,000

Percentage Complete 15% 20% 40% 25%

$76,000,000 076,000,000 076,000,000 076,000,000

Year 2009 2010 2011 2012 Totals

$11,400,000 0015,200,000 030,400,000 19,000,000 $76,000,000

Percentage Complete

$60,000,000 60,000,000 60,000,000 60,000,000

Total Revenue

Revenue Recognized

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Total Estimated Cost

–

Revenue Recognized $11,400,000 0 15,200,000 030,400,000 19,000,000 $76,000,000

Actual Cost Incurred $09,000,000 0012,000,000 0024,000,000 15,000,000 $60,000,000

11-56

15% 20% 40% 25%

Gross Profit Recognized $2,400,000 03,200,000 06,400,000 4,000,000 $16,000,000

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PROBLEM 11-8B (Continued) (b) Year

Revenue Recognized

2009 2010 2011 2012 Totals

$ 9,000,000 0012,000,000 024,000,000 31,000,000 $76,000,000

–

Actual Cost Incurred $09,000,000 0012,000,000 0024,000,000 15,000,000 $60,000,000

Gross Profit Recognized $0 00 00 16,000,000 $16,000,000

If Cosky Construction used the zero-profit method, revenues would be recognized equal to the costs incurred for the first three years. In the last year, the remaining revenue is recognized to add up to the contract price of $76,000,000. Taking It Further: The percentage completion method provides the most relevant information. It measures revenues, expenses and gross profit based on work done each year of a long-term construction contract. The zero-profit method defers gross profit until the last year of the contract since the state of completion of the contract cannot be reliably measured. It shows no gross profit during the years the work is performed, and all the profit in the last year. This approach is not consistent with representational faithfulness.

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PROBLEM 11-9B Total gross profit will fall by $8,000,000, which represents the additional four million dollars in costs in each of 2010 and 2011.

Year 2009 2010 2011 2012

Year 2009 2010 2011 2012 Totals

Costs Incurred (To Date) ÷ $ 9,000,000 21,000,000 49,000,000 68,000,000

Revised Revenue $11,400,000 26,600,000 54,765,600 76,000,000

Total Estimated Cost = $60,000,000 60,000,000 68,000,000 68,000,000

Revenue Recognized Previously $11,400,000 26,600,000 54,765,600

Percentage Complete Total Revised (To Date) X Revenue = Revenue 15.00% $76,000,000 $11,400,000 35.00% 76,000,000 26,600,000 72.06% 76,000,000 54,765,600 100.00% 76,000,000 76,000,000

Revenue Cost Recognized Incurred (Current (Current = Period) Period) = $11,400,000 $ 9,000,000 15,200,000 12,000,000 28,165,600 28,000,000 21,234,400 19,000,000 $76,000,000 $68,000,000

Taking It Further: The information produced by the percentage-completion method meets the objectives of financial reporting in that it provides information that is relevant to users’ needs because it reflects revenues and gross profits in the years in which the work is done. Like other estimates used throughout financial reporting, actual results will vary from the estimates used. The relevance and timeliness of the information produced outweigh the inaccuracy of the estimation, as long as the information can be reasonably estimated.

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Gross Profit (Current Period) $2,400,000 3,200,000 165,600 2,234,400 $8,000,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 11-10B

Costs Incurred

Year 2009 2010 2011



$1,980,000 2,970,000 01,650,000 $6,600,000

Total Estimated Cost

2009 2010 2011

Percentage Complete

$6,600,000 6,600,000 6,600,000

Revenue Recognized

Year

$2,700,000 4,050,000 2,250,000 $9,000,000

30% 45% 25%

Actual Cost Incurred

–

$1,980,000 00 2,970,000 1,650,000 $6,600,000

Total Revenue Revenue = Recognized $9,000,000 $2,700,000 9,000,000  4,050,000 9,000,000 2,250,000 $9,000,000

Gross Profit Recognized $ 720,000 1,080,000 600,000 $2,400,000

Taking It Further: Under the percentage-of-completion method, the recognition of revenue is based on the costs incurred to date as a percent of total costs. In addition, revenue can only be recognized at the same time that an increase in an asset is recognized. This usually implies that collectability of the amount for services rendered is reasonably assured, such that the receivable can be recognized as an asset. So long as there is a reasonable expectation that the cash will be paid, it is appropriate to continue to recognize revenue using the percentage-ofcompletion method. If the failure to pay cash becomes a problem and there is no longer reasonable assurance that collection will take place, revenue is no longer considered earned and the percentage-of-completion method can no longer be used.

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PROBLEM 11-11B

(a)

I do not agree. For revenue to be recognized, collectability must be reasonably assured. For this particular transaction, retailers can return unsold the vitamins up to March 31, 2011. 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 of non-collection from provided 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, 2011.

Taking It Further: Yes. The same promotion on the same 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 the same product may not yield the same results if other factors to the transaction have changed. For example, due to changed economic conditions, sales of expensive vitamins 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.

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CONTINUING COOKIE CHRONICLE (a)

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.

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.

Since the goal in recording this revenue as earned on the income statement is to deceive the bank, the conclusion to be reached is that Katy is being dishonest. Katy is not doing so because she doesn’t understand the consequences of her decision.

(b) Revenue will be earned when the goods will be delivered. Correspondingly, Kathy’s customers will have an obligation to pay Katy for the goods when they are delivered and no earlier. (c)

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 most likely be found in the first 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

DecliningBalance Rate (10% x 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)

Estimates are required to make accruals or apply a reasonable estimate for the measurement of amounts to be reported as assets or liabilities, or for the disclosure of contingent assets or liabilities at the date of the financial statements. Those estimates also affect the amount of the revenues and expenses during the reporting period. Estimates are used when accounting for items such as employee benefits, product warranties, inventory provisions, depreciation and assessment for impairments, uncollectible receivables and the liability for the business’ loyalty program.

(b)

Yes. Revenue from sales to customers is recognized at the point of sale, net of an allowance for returns. Revenue from merchandise sales to franchise stores is recognized at the time of shipment. Royalties and administration fees are recognized when earned, in accordance with the terms of the franchise/license agreements.

(c)

The company has implemented the policy of capitalizing the cost of the rent during the fixturing period of opening new stores. All other operating costs incurred are expensed. Unlike costs to refurbish store space, operating costs, do not have a direct relationship to revenue nor the ability to assist in producing revenue in the future. As such, they are not assets and should be expensed. An alternate treatment for the store opening costs would be to capitalize the costs and then amortize them over a reasonable period of time once the new stores are open and are earning revenue. The expenditures incurred during the pre-operating period may be deferred to the extent that the following criteria are satisfied:

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BYP11-1 (Continued) (c)

Continued 1. The expenditure is related directly to placing the new business into service; 2. The expenditure is incremental in nature (i.e., a cost that would not have been incurred in the absence of the new business); and 3. It is probable that the expenditure is recoverable from the future operations of the new business.

(d)

The disclosures provided in Note 15 on Contingencies and Guarantees would be required as a result of the full disclosure principle. The information provides relevant information to users of the financial statements. The information would assist users in predicting cash flows. However, the fact that only summary information has been presented is an example of the company applying the cost-benefit constraint.

(e)

The auditors’ report adds credibility to the Forzani financial statements for users such as creditors and shareholders. In the third paragraph of their report, the auditors expressed the opinion that “the financial statements presented fairly, in all material respects, the financial position of the Company as at February 1, 2009 and February 3, 2008 and the results of its operations and its cash flows for the 52 week period ended February 1, 2009 and the 53 week period ended February 3, 2008 in accordance with Canadian generally accepted accounting principles.”

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BYP 11-2 INTERPRETING FINANCIAL STATEMENTS (a)

(b)

(1)

Because Nestlé is much larger and more diverse than Ganong, comparison is more difficult. For example, in addition to chocolates, Nestlé also sells baby foods, beverages, dairy products, prepared foods, and pet food. It is unlikely that results of Nestlé’s line of chocolates would be reported separately.

(2)

Nestlé follows the International Financial Reporting Standards. Ganong is a private Canadian company and follows Canadian GAAP for Private Enterprises. Because these standards differ, then comparison may be difficult.

If management expects that it would be to the benefit of shareholders or creditors to obtain financial statements prepared using IFRS, in order to enhance comparability, they might adopt IFRS. Another reason this adoption might present a benefit in the future is if they expect to sell the business to an international public company already using IFRS. The accounting for the transaction and the preparation of future financial statements would be a great deal easier to prepare under those conditions and also easier to understand for the users of the financial statements.

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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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BYP 11-4 COMMUNICATION ACTIVITY MEMO To:

President of Junk R Us

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 mini-disc players to Cheap But Good, and (b) the way in which these mini-disc players should be reported in the financial statements of Junk R Us for the year ending September 30, 2010.

(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 the mini-disc players. It is unlikely that you can reasonably estimate how many of the mini-disc players 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 mini-discs and pays you for their purchase. This approach would be a similar treatment to a consignment sale.

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BYP11-4 (Continued) (b)

Also similar to the treatment of a consignment sale will be the treatment of inventory of mini-disc players on your balance sheet at September 30, 2010. 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 mini-disc players, 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, 2010. You will need to assess your best estimate of the probability between 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 mini-disc players.

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BYP 11-5

Accounting Principles, Fifth Canadian Edition

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 budget will tell the bank what kind of revenues and costs you expect to have during the loan period and the second report will determine the amount of resources and obligations you will have during the loan period. (b)

1. 2.

Rent Groceries Cash in savings 3. account 4. Tuition fees 5. RESP equity fund 6. Textbooks 7. Clothes 8. Student loan 9. Summer earnings Two-year-old 10. mountain bike Three-year-old 11. furniture

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(1) (2) Measurement Assets and Fair ReplaceBudget Liabilities Cost Value ment X X X

X X X X X

X X

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BYP11-6 (Continued) The bank manager will be interested in the fair value of the cash account, the RESP Equity fund, the mountain bike and the furniture because it provides the amount of cash that would be received if withdrawn from the bank or sold to pay off the loan. The replacement cost of the clothes provides the bank manager with information about future cash outflows that may be necessary. The cost of the student loan is relevant because it tells the bank manager about obligations that will have to be paid.

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Legal Notice Copyright

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CHAPTER 12 Accounting for Partnerships ASSIGNMENT CLASSIFICATION TABLE

Exercises

Problems Set A

Problems Set B

2, 3

2, 12

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

3, 4, 6

3, 4, 5, 12 3, 4, 12

4. Prepare partnership financial statements.

5, 6

2, 3, 4, 5, 12

5. Prepare the entries to record the admission of a partner.

14, 15, 16

10, 11

7, 8

6, 7, 12

6. Prepare the entries to record the withdrawal of a partner.

17, 18, 19

12, 13,

9, 10

8, 9, 12

7. Prepare the entries to record the 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, 5, 6

2. Account for the formation of a partnership. 3. Allocate and record profit or loss to partners.

7, 8

Brief Exercises

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Difficulty Level

Time Allotted (min.)

Discuss partnership agreements and advantages and disadvantages of partnerships. Record formation of partnership and prepare balance sheet.

Simple

10-15

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

Record admission of partner.

Moderate

20-30

Calculate investment and bonus on admission of partner.

Complex

25-35

Record withdrawal of partner.

Moderate

20-20

Calculate bonus and payment on withdrawal of partner.

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 partnership characteristics.

Complex

40-50

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

Description

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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

Record admission of partner.

Moderate

20-30

Calculate investment and bonus on admission of partner.

Complex

25-35

Record withdrawal of partner.

Moderate

20-30

Calculate bonus and payment on withdrawal of partner.

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.

Knowledge Q12-4 Q12-5 Q12-6 BE12-1

Comprehension Q12-1 Q12-2 Q12-3 P12-1A P12-1B

Application

Q12-7

Q12-8

BE12-2 BE12-3 E12-2

P12-2A P12-12A P12—2B P12-12B

Analysis E12-1

Account for the formation of a partnership.

Allocate and record profit or loss to partners.

Q12-9 Q12-10 Q12-11 Q12-12

BE12-4 BE12-5 BE12-6 BE12-7 BE12-8 E12-3 E12-4 E12-6

P12-3A P12-4A P12-5A P12-3B P12-4B P12-12A P12-12B

Prepare partnership financial statements.

Q12-13

BE12-9 E12-5 E12-6

P12-2A P12-3A P12-4A P12-5A P12-2B P12-3B P12-4B P12-5B P12-12A P12-12B

Prepare the entries to record the admission of a partner.

Q12-15 Q12-16

Q12-14 BE12-10 BE12-11 E12-7 E12-8

P12-6A P12-6B P12-12A P12-12B

P12-7A P12-7B

Prepare the entries to record the withdrawal of a partner.

Q12-17 Q12-18 Q12-19

BE12-12 BE12-13 E12-9 E12-10

P12-8A P12-12A P12-8B P12-12B

P12-9A P12-9B

Prepare the entries to record 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

Synthesis

Evaluation

BYP12-4

BYP12-5

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ANSWERS TO QUESTIONS 1.

(a)

Association of individuals. A partnership is a voluntary association of two or more individuals. Although a written agreement is preferable, a simple handshake can be the basis for a partnership.

(b)

Limited life. A partnership does not have unlimited life. A partnership may be ended voluntarily or involuntarily. Thus, the lifespan of a partnership is uncertain. Any change in the number of partners results in the dissolution of the partnership, although it may be reformed with different partners. The partnership can continue following the withdrawal or admission of partners if measures for doing so are included in the partnership agreement.

(c)

Co-ownership of property. Partnership assets are jointly owned by all the partners. If the partnership is terminated, the assets do not legally revert to the original contributor. Each partner has a claim on total assets equal to his or her capital balance. This claim does not attach to any specific assets which an individual partner contributes to the firm.

(a)

Mutual agency. This characteristic means that the act of any partner is binding on all other partners when engaging in partnership business. This is true even when the partners act beyond the scope of their authority, so long as the act appears to be appropriate for the partnership. Unlimited liability. Each partner is personally and individually liable for all partnership liabilities. Creditors' claims attach first to partnership assets and then to the personal resources of any partner, irrespective of that partner's equity in the partnership.

(b)

An unethical or incompetent partner can commit the partnership to a deal that may bankrupt the partnership. The creditors may then be able to claim the partners’ personal assets – the assets of all the partners, not just the partner that made the bad deal.

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 4.

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.

General partners have unlimited liability and are normally actively involved in the business. 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 the day-to-day operations.

(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.

(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.

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QUESTIONS (Continued) 8.

(a)

The accumulated depreciation account is not transferred into the partnership. Instead, the equipment is recorded at fair value. A new accumulated depreciation account is created to accumulate the depreciation recorded for the equipment used by the partnership.

(b)

The allowance for doubtful accounts is transferred into the partnership. Before being transferred into the partnership however, the balance in the allowance for doubtful accounts is adjusted so that the accounts receivable are recorded at net realizable value at the time of their transfer.

When the partnership agreement does not specify the division of profit or loss, profit and loss will be divided equally among all partners.

10. Hark and Green should consider how much money and effort they each will be putting into the partnership. They may wish to consider dividing profit and loss using one of the following: (1) (2) (3)

fixed ratios are easy to apply and may be an equitable basis in some circumstances; capital balance ratios, when the funds invested in the partnership are considered the most critical factor; or salary allowance and/or interest allowance, coupled with a fixed ratio.

This last approach gives specific recognition to differences that may exist among partners by providing salary allowances for time worked and interest allowances for capital invested. 11. A salary allowance is based on efforts put forth by the individual partners and is used as a means of allocating profit to the partners. Cash withdrawals by the partners represent reductions in the partners’ capital accounts. Provided the partnership earns profit, a higher salary allowance should lead to a higher capital account for the partner receiving the allowance. A higher capital account allows a partner to take more cash withdrawals for personal use.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 12. 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 is rewards partners for their levels of investment in the partnership, based on the capital account balances. 13. The financial statements of a partnership are similar to those of a proprietorship. The differences are due to the number of owners involved. The cash flow statement and the income statement for a partnership are identical to those of a proprietorship. The statement of equity for a proprietorship is called a statement of owner’s equity. In a partnership, it is called a statement of partners’ equity. This statement shows the changes in each partner's capital account and in total partnership capital during the year. The balance sheet differs in the equity section. In a proprietorship, the equity section is titled “owner’s equity.” In a partnership, it is titled “partners’ equity” and each partner's capital balance is reported in this section. 14. The effect on net assets will depend on how the interest is purchased. If Holly purchases an interest from an existing partner, the net assets will remain unaffected. If her interest is purchased as an additional investment in the partnership, net assets will increase by the amount of her 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. 16. A new partner may be willing to pay a bonus as part of the cost of investing in an existing partnership because there may be additional value in the partnership that is not reflected in the financial statements. For example, the fair value of partnership assets may be higher than the carrying amounts presented on the balance sheet. As well, the partnership may have developed significant goodwill that is not shown in the financial statements.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 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. 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)

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.

22. (a)

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. However, if the partner with the deficiency is unable to pay the amount owed, the other partners must absorb the loss. The remaining cash is then distributed to the partners, based on their capital balances.

(b)

When there is no capital deficiency, the remaining cash is distributed to the partners based on their capital balances.

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) (b) (c) (d) (e)

8 9 1 2 6

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

4 5 10 7 3

Limited liability partnership General partnership Profit and loss ratio Admission by investment Withdrawal by payment from partners’ personal assets Mutual agency Salary allowance Partnership dissolution Capital deficiency Partnership liquidation

BRIEF EXERCISE 12-2 July 1

Cash .................................................... 10,000 Equipment .......................................... 5,000 R. Black, Capital ............................ Accounts Receivable ......................... 2,000 Cash .................................................... 14,100* Allowance for Doubtful Accounts B. Rivers, Capital ........................... *[$15,000 – ($2,000 − $1,100) = $14,100

15,000

1,100 15,000

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BRIEF EXERCISE 12-3 HELD-KAMP COMPANY Balance Sheet (partial) March 1

Current assets Accounts receivable...................................... $16,000 Less: Allowance for doubtful accounts ....... 2,000 $14,000

Property, plant, and equipment Equipment ......................................................

12,000

Accumulated depreciation should not be shown because a new company cannot have any accumulated depreciation.

BRIEF EXERCISE 12-4

(a)

Proportions 2:1

Fractions 2/3 & 1/3

Percentages 66.7% & 33.3%

(b)

6:4

3/5 & 2/5

60% & 40%

(c)

3:5

3/8 & 5/8

37.5% & 62.5%

(d)

4:3:2

4/9 & 1/3 & 2/9

44.4% & 33.3% & 22.2%

(e)

1:1:2

¼&¼&½

25% & 25% & 50%

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-5 (a) A. Brung P. Rohls (b)

$60,000 × 60% = $36,000 $60,000 × 40% = $24,000

Income Summary ........................................ 60,000 A. Brung, Capital .................................... P. Rohls, Capital .....................................

36,000 24,000

BRIEF EXERCISE 12-6 MET CO. Division of Profit J. Moses T. Eaton M. Talty Total Profit ..................................... $75,000 Salary allowance J. Moses ........................... $25,000 T. Eaton ........................... $15,000 M. Talty ............................ $15,000 Total ............................. 55,000 Profit remaining for allocation 20,000 Fixed ratio J. Moses ($20,000 × 50%) 10,000 T. Eaton ($20,000 × 30%) . 6,000 M. Talty ($20,000 × 20%) .. 4,000 Total ............................. 20,000 Profit remaining for allocation 00 0000 000 000 $ 0 Profit allocated to partners .. $35,000 $21,000 $19,000 $75,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-7 THE MILLSTONE PARTNERSHIP Division of Profit Year Ended February 28, 2011 K. Mills Profit................................................. Salary allowance K. Mills ......................................... $30,000 S. Stone ....................................... Total ........................................ Profit (deficiency) remaining for allocation ............. Interest allowance K. Mills ($70,000 × 5%)................ 3,500 S. Stone ($45,000 × 5%) .............. Total ........................................ Profit (deficiency) remaining for allocation ............. Fixed ratio K. Mills [$(10,750) × 60%] ........... (6,450) S. Stone [$(10,750) × 40%].......... Total ........................................ Profit (deficiency) remaining for allocation ............. Profit allocated to the partners....... $27,050

S. Stone

Total $50,000

$25,000 55,000 (5,000)

2,250 5,750 (10,750)

(4,300) (10,750) 000 000 $ 0 $22,950 $50,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-8 S & T CO. Division of Profit J. Siebrasse S. Tong Total Loss.................................................. $(44,000) Salary allowance J. Siebrasse................................. $15,000 S. Tong ........................................ $10,000 Total ........................................ 25,000 Deficiency remaining for allocation (69,000) Interest allowance J. Siebrasse................................. 8,000 S. Tong ........................................ 6,000 Total ........................................ 14,000 Deficiency remaining for allocation (83,000) Fixed ratio J. Siebrasse [$(83,000) × 50%] ... (41,500) S. Tong [$(83,000) × 50%] ........... (41,500) Total ........................................ (83,000) Loss remaining for allocation ........ 000 000 00 0000 $ 0 Loss allocated to the partners........ $(18,500) $(25,500) $(44,000)

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-9 DRS. JARRATT AND BRAMSTRUP Income Statement Year Ended April 30, 2011 Fee revenue ..................................................................... $365,000 Operating expenses ........................................................ 145,000 Profit................................................................................. $220,000

DRS. JARRATT AND BRAMSTRUP Statement of Partners’ Equity Year Ended April 30, 2011

Capital, May 1, 2010 .................... Add: Profit.................................... Less: Drawings ............................ Capital, April 30, 2011 .................

W. M. Jarratt Bramstrup Total $ 40,000 $ 50,000 $ 90,000 110,000 110,000 220,000 150,000 160,000 310,000 130,000 120,000 250,000 $ 20,000 $ 40,000 $ 60,000

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BRIEF EXERCISE 12-9 (Continued) DRS. JARRATT AND BRAMSTRUP Balance Sheet April 30, 2011

Assets Current assets Cash................................................................ Property, plant and, equipment Equipment ...................................................... $75,000 Less: Accumulated depreciation .................. 20,000 Total assets ........................................................

$25,000

55,000 $80,000

Liabilities and Partners’ Equity Current liabilities Note payable, due 2012 ................................. Partners’ equity W. Jarratt, capital ........................................... $20,000 M. Bramstrup, capital .................................... 40,000 Total liabilities and partners’ equity .................

$20,000

60,000 $80,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-10 (a) June 9 K. Carter, Capital .............................. 23,000 D. Dutton, Capital ........................

23,000

(b) Regardless of the amount paid for the partnership interest, the entry to record Dutton’s admission to the partnership would remain the same.

BRIEF EXERCISE 12-11 (a) Investment of $45,000 Oct. 1 Cash .................................................. 45,000 J. Edie, Capital (50% × $3,000*) ....... 1,500 K. Zane, Capital (50% × $3,000*) ..... 1,500 J. Kerns, Capital (40% × $120,000)

48,000

* [($45,000 + $30,000 + $45,000) × 40%] – $45,000 = $3,000 (b) Investment of $70,000 Oct. 1 Cash .................................................. 70,000 J. Edie, Capital (50% × $12,000*) K. Zane, Capital (50% × $12,000*) J. Kerns, Capital (40% × $145,000)

6,000 6,000 58,000

* [($45,000 + $30,000 + $70,000) × 40%] – $70,000 = $(12,000)

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-12 (a) Dec. 31

E. Embs, Capital .......................... 30,000 M. Ditka, Capital ...................... B. Boyd, Capital ......................

15,000 15,000

(b) Regardless of the amount paid for E. Embs’ capital, the entry to record Dutton’s withdrawal from the partnership would remain the same.

BRIEF EXERCISE 12-13 (a) Embs Receives $36,000 Dec. 31 E. Embs, Capital .......................... 30,000 M. Ditka, Capital (50% × $6,000).. 3,000 B. Boyd, Capital (50% × $6,000) .. 3,000 Cash .........................................

36,000

(b) Embs Receives $26,000 Dec. 31 E. Embs, Capital .......................... 30,000 M. Ditka, Capital (50% × $4,000) B. Boyd, Capital (50% × $4,000) Cash .........................................

2,000 2,000 26,000

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BRIEF EXERCISE 12-14 (a) Nov. 15 Cash .................................................... 17,000 Other Assets .................................. Gain on Realization........................

14,000 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 ($8,000 + $1,000).. 9,000 V. Dueck, Capital ($9,000 + $1,000) ... 10,000 B. Veitch, Capital ($1,000 + $1,000) ... 2,000 Cash ($4,000 + $17,000) .................

21,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 12-15 (a) Nov. 15 Cash ................................................... 11,000 Loss on Realization ............................ 3,000 Other Assets ..................................

14,000

(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 ($8,000 – $1,000) .. V. Dueck, Capital ($9,000 – $1,000) ... B. Veitch, Capital ($1,000 – $1,000) ... Cash ($4,000 + $11,000) .................

7,000 8,000 0 15,000

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BRIEF EXERCISE 12-16 (a) (1) Sept. 30 Cash ............................................... 4,000 A. Norin, Capital ........................ (2)

4,000

30 G. Lodge, Capital ........................... 22,000 L. McDonald, Capital ..................... 19,000 Cash ($37,000 + $4,000) ............

41,000

(1) Sept. 30 G. Lodge, Capital ($4,000 × 5/8) .................................. 2,500 L. McDonald, Capital ($4,000 × 3/8) .................................. 1,500 A. Norin, Capital ........................

4,000

(b)

(2)

30 G. Lodge, Capital ($22,000 – $2,500) .......................... 19,500 L. McDonald, Capital ($19,000 – $1,500) .......................... 17,500 Cash ...........................................

37,000

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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 vacation.

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. A partnership has more difficulty raising capital and its partners do not enjoy unlimited liability. If the business were to find itself in financial difficulty, Joe and Cathy would be held personally liable for 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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EXERCISE 12-2 Jan. 1

Cash......................................................... 24,000 Accounts Receivable.............................. 28,000 Equipment ............................................... 35,000 Allowance for Doubtful Accounts ..... Accounts Payable .............................. T. Karl, Capital ....................................

6,000 12,000 69,000

EXERCISE 12-3 (a) (1) HUMA AND HOW Division of Profit Year Ended June 30, 2011 R. Huma Profit................................................. Salary allowance R. Huma ....................................... $30,000 W. How ....................................... Total ........................................ Profit remaining for allocation ....... Interest allowance R. Huma ($75,000 × 5%).............. 3,750 W. How ($60,000 × 5%) ............... Total ........................................ Profit remaining for allocation ....... Fixed ratio R. Huma ($16,250 × 60%) ............ 9,750 W. How ($16,250 × 40%) ............. Total ........................................ Profit remaining for allocation ....... 00000 0 Profit allocated to the partners....... $43,500

W. How

Total $75,000

$22,000 52,000 23,000

3,000 6,750 16,250

6,500 16,250 00 0000 $ 0 $31,500 $75,000

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EXERCISE 12-3 (Continued) (a) (Continued) (2) HUMA AND HOW Division of Profit Year Ended June 30, 2011 R. Huma Profit................................................. Salary allowance R. Huma ....................................... $30,000 W. How ....................................... Total ........................................ Profit (deficiency) remaining for allocation ............. Interest allowance R. Huma ($75,000 × 5%).............. 3,750 W. How ($60,000 × 5%) ............... Total ........................................ Profit (deficiency) remaining for allocation ............ Fixed ratio R. Huma ($23,750 × 60%) ............ (14,250) W. How ($23,750 × 40%) ............. Total ........................................ Profit remaining for allocation ....... 00 0000 Profit allocated to the partners....... $19,500

W. How

Total $35,000

$22,000 52,000 (17,000)

3,000 6,750 (23,750)

(9,500) (23,750) 00 0000 $ 0 $15,500 $35,000

(b) (1) June 30 Income Summary........................... 75,000 R. Huma, Capital ....................... W. How, Capital .........................

43,500 31,500

(2) June 30 Income Summary........................... 35,000 R. Huma, Capital ....................... W. How, Capital .........................

19,500 15,500

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Accounting Principles, Fifth 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 ........ 00 00 00 00 0000 $ 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 sharing of profit and loss would be allocated to each partner, any profit or loss would be shared equally.

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EXERCISE 12-5 (a) SCHOTT CO. Statement of Partners’ Equity Year Ended December 31, 2011

Capital, January 1........................ Add: Profit.................................... Less: Drawings ............................ Capital, December 31 ..................

M. Salz $20,000 24,000* 44,000 8,000 $36,000

C. Toni $18,000 8,000 26,000 5,000 $21,000

Total $38,000 32,000 70,000 13,000 $57,000

* $32,000 × ¾ = $24,000 (b) SCHOTT CO. Balance Sheet (partial) December 31, 2011

Partners' equity M. Salz, capital .............................................................. $36,000 C. Toni, capital .............................................................. 21,000 Total partners' equity ........................................................ $57,000

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EXERCISE 12-6 (a) DRS. KOVACIK AND DONOVAN Income Statement Year Ended November 30, 2011 Dental fee revenue .......................................................... $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, 2011

Capital, December 1, 2010 .......... Add: Profit.................................... Less: Drawings ............................ Capital, November 30, 2011 ........

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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EXERCISE 12-6 (Continued) (a) (Continued) DRS. KOVACIK AND DONOVAN Balance Sheet November 30, 2011

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 ....................................... Long-term liabilities Note payable, due 2015 .............................. Total liabilities ........................................ Partners’ equity J. Kovacik, capital....................................... S. Donovan, capital ..................................... Total liabilities and partners’ equity .....

$15,000 50,000 65,000 $72,200 44,800

117,000 $182,000

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EXERCISE 12-6 (Continued) (b) Closing entries dated November 30, 2011 Dental Fee Revenue ...................................... 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 ...........................

90,000

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EXERCISE 12-7 (a) July 1

(b) July 1

T. Halo, Capital ...................... 12,000 R. Zahn, Capital ............... ($36,000 × 1/3) = $12,000

12,000

K. Rose, Capital .................... 14,000 R. Zahn, Capital ............... ($28,000 × 50%) = $14,000

14,000

J. Lamp, Capital ................... 16,000 R. Zahn, Capital ...............

16,000

(d) July 1

Cash ..................................... 20,000 R. Zahn, Capital ............... 20,000 [($36,000 + $28,000 + $16,000 + $20,000) × 20%] = $20,000

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EXERCISE 12-8 (a) Jan. 1

Cash .................................................. 75,000 J. Keho, Capital (4/6 × $15,000) .. M. McLain, Capital (2/6 × $15,000) E. Kehler, Capital .........................

10,000 5,000 60,000

Total capital of existing partnership ....................... $165,000 Investment by new partner, E. Kehler ..................... 75,000 Total capital of new partnership .............................. $240,000 E. Kehler's capital credit (25% × $240,000) .............

$60,000

Investment by new partner, E. Kehler ..................... E. Kehler's capital credit .......................................... Bonus to old partners ..............................................

$75,000 60,000 $15,000

(b) Jan. 1

Cash .................................................. 45,000 J. Keho, Capital (4/6 × $7,500) ......... 5,000 M. McLain, Capital (2/6 × $7,500) .... 2,500 E. Kehler, Capital .........................

52,500

Total capital of existing partnership ....................... $165,000 Investment by new partner, E. Kehler ..................... 45,000 Total capital of new partnership .............................. $210,000 E. Kehler's capital credit (25% × $210,000) .............

$52,500

Investment by new partner, E. Kehler ..................... E. Kehler's capital credit .......................................... Bonus to new partner ...............................................

$45,000 52,500 $ 7,500

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EXERCISE 12-8 (Continued) (c) Total capital of existing partnership ....................... $165,000 Divide by 75% for combined partnership capital ... 220,000 E. Kehler's capital credit .......................................... $ 55,000 Alternately: Total capital of existing partnership ....................... $165,000 Investment by new partner, E. Kehler ..................... 55,000 Total capital of new partnership .............................. $220,000 E. Kehler's capital credit (25% × $220,000) .............

$55,000

The amount of cash to be paid is therefore ...........

$55,000

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Accounting Principles, Fifth 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 J. Lane, Capital..........................

30,000

Dec. 31 A. Noll, Capital ............................... 30,000 Cash ...........................................

30,000

(b) Alternative 1

J. Lane Capital

S. Miles Capital

A. Noll Capital

Total Capital

Beginning balance A. Noll withdrawal Ending balance

$ 50,000 15,000 $ 65,000

$ 40,000 15,000 $ 55,000

$ 30,000 (30,000) 0

$120,000

Alternative 4

J. Lane Capital

S. Miles Capital

A. Noll Capital

Total Capital

Beginning balance A. Noll withdrawal Ending balance

$ 50,000

$ 40,000

$ 50,000

$ 40,000

$ 30,000 $120,000 (30,000) (30,000) 0 $ 90,000

$120,000

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Accounting Principles, Fifth Canadian Edition

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 .................. $73,000 Payment to withdrawing partner ............................. 0 85,000 Bonus to retiring partner ......................................... $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 ...........................................

2,667 1,333 69,000

Capital balance of withdrawing partner .................. Payment to withdrawing partner ............................. Bonus to remaining partners ................................... Allocation of bonus: D. Nagel, Capital ($4,000 × 4/6) .................... $2,667 I. Mbango, Capital ($4,000 × 2/6).................. 1,333,

$73,000 069,000 $ 4,000

$4,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 12-10 (Continued) (b) Alternative 1

D. Nagel K. White I. Mbango Capital Capital Capital

Beginning balance K. White withdrawal Ending balance

$ 95,000 $73,000 (8,000) (73,000) $ 87,000

Alternative 2

D. Nagel K. White I. Mbango Capital Capital Capital

Beginning balance $ 95,000 K. White withdrawal 2,667 Ending balance $ 97,667

Total Capital

$ 65,000 $233,000 (4,000) (85,000) $ 61,000 $148,000

$73,000 $ 65,000 (73,000) 1,333 $ 66,333

Total Capital $233,000 (69,000) $164,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 12-11 (a)

Partners' Capital Cash

Windl

Houghton Pesowski

Capital

Total Capital

$172,500

Balance before liquidation $172,500 $86,250 Final liquidation (172,500) (86,250) Final balances $ 0 $ 0

$34,500

$51,750

(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 liquidation (139,500) (75,250) (23,500) (40,750) (139,500) Final balances $ 0 $ 0 $ 0 $ 0 $ 0

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Accounting Principles, Fifth Canadian Edition

EXERCISE 12-12

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 $30,000 $ 140,000 Sale of assets and share of gain 120,000 (140,000) Balances 150,000 0 Payment of liabilities (55,000) Balances 95,000 0 Distribution of cash to partners (95,000) Final balances $ 0 $ 0

$ (40,000)

$ 55,000

$ 50,000

$25,000

$75,000

40,000 0

55,000

12,000 62,000

8,000 33,000

20,000 95,000

(55,000) 0

62,000

33,000

95,000

(62,000) (33,000) (95,000) $ 0 $ 0 $ 0

_____ Solutions Manual

Chapter 12

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Accounting Principles, Fifth Canadian Edition

EXERCISE 12-13 (a) Dec. 31 Accumulated Depreciation ......... 40,000 Cash ............................................. 120,000 Equipment ............................... Gain on Realization ................. (b) Dec. 31 Gain on Realization ..................... 20,000 H. Bayer, Capital ($20,000 × 60%) ....................... J. Leech, Capital ($20,000 × 40%) .......................

140,000 20,000

12,000 8,000

55,000

(d) Dec. 31 H. Bayer, Capital .......................... 62,000 J. Leech, Capital .......................... 33,000 Cash .........................................

95,000

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Accounting Principles, Fifth Canadian Edition

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

_____ Solutions Manual

Chapter 12

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Accounting Principles, Fifth Canadian Edition

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 Cash ........................................... 79,000

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

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. Ethics note 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-2A (a) Jan.

(b) Jan.

1 Cash ............................................. 14,000 Accounts Receivable .................. 18,500 Merchandise Inventory................ 25,000 Equipment .................................... 23,000 Allowance for Doubtful Accounts Notes Payable ......................... Accounts Payable ................... I. Domic, Capital ......................

4,500 30,000 11,000 35,000

1 Cash ............................................. 12,000 Accounts Receivable .................. 26,000 Merchandise Inventory................ 20,000 Equipment .................................... 15,000 Allowance for Doubtful Accounts Notes Payable ......................... Accounts Payable ................... P. Dasilva, Capital ...................

4,000 15,000 28,000 26,000

1 Cash ($35,000 – $26,000)............. P. Dasilva, Capital ...................

9,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-2A (Continued) (c) DOMIC DASILVA PARTNERSHIP Balance Sheet January 1, 2011

Assets Current assets Cash ($14,000 + $12,000 + $9,000) ............................. $ 35,000 Accounts receivable ($18,500 + $26,000) ..... $44,500 Less: Allowance for doubtful accounts ($4,500 + $4,000) ................................. 8,500 36,000 Merchandise inventory ($25,000 + $20,000) .............. 45,000 Total current assets ............................................... 116,000 Property, plant, and equipment Equipment ($23,000 + $15,000) .................................. 38,000 Total assets ............................................................ $154,000 Liabilities and Partners' Equity Current liabilities Notes payable ($30,000 + $15,000) ............................ Accounts payable ($11,000 + $28,000) ...................... Total current liabilities ...........................................

$ 45,000 39,000 84,000

Partners' equity I. Domic, capital .......................................................... 35,000 P. Dasilva, capital ($26,000 + $9,000) ........................ 35,000 Total partners' equity ............................................. 70,000 Total liabilities and partners' equity ............................... $154,000

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3A (a) 1. Dec. 31 Income Summary ........................... 40,000 J. Chapman-Brown, Capital ...... C. Nelson, Capital ...................... H. Weir, Capital ..........................

20,000 13,333 6,667

CNW COMPANY Division of Profit Year Ended December 31, 2011 J. ChapmanBrown C. Nelson Profit............................... Fixed ratio J. Chapman-Brown ($40,000 × 3/6) ........... $20,000 C. Nelson ($40,000 × 2/6) ........... $13,333 H. Weir ($40,000 × 1/6) ........... Total ...................... Profit remaining for allocation ............. 0000 00 000 000 Profit allocated to the partners ............... $20,000 $13,333

H. Weir

Total $40,000

$6,667 40,000 0 0000

$6,667

$40,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3A (Continued) (a) (Continued) 2. Dec. 31 Income Summary ........................... 30,000 J. Chapman-Brown, Capital ...... C. Nelson, Capital ...................... H. Weir, Capital ..........................

3,333 11,333 15,334

CNW COMPANY Division of Profit Year Ended December 31, 2011 J. Chapman -Brown C. Nelson H. Weir Profit............................... Salary allowance C. Nelson ................... $8,000 H. Weir ....................... $12,000 Total ...................... Profit remaining for allocation ............. Fixed ratio (remainder shared equally) J. Chapman-Brown ($10,000 × 1/3) ........... $3,333 C. Nelson ($10,000 × 1/3) ........... 3,333 H. Weir ($10,000 × 1/3) ........... 3,334 Total ...................... Profit remaining for allocation ............. 00 000 0 0000 0000 00 Profit allocated to the partners ............... $3,333 $11,333 $15,334

Total $30,000

20,000 10,000

10,000 0 $30,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3A (Continued) (a) (Continued) 3. Dec. 31 Income Summary ........................... 28,000 J. Chapman-Brown, Capital ...... C. Nelson, Capital ...................... H. Weir, Capital ..........................

3,167 12,667 12,166

CNW COMPANY Division of Profit Year Ended December 31, 2011 J. Chapman -Brown C. Nelson H. Weir Profit............................... Interest allowance J. Chapman-Brown ($30,000 × 5%) ........... $1,500 C. Nelson ($20,000 × 5%) $1,000 H. Weir ($10,000 × 5%) $500 Total ...................... Profit remaining for allocation ............. Salary allowance J. Chapman-Brown ... 5,000 C. Nelson .................. 15,000 H. Weir ....................... 15,000 Total ...................... Profit (deficiency) remaining for allocation Fixed ratio (remainder shared equally) Chapman-Brown [$(10,000) × 1/3] ......... (3,333) Nelson [$(10,000) × 1/3] (3,333) H. Weir [$(10,000) × 1/3] (3,334) Total ...................... Profit remaining for allocation ............. 00000 000 000 000 000 Profit allocated to the partners ........... $3,167 $12,667 $12,166

Total $28,000

3,000 25,000

35,000 (10,000)

(10,000) 0 $28,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3A (Continued) (b) Dec. 31 J. Chapman-Brown, Capital .......... 10,000 C. Nelson, Capital .......................... 8,000 H. Weir, Capital .............................. 6,000 J. Chapman-Brown, Drawings .. C. Nelson, Drawings.................. H. Weir, Drawings ......................

10,000 8,000 6,000

J. ChapmanBrown C. Nelson Capital, January 1 $30,000 $20,000 Add: Profit 3,167 12,667 33,167 32,667 Less: Drawings 10,000 8,000 Capital, December 31 $23,167 $24,667

H. Weir $10,000 12,166 22,166 6,000 $16,166

Total $60,000 28,000 88,000 24,000 $64,000

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, 2011

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, 2011 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 ...... 0000 00 00 0000 0 Loss allocated to the partners...... $(13,680) $(26,320) $(40,000)

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-4A (Continued) (c) STOREY ROGERS PARTNERSHIP Statement of Partners’ Equity Year Ended December 31, 2011

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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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5A (a) KANT-ADDER PARTNERSHIP Income Statement Year Ended March 31, 2011 ______________________________________________________ Professional fees............................................................. $350,000 Expenses Salaries expense......................................... $100,000 Rent expense .............................................. 24,000 Interest expense ......................................... 20,000 Insurance expense ..................................... 12,000 Utilities expense ......................................... 10,000 Depreciation expense ................................. 6,000 Supplies expense ....................................... 5,000 Total expenses ............................................................ 177,000 Profit................................................................................. $173,000 KANT-ADDER PARTNERSHIP Statement of Partners’ Equity Year Ended March 31, 2011

U. Adder Capital, April 1 ........................... $10,000 Add: Investment ........................ 0 Profit* ................................ 69,200 79,200 Less: Drawings .......................... 70,000 Capital, March 31 ....................... $ 9,200 * U. Adder: I. Kant:

I. Kant $ 10,000 5,000 103,800 118,800 90,000 $ 28,800

Total $ 20,000 5,000 173,000 198,000 160,000 $ 38,000

$173,000 × 40% = $69,200 $173,000 × 60% = $103,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5A (Continued) (a) (Continued) KANT-ADDER PARTNERSHIP Balance Sheet March 31, 2011 __________________________________________________ Assets Current assets Cash............................................................................. $ 16,000 Accounts receivable ................................................... 80,000 Supplies....................................................................... 4,000 Prepaid insurance....................................................... 3,000 Total current assets ............................................... 103,000 Property, plant, and equipment Office equipment .......................................... $30,000 Less: Accumulated depreciation .................. 12,000 18,000 Total assets ............................................................ $121,000 Liabilities and Partners' Equity Current liabilities Accounts payable ....................................................... $010,000 Salaries payable.......................................................... 008,000 Unearned fees ............................................................. 15,000 Demand bank loan ...................................................... 40,000 Current portion of note payable ................................ 1,500 Total current liabilities ........................................... 74,500 Long-term liabilities Note payable, net of current portion ......................... 8,500 Total liabilities ........................................................ 83,000 Partners' equity U. Adder, capital ......................................................... 9,200 I. Kant, capital ............................................................. 28,800 Total partners' equity ............................................. 38,000 Total liabilities and partners' equity ............................... $121,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5A (Continued) (b) Mar. 31 Professional Fees .......................... 350,000 Income Summary ......................

350,000

31 Income Summary ........................... 177,000 Salaries Expense ....................... Rent Expense ............................ Interest Expense ....................... Insurance Expense.................... Utilities Expense ....................... Depreciation Expense ............... Supplies Expense......................

100,000 24,000 20,000 12,000 10,000 6,000 5,000

31 Income Summary ........................... 173,000 U. Adder, Capital ....................... I. Kant, Capital ...........................

69,200 103,800

31 U. Adder, Capital ............................ 70,000 I. Kant, Capital ................................ 90,000 U. Adder, Drawings ................... I. Kant, Drawings .......................

70,000 90,000

Taking It Further: In this case, once the profit is added to the capital accounts drawings are not larger than the capital balances. 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.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-6A (a)

(b)

(c)

May 1 W. Sanga, Capital ........................... 30,000 N. Osvald, Capital ......................

30,000

May 1 K. Osbourne, Capital ..................... 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 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-6A (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

(e)

N. Osvald's capital credit ($160,000 × 20%)

$32,000

Investment by N. Osvald ............................ N. Osvald's capital credit ........................... Bonus to old partners.................................

$40,000 32,000 $ 8,000

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-7A (a) Total capital after admission ................................... $170,000 Total capital before admission ................................ 150,000 Cash investment by S. Dionne ................................ $ 20,000 (b) Assad has a 30% ownership in the new partnership. Assad’s capital account will be $51,000 = 30% × $170,000. Bonus to Assad = New capital account − Old capital account = $51,000 − $50,000 = $1,000 Assad’s share of bonus = 4 ÷ (5 + 4+ 3) = 4/12 If 4/12ths of the bonus = $1,000, then Total bonus = $1,000 × 12/4 = $3,000 (c) Bonus allocated as follows: Meechum $3,000 × 5/12 = $1,250 Assad $3,000 × 4/12 = $1,000 Dong $3,000 × 3/12 = $750 Investment by S. Dionne ................................... Bonus allocated to old partners ....................... S. Dionne’s capital in partnership ................... Original Capital Accounts L. Meechum $ 62,500 D. Assad 50,000 D. Dong 37,500 S. Dionne 00000 00 Total $150,000

Bonus to Old Partners $1,250 1,000 750 $3,000

$20,000 3,000 $17,000

New Capital Accounts $63,750 51,000 38,250 17,000 $170,000

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Accounting Principles, Fifth Canadian Edition

Problem 12-7A (Continued) Taking It Further: The four partners of the new partnership will need to come up with a new profit and loss ratio which they believe to be fair in their new circumstances.

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Accounting Principles, Fifth Canadian Edition

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..................... 058,000 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..................... 038,200 Bonus to remaining partners ........ $10,800

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-9A (a)

K. Children D. Picard V. Markle Total

Original Capital $ 90,000 60,000 75,000 $225,000

Bonus Paid $ (7,500) (7,500) $(15,000)

New Capital $ 82,500 0 67,500 $150,000

V. Markle’s capital after withdrawal ........................ V. Markle’s capital before withdrawal ..................... Bonus to D. Picard ...................................................

$67,500 75,000 $ 7,500

K. Children’s profit and loss ratio with V. Markle ... Total bonus ($7,500 ÷ ½) ..........................................

1:1 $15,000

Check: Bonus from K. Children ($15,000 × 1/2) = $7,500 Bonus from V. Markle ($15,000 × ½) = $7,500 (b) K. Children ($82,500  $150,000) ............................. V. Markle ($67,500  $150,000) .................................

55% 45%

(c) D. Picard’s capital balance ...................................... Total bonus to D. Picard .......................................... Cash paid to D. Picard .............................................

$60,000 15,000 $75,000

(d) Total bonus allocated to D. Picard ..........................

$15,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-9A (Continued)

Taking It Further: The remaining partners would be willing to pay a bonus to a withdrawing partner to take over a portion of a practice that was previously managed by the withdrawing partner. A client list for example would be valued by the continuing partners. Or, there might have been some personality conflicts with the remaining partners that lead to the withdrawing partner being asked to leave the partnership.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-10A (a) (1)

May 5 Cash ................................................ 67,200 Allowance for Doubtful Accounts. 1,400 Accumulated Depreciation ............ 14,000 Loss on Realization ....................... 7,000 Accounts Receivable ................ Inventory .................................... Equipment..................................

26,600 39,200 23,800

Noncash assets (net) ..................... $74,200 Sale proceeds ................................ 067,200 Loss on sale of noncash assets ... $ 7,000 5 A. Hoffer, Capital ($7,000 × 50%) .. K. Lonseth, Capital ($7,000 × 30%) D. Posca, Capital ($7,000 × 20%) .. Loss on Realization................... (2)

(3)

3,500 2,100 1,400 7,000

May 7 Notes Payable ................................ 29,400 Accounts Payable .......................... 25,200 Wages Payable............................... 7,000 Cash ........................................... May 9 Cash ................................................ D. Posca, Capital .......................

61,600

280

(4) May 12 A. Hoffer, Capital ($35,000 – $3,500) .......................... 31,500 K. Lonseth, Capital ($15,680 – $2,100) .......................... 13,580 Cash ($39,200 + $67,200 – $61,600 + $280) .......................

280

45,080

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-10A (Continued) (b) Cash

A. Hoffer, Capital

Apr. 30 Bal. 39,200 May 7 61,600 May 5 3,500 Apr. 30 Bal. 35,000 May 5 67,200 May 12 45,080 May 12 31,500 May 9 280 0

K. Lonseth, Capital

D. Posca, Capital

May 5 2,100 Apr. 30 Bal.15,680 May 12 13,580

May 5 1,400 Apr. 30 Bal. May 9

0 (c)

May 9 A. Hoffer, Capital ($280 × 5/8) ....... K. Lonseth, Capital ($280 × 3/8) .... D. Posca, Capital .......................

1,120 280 0

175 105

12 A. Hoffer, Capital ($35,000 – $3,500 – $175)............... 31,325 K. Lonseth, Capital ($15,680 – $2,100 – $105)............... 13,475 Cash ($39,200 + $67,200 – $61,600) ...

280

44,800

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-11A (a) June 2 Cash ........................................... 3,000,000 Gain on Realization .............. 100,000 Noncash Assets ................... 2,900,000 Noncash assets (net) .................. $2,900,000 Sale proceeds .............................. 3,000,000 Gain on Realization ..................... $ 100,000 ÷ 4 = $25,000 2 Gain on Realization................... M. James, Capital ................. S. Lars, Capital ..................... J. Kirk, Capital ...................... B. Robert, Capital .................

100,000 25,000 25,000 25,000 25,000

2 Liabilities ................................... 1,550,000 Cash ...................................... 1,550,000 2 M. James, Capital ($500,000 + $25,000) ................. S. Lars, Capital ($500,000 + $25,000) ................. J. Kirk, Capital ($500,000 + $25,000) ................. B. Robert, Capital ($250,000 + $25,000) ................. Cash ......................................

525,000 525,000 525,000 275,000 1,850,000

Cash ............................................. $ 400,000 Add: Proceeds from sale ........... 3,000,000 Less: Payment of liabilities ........ (1,550,000) Cash available to partners.......... $1,850,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-11A (Continued) (b) June 2 Cash ........................................... 1,700,000 Loss on Realization .................. 1,200,000 Noncash Assets ................... 2,900,000 Noncash assets (net) ............................. $2,900,000 Sale proceeds ......................................... 1,700,000 Loss on Realization ................................ $1,200,000 ÷ 4 = $300,000 2 M. James, Capital ...................... S. Lars, Capital .......................... J. Kirk, Capital ........................... B. Robert, Capital ...................... Loss on Realization..............

300,000 300,000 300,000 300,000 1,200,000

2 Liabilities ................................... 1,550,000 Cash ...................................... 1,550,000 2 Cash ........................................... B. Robert, Capital ................. ($250,000 – $300,000) 2 M. James, Capital ($500,000 – $300,000)................ S. Lars, Capital ($500,000 – $300,000)................ J. Kirk, Capital ($500,000 – $300,000)................ Cash ......................................

50,000 50,000

200,000 200,000 200,000 600,000

Cash ........................................................ $ 400,000 Add: Proceeds from sale .................... 1,700,000 Add: Cash from Robert ........................ 50,000 Less: Payment of liabilities.................... (1,550,000) Cash available to partners ..................... $ 600,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-11A (Continued) (c) June 2 Cash ........................................... 1,700,000 Loss on Realization .................. 1,200,000 Noncash Assets ................... 2,900,000 Noncash assets (net) ........................... $2,900,000 Sale proceeds ....................................... 1,700,000 Loss on Realization ............................. $1,200,000 ÷ 4 = $300,000 2 M. James, Capital ...................... S. Lars, Capital .......................... J. Kirk, Capital ........................... B. Robert, Capital ...................... Loss on Realization..............

300,000 300,000 300,000 300,000 1,200,000

2 Liabilities ................................... 1,550,000 Cash ...................................... 1,550,000 2 M. James, Capital ...................... S. Lars, Capital .......................... J. Kirk, Capital ........................... B. Robert, Capital ................. 2 M. James, Capital ($500,000 – $300,000 – $16,666) S. Lars, Capital ($500,000 – $300,000 – $16,667) J. Kirk, Capital ($500,000 – $300,000 – $16,667) Cash ......................................

16,666 16,667 16,667 50,000

183,334 183,333 183,333 550,000

Cash ...................................................... $ 400,000 Add: proceeds from sale .................... 1,700,000 Less: payment of liabilities.................. (1,550,000) Cash available to partners ................... $ 550,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-11A (Continued)

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-12A (a) 2010 Mar. 2 Cash ....................................................... Office Equipment ................................... Z. Moreau, Capital ............................ 2

15,000 18,000 33,000

Cash ....................................................... Furniture ................................................ Notes Payable .................................. K. Krneta, Capital .............................

10,000 17,000

Cash ....................................................... Fitness 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

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 CSV Personal Coaching Capital Balances December 31, 2010

Investments Drawings Profit Ending Balance

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-12A (Continued) 2011 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 2012 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-12A (Continued) (b) CSV Personal Coaching Balance of Partners’ Capital Accounts January 4, 2012

Balance Dec. 31, 2010 Withdrawal of partner Drawings 2011 Profit 2011 Balance Dec. 31, 2011 Admission new partner Balance Jan. 4, 2012

Solutions Manual

D. Hirjikaka

Z. Moreau

$40,000 $40,000

$44,250 2,250 (42,750) 55,000 58,750 (4,000) $54,750

K. Krneta V. Visentin $19,500 (19,500) ___ $0

$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

Chapter 12

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-12A (Continued) (b) (Continued) CSV PERSONAL COACHING Balance Sheet (partial) January 4, 2012 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 CSV 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-1B (a) The likely reason the business was organized as a limited partnership is to enjoy the advantages of limited liability, while at the same time enjoy the advantages of the partnership structure. (b) Since the units are limited partnership units are held by employees who are not the general partner, the employees are liable to the amount of their investment for the units. Taking It Further: The advantage of the limited partnership being listed on a public stock exchange is its ability to raise capital though the issuance of limited partnership units.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-2B (a) Jan. 1 Cash .................................................. 14,500 Accounts Receivable ....................... 15,000 Merchandise Inventory .................... 32,000 Equipment ........................................ 28,000 Allowance for Doubtful Accounts Notes Payable.............................. Accounts Payable ....................... F. Visanji, Capital.........................

3,500 35,000 15,000 36,000

1 Cash .................................................. 6,000 Accounts Receivable ....................... 23,000 Merchandise Inventory .................... 15,000 Equipment ........................................ 15,000 Allowance for Doubtful Accounts Notes Payable.............................. Accounts Payable ....................... P. Vanbakel, Capital ....................

5,000 20,000 17,000 17,000

(b) Jan. 1 Cash ($36,000 / 2– $17,000) ............. 1,000 P. Vanbakel, Capital ....................

1,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-2B (Continued) (c) VARSITY PARTNERSHIP Balance Sheet January 1, 20XX

Assets Current assets Cash ($14,500 + $6,000 + $19,000) .................... $ 39,500 Accounts receivable ($15,000 + $23,000) ......... $38,000 Less: Allowance for doubtful accounts ($3,500 + $5,000) ..................................... 8,500 29,500 Merchandise inventory ($32,000 + $15,000) ..... 47,000 Total current assets .................................. 116,000 Property, plant, and equipment Equipment ($28,000 + $15,000) ..................... Total assets ...............................................

43,000 $159,000

Liabilities and Partners' Equity Current liabilities Notes payable ($35,000 + $20,000) ............................ $055,000 Accounts payable ($15,000 + $17,000) ...................... 32,000 Total current liabilities ........................................... 87,000 Partners' equity F. Visanji, Capital ........................................................ 36,000 P. Vanbakel, Capital ($17,000 + $19,000) ................... 36,000 Total partners' equity ............................................. 72,000 Total liabilities and partners' equity...................... $159,000

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Accounting Principles, Fifth Canadian Edition

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 than if they were apart. 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3B (a) 1.

Dec. 31 Income Summary........................... 55,000 S. Little, Capital ......................... L. Brown, Capital ....................... G. Scholz, Capital ......................

30,000 15,000 10,000

LBS COMPANY Division of Profit Year Ended December 31, 2011 S. Little Profit............................... Fixed ratio S. Little ($55,000 × 60/110) ..... $30,000 L. Brown ($55,000 × 30/110) ..... G. Scholz ($55,000 × 20/110) ..... Total ...................... Profit remaining for allocation ............. 0000 00 Profit allocated to the partners ............... $30,000

L. Brown G. Scholz

Total $55,000

$15,000 $10,000 55,000 000 000

0 0000

$15,000

$10,000 $55,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3B (Continued) (a) (Continued) 2.

Dec. 31 Income Summary........................... 41,000 S. Little, Capital ......................... L. Brown, Capital ....................... G. Scholz, Capital ......................

8,666 18,667 13,667

LBS COMPANY Division of Profit Year Ended December 31, 2011 S. Little L. Brown G. Scholz Profit............................... Salary allowance S. Little ...................... $5,000 L. Brown .................... G. Scholz ................... Total ...................... Profit remaining for allocation ............. Fixed ratio (remainder shared equally) S. Little ($11,000 × 1/3) ........... $3,666 L. Brown ($11,000 × 1/3) ........... G. Scholz ($11,000 × 1/3) ........... Total ...................... Profit remaining for allocation ............. 00 000 Profit allocated to the partners ............... $8,666

Total $41,000

$15,000 $10,000 30,000 11,000

3,667 3,667 11,000 0 0000

0000 00

$18,667

$13,667 $41,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3B (Continued) (a) (Continued) 3.

Dec. 31 Income Summary........................... 23,000 S. Little, Capital ......................... L. Brown, Capital ....................... G. Scholz, Capital ......................

1,500 10,000 11,500

LBS COMPANY Division of Profit Year Ended December 31, 2011 S. Little L. Brown G. Scholz Profit............................... Interest allowance S. Little ($60,000 × 5%) $3,000 S. Little ($30,000 × 5%) G. Scholz ($20,000 × 5%) Total ...................... Profit remaining for allocation Salary allowance L. Brown .................... G. Scholz ................... Total ...................... Profit (deficiency) remaining for allocation Fixed ratio (remainder shared equally) S. Little [$(4,500) × 1/3] ........... (1,500) G. Scholz [$(4,500) × 1/3] ........... G. Scholz [$(4,500) × 1/3] ........... Total ...................... Profit remaining for allocation ............. 00000 Profit allocated to the partners ........... $1,500

Total $23,000

$1,500 $1,000 5,500 17,500 10,000 12,000 22,000 (4,500)

(1,500) (1,500) (4,500) 000 000 000 000

$10,000 $11,500

$23,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-3B (Continued) (b) Dec. 31 S. Little, Capital.............................. 20,000 L. Brown, Capital ........................... 15,000 G. Scholz, Capital .......................... 10,000 S. Little, Drawings ..................... L. Brown, Drawings................... G. Scholz, Drawings..................

20,000 15,000 10,000

Capital, January 1 Add: Profit Less: Drawings Capital, December 31

S. Little L. Brown G. Scholz Total $60,000 $30,000 $20,000 $110,000 1,500 10,000 11,500 23,000 61,500 40,000 31,500 133,000 20,000 15,000 10,000 45,000 $41,500 $25,000 $21,500 $88,000

Taking It Further: The partnership would include a salary allowance in its profitand loss- sharing arrangements to reward those 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-4B (a) LAM TAN PARTNERSHIP Income Statement Year Ended January 31, 2011

$395,000 275,000 120,000 150,000 $( 30,000)

(b) LAM TAN PARTNERSHIP Division of Loss Year Ended January 31, 2011

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 ...... 000 000 000 000 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, 2011

Capital, February 1, 2010 ............ Less: Drawings........................... Loss .................................. Capital, January 31, 2011 ............

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5B (a) CLAY AND OGLETREE, LLP Income Statement Year Ended September 30, 2011

Professional fees............................................. $675,000 Expenses Salaries expense......................................... $225,000 Depreciation expense ................................. 22,500 Interest expense ......................................... 5,000 Utilities expense ......................................... 25,000 Property tax expense ................................. 15,000 Supplies expense ....................................... 7,500 Total expenses ............................................ 300,000 Profit................................................................. $375,000

CLAY AND OGLETREE, LLP Statement of Partners’ Equity Year Ended September 30, 2011

G. Clay M. Ogletree Total Capital, October 1, 2010 ............ $ 65,000 $ 37,500 $102,500 Add: Investment ........................ 10,000 0 10,000 Profit* ................................ 250,000 125,000 375,000 325,000 162,500 487,500 Less: Drawings .......................... 150,000 150,000 300,000 Capital, September 30, 2011 ..... $175,000 $ 12,500 $187,500 *G. Clay $375,000 × 2/3 = $250,000 M. Ogletree $375,000 × 1/3 = $125,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5B (Continued) (a) (Continued) CLAY AND OGLETREE, LLP Balance Sheet September 30, 2011

Assets Current assets Cash............................................................................. $ 11,250 Accounts receivable ................................................... 105,000 Supplies....................................................................... 3,750 Total current assets ............................................... 120,000 Property, plant, and equipment Land ........................................... $75,000 Building ..................................... $225,000 Accumulated depreciation ....... 112,500 112,500 Office equipment ...................... 60,000 Accumulated depreciation ....... 30,000 30,000 Total property, plant, and equipment ................... 217,500 Total assets ..................................................................... $337,500 Liabilities and Partners' Equity Current liabilities Accounts payable ....................................................... $015,000 Salaries payable.......................................................... 7,500 Unearned fees ............................................................. 37,500 Bank loan .................................................................... 67,500 Current portion of note payable ................................ 5,000 Total current liabilities ........................................... 00132,500 Long-term liabilities Note payable, net of current portion ......................... 17,500 Total liabilities ........................................................ 150,000 Partners' equity G. Clay, Capital ........................................................... 175,000 M. Ogletree, Capital .................................................... 12,500 Total partners' equity ............................................. 187,500 Total liabilities and partners' equity ............................... $337,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-5B (Continued) (b) Sept. 30 Professional Fees ..................... Income Summary .................

675,000

30 Income Summary...................... Salaries Expense ................. Depreciation Expense.......... Interest Expense .................. Utilities Expense .................. Property Tax Expense ......... Supplies Expense ................

300,000

30 Income Summary...................... G. Clay, Capital..................... M. Ogletree, Capital..............

375,000

30 G. Clay, Capital ......................... M. Ogletree, Capital .................. G. Clay, Drawings ................ M. Ogletree, Drawings .........

150,000 150,000

675,000

225,000 22,500 5,000 25,000 15,000 7,500

250,000 125,000

150,000 150,000

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, 2011 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-6B (a) Oct. 1

A. Nolan, Capital ................................ 15,500 C. Santos, Capital ......................... 15,500

(b) Oct. 1

D. Elder, Capital ................................. 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-6B (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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Accounting Principles, Fifth Canadian Edition

PROBLEM 12-7B (a) Total capital after admission ................................... $234,000 Total capital before admission ................................ 200,000 Cash investment by S. Rafael .................................. $ 34,000 (b) Donatella has a 40% ownership in the new partnership. Donatella’s new capital account: = 40% × $234,000 = $93,600 Donatella’s share of bonus to new partner: = Old capital account − new capital account = $100,000 − $93,600 = $6,400 Donatella’s share of bonus: = 5 ÷ (5 + 3+ 2) = 5/10 = 50% If 50% of the bonus = $6,400, then Total bonus = $6,400 ÷ 50% = $12,800 (c) Bonus allocated as follows: Donatella $12,800 × 50% = $6,400 Liebovitz $12,800 × 30% = $3,840 Michaels $12,800 × 20% = $2,560 Investment by S. Rafael ................................... Bonus from old partners ................................... S. Dionne’s capital in partnership ...................

Donatella Liebovitz Michaels Rafael Total

Original Capital Accounts $100,000 60,000 40,000 $200,000

Bonus to New Partner $6,400 3,840 2,560 ______ $12,800

$34,000 12,800 $46,800

New Capital Accounts $93,600 56,160 37,440 46,800 $234,000

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Problem 12-7B (Continued)

Taking It Further: The percentage ownership interest of Donatella will not necessarily correspond to his share of the profits. The profits will be allocated in accordance with the agreement set by all partners.

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PROBLEM 12-8A (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 as dictated by the withdrawing partner.

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PROBLEM 12-9A (a)

G. Harper F. Chiconi M. Gauchon Total

Original Capital $ 96,000 64,000 48,000 $208,000

Bonus Paid $16,000 12,800 0 $28,800

New Capital $112,000 76,800 0 $188,800

F. Chiconi's capital after withdrawal ....................... F. Chiconi's capital before withdrawal .................... Bonus to Chiconi ......................................................

$76,800 64,000 $ 12,800

G. Harper’s profit and loss ratio with F. Chiconi .... Total bonus ($12,800 ÷ 4/9) ......................................

5:4 $28,800

Check: Bonus to G. Harper $28,800 × 5/9 = $16,000 Bonus to F. Chiconi $28,800 × 4/9 = $12,800 (b) G. Harper’s percentage ($112,000  $188,800) ....... F. Chiconi’s percentage ($76,800  $188,800) ........

59.32% 40.68%

(c) M. Gauchon’s capital balance ................................. Total bonus to other partners ($12,800 + $16,000) . Cash paid to M. Gauchon.........................................

$48,000 (28,800) $19,200

(d) Total bonus allocated to remaining partners: ($12,800 + $16,000) ..........................................

$28,800

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PROBLEM 12-9B (Continued) 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....................................................... 60,000 Allowance for Doubtful Accounts ....... 1,200 Accumulated Depreciation................... 6,600 Loss on Realization .............................. 28,800 Accounts Receivable ....................... Inventory ........................................... Equipment ........................................

30,000 41,400 25,200

Noncash assets (net)............................ $88,800 Sale proceeds ....................................... 60,000 Loss on sale of noncash assets .......... $28,800 2 L. Sciban, Capital ($28,800 × 5/10)....... 14,400 V. Subra, Capital ($28,800 × 3/10) ........ 8,640 C. Werier, Capital ($28,800 × 2/10) ....... 5,760 Loss on Realization .........................

28,800

(2) 4 Notes Payable ....................................... 16,200 Accounts Payable ................................. 32,400 Wages Payable ..................................... 4,560 Cash ..................................................

53,160

(3) 6 Cash....................................................... C, Werier, Capital ............................. ($3,840 – $5,760) = $1,920

1,920

(4) 9 L. Sciban, Capital ($39,600 – $14,400) . 25,200 V. Subra, Capital ($25,200 – $8,640) .... 16,560 Cash ..................................................

1,920

41,760

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PROBLEM 12-10B (Continued) (b) Cash Bal. 33,000 (1) 60,000 (3) 1,920

L. Sciban, Capital (2) 53,160 (4) 41,760

(2) 14,400 Bal. (4) 25,200

39,600

V. Subra, Capital (2) 8,640 Bal. (4) 16,560

C. Werier, Capital

25,200

(2)

5,760 Bal. (3)

3,840 1,920 0

(c) (1) June 9 L. Sciban, Capital ($1,920 × 5 ÷ 8) .... V. Subra, Capital ($1,920 × 3 ÷ 8) ...... C. Werier, Capital ..........................

1,200 720

(2) June 9 L. Sciban, Capital ($25,200 – $1,200) V. Subra, Capital ($16,560 – $720) .... Cash ...............................................

24,000 15,840

1,920

39,840

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. 2 Cash ............................................. 78,000 Accumulated Depreciation ......... 100,000 Gain on Disposal ..................... Office Equipment ....................

8,000 170,000

Office equipment (net).............................. Sale proceeds ........................................... Gain on Realization ..................................

$70,000 78,000 $ 8,000

M. Broski ($8,000 × ¼) .............................. B. Hazle ($8,000 × ¾) ................................

$2,000 6,000 $8,000

2 Gain on Disposal ......................... M. Broski, Capital .................... B. Hazle, Capital ......................

8,000 2,000 6,000

2 Accounts Payable........................ 110,000 Cash .........................................

110,000

2 M. Broski, Capital ($90,000 + $2,000) ........................ 92,000 B. Hazle, Capital ($30,000 + $6,000) ........................ 36,000 Cash ($160,000 + $78,000 – $110,000)

128,000

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PROBLEM 12-11B (Continued) (b) Sept. 2 Accumulated Depreciation ......... 100,000 Loss on Realization ..................... 70,000 Office Equipment ....................

170,000

Office equipment (net).............................. Sale proceeds ........................................... Loss on realization ..................................

$70,000 0 $70,000

Broski ($70,000 × ¼) ................................. Hazle ($70,000 × ¾) ...................................

$17,500 52,500 $70,000

2 M. Broski, Capital ........................ 17,500 B. Hazle, Capital........................... 52,500 Loss on Realization ................

70,000

2 Accounts Payable........................ 110,000 Cash .........................................

110,000

2 Cash ............................................. 22,500 B. Hazle, Capital ($30,000 – $52,500) .................

22,500

2 M. Broski, Capital ($90,000 – $17,500) ...................... 72,500 Cash ($160,000 – $110,000 + $22,500)

72,500

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PROBLEM 12-11B (Continued) (c) Sept. 2 Accumulated Depreciation ......... 100,000 Loss on Realization ..................... 70,000 Equipment ...............................

170,000

Office equipment (net).............................. Sale proceeds ........................................... Loss on Realizaiton ..................................

$70,000 0 $70,000

Broski ($70,000 × ¼) ................................. Hazle ($70,000 × ¾) ...................................

$17,500 52,500 $70,000

2 M. Broski, Capital ........................ 17,500 B. Hazle, Capital........................... 52,500 Loss on Realization ................

70,000

2 Accounts Payable........................ 110,000 Cash .........................................

110,000

2 M. Broski, Capital ........................ 22,500 B. Hazle, Capital ($30,000 – $52,500) .................

22,500

2 M. Broski, Capital ($90,000 – $17,500 – $22,500)...... 50,000 Cash ($160,000 – $110,000) ....

50,000

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) 2010 Feb. 14 Cash ....................................................... Furniture ................................................ I. Moreau, Capital .............................

9,000 15,000 24,000

14 Cash ....................................................... Office Equipment ................................... A. Krneta, Capital .............................

12,000 24,000

14 Cash ....................................................... Graphic Equipment ............................... Accounts Payable ............................ C. Fenandoe, Capital .......................

18,000 40,000

Dec. 20 I. Moreau, Drawings ($72,000 × 2/9)...... A. Krneta, 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. Moreau, Capital ($81,900 × 2/9) .... 18,200 A. Krneta, Capital ($81,900 × 3/9) .... 27,300 C. Fenandoe, Capital ($81,900 × 4/9) 36,400 MKF Marketing Capital Balances December 31, 2010 C. FeI. Moreau A. Krneta 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) 2011 Jan. 5

C. Fenandoe, Capital (1/2 × $52,400) .... C. Wells, Capital (2/6 × $15,000) .

26,200

Dec. 20 I. Moreau, Drawings ($91,800 × 2/9)...... A. Krneta, Drawings ($91,800 × 3/9) ..... C. Fenandoe, Drawings ($91,800 × 2/9) C. Wells, Drawings ($91,800 × 2/9) ....... Cash ..................................................

20,400 30,600 20,400 20,400

26,200

91,800

31 Income Summary................................... 103,050 I. Moreau, Capital ($103,050 × 2/9) .. A. Krneta, Capital ($103,050 × 3/9) .. C. Fenandoe, Capital ($103,050 × 2/9) C. Wells, Capital ($103,050 × 2/9) .... 2012 Jan. 2

C. Fenandoe, Capital ............................. I. Moreau, Capital ............................. A. Krneta, Capital ............................. C. Wells, Capital ............................... Cash ..................................................

22,900 34,350 22,900 22,900

28,700 900 1,350 900 25,550

Capital balance of withdrawing partner .................. $28,700 Payment to withdrawing partner ............................. 25,550 Bonus to remaining partners ................................... $ 3,150 Allocation of bonus: I. Moreau, Capital ($3,150 × 2/7).................. $900 A. Krneta, Capital ($3,150 × 3/7) ................. 1,350 C. Wells, Capital ($3,150 × 2/7) ................... 900, $3,150

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PROBLEM 12-12B (Continued) (b) MKFW MARKETING Statement of Partners’ Equity Year ending December 31, 2011

Capital January 1 Admission of partner Add: Profit Less: Drawing Capital, December 31

I. Moreau $26,200 22,900 49,100 20,400 $28,700

A. Krnetan $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, 2011 Withdrawal of partner Balance Jan. 2, 2012

Solutions Manual

I. Moreau

A. Krnetan

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

Chapter 12

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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. On the other hand, when the name of the withdrawing partner appears in the name of the partnership it becomes necessary to change the name. This is necessary to avoid the implication of that partner’s involvement, and consequently exposure to liability as a member of the partnership. The change would also be necessary for the name of the partner being admitted to the partnership.

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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 principle 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 $8,250. Total fair value of Cookie Creations’ net assets: ($10,000 + $800 + $1,200 + $1,000) Total fair value of K. Peterson’s (The Baker’s Nook) net assets: ($1,500 + $5,250 + $500 + $7,500 – $10,000) Difference

$13,000

4,750 $ 8,250

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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 November 1, 2011 Assets Current assets Cash............................................................................. Accounts receivable ................................................... Inventory ..................................................................... Total current assets ............................................... Property, plant, and equipment Equipment ................................................................... Total assets ............................................................

$19,750* 6,050 1,700 27,500 8,500 $36,000

Liabilities and Partners' Equity Current liabilities Bank loan payable ...................................................... Partners' equity K. Peterson, Capital ...................................... $13,000 N. Koebel, Capital ......................................... 13,000 Total liabilities and partners' equity...................... * Value of N. Koebel’s proprietorship net assets .......... Value of K. Peterson’s proprietorship net assets ....... Cash K. Peterson would have to borrow ..................... Cash from N. Koebel’s proprietorship ......................... Cash from K. Peterson’s proprietorship ...................... Total cash when partnership is formed .......................

$10,000

26,000 $36,000

$13,000 4,750 8,250 10,000 1,500 $19,750

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BYP 12-1 FINANCIAL REPORTING PROBLEM (a) The prime motivation for forming a corporation was likely to raise additional capital by issuing shares to the public. Limited liability may have also been a welcome feature of the corporate form of organization. (b) When a partnership is liquidated, the following steps are required: 1. Sell the noncash assets for cash and recognize any gain or loss on realization. 2. Allocate any gain or loss on realization to the partners, based on their profit and loss ratios. 3. Pay partnership liabilities in cash. 4. Distribute the remaining cash to the partners, based on their capital balances. (c) The assets and liabilities would be transferred to the corporation at their fair values as of the transfer date. Accounts receivable and the allowance for doubtful accounts would be recorded at the net realizable value of the receivables. Amortizable assets would be recorded at their current values. No accumulated depreciation would be recorded at the time of the transfer. (d) Balance Sheet: The equity section of the balance sheet would be different. It would be called Partnership Equity instead of Shareholders’ Equity. Each partner’s capital account balance would be listed, in place of Contributed Capital and Retained Earnings. Statements of Operations and Retained 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. The Retained Earnings section would be replaced by a Statement of Partner’s Equity.

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BYP12-1 (Continued) (d) (Continued) Statement of Cash Flows: There would be no difference.

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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 partners also maintain control of the day-to-day operations. (b) The Limited Partners liability is restricted to the dollar amount of the original investment less the Limited Partner’s share of the deficit which equals $1,692,704.

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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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BYP12-4 (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.

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BYP12-6 (Continued) (d) (Continued) 4. Money might be used to finance the band which might have been spent by one band member compared to others. (e)

Should one of the band member want to leave, the issues that could come up 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.

(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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BYP12-6 (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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Legal Notice Copyright

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CHAPTER 13 Corporations: Organization and Share Capital Transactions

ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

1. Identify and discuss the major characteristics of the corporate form of organization.

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

2. Record common share transactions. 3. Record preferred share transactions.

Problems Brief Set A Exercises Exercises

Problems Set B

1, 2

1, 2, 8

11, 12, 13, 3, 4, 5, 6 14, 15

3, 4, 5, 8, 11

2, 5, 6, 7, 8, 12

16, 17, 18, 7, 8, 9 19

4, 5, 6, 7, 8, 11

3, 4, 5, 6, 7, 8, 12

4. Prepare the 20, 21, 22, 10, 11, shareholders’ equity 23, 24 12, 13 section of the balance sheet and calculate return on equity.

8, 9, 10, 11

5, 6, 7, 8, 9, 10, 11, 12

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine form of business organization.

Simple

15-20

Determine impact of reacquired shares.

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

Show impact of transactions on accounts.

Simple

25-30

Record and post transactions. Prepare shareholders’ equity section.

Moderate

45-60

Record and post transactions. Prepare shareholders’ equity section.

Moderate

40-50

Record and post transactions. Prepare shareholders’ equity section.

Moderate

50-60

Record closing entries and prepare balance sheet.

Simple

30-40

10A

Prepare balance sheet and calculate return on equity.

Simple

25-35

11A

Calculate return on equity.

Simple

10-15

12A

Answer questions about shareholders’ equity section.

Simple

15-20

Identify and discuss major characteristics of a corporation.

Simple

15-20

Determine impact of reacquired shares.

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

Show impact of transactions on accounts.

Simple

25-30

Record and post transactions. Prepare shareholders’ equity section.

Moderate

45-60

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record and post transactions. Prepare shareholders’ equity section.

Moderate

40-50

Record and post transactions. Prepare shareholders’ equity section.

Moderate

50-60

Record closing entries and prepare balance sheet.

Simple

30-40

10B

Prepare balance sheet and calculate return on equity.

Simple

25-35

11B

Calculate return on equity.

Simple

10-15

12B

Answer questions about shareholders’ equity section.

Simple

15-20

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material. Study Objectives 1.

Identify and discuss the major characteristics of the corporate form of organization.

Record common share transactions.

Record preferred share transactions.

Prepare the shareholders’ equity section of the balance sheet and calculate return on equity.

Broadening Your Perspective

Knowledge

Comprehension Q13-1 Q13-2 Q13-3 Q13-4 Q13-5 Q13-6 Q13-7 Q13-8 BE13-1 E13-8 Q13-12 Q13-13 Q13-14 Q13-15 E13-8

Q13-16 Q13-17 Q13-18 Q13-19 E13-8

Q13-20 Q13-22

Application Q13-9 Q13-10 BE13-2 E13-2

Q13-11 BE13-3 BE13-4 BE13-5 BE13-6 E13-3 E13-4 E13-5 P13-2A P13-5A BE13-7 BE13-8 BE13-9 E13-4 E13-5 E13-6 E13-7 P13-3A P13-4A P13-5A

Analysis

Synthesis

E13-1 P13-1A P13-1B

P13-6A P13-7A P13-8A P13-12A P13-2B P13-5B P13-6B P13-7B P13-8B P13-12B P13-6A P13-7A P13-8A P13-12A P13-3B P13-4B P13-5B P13-6B P13-7B P13-8B P13-12B P13-8A P13-9A P13-10A P13-11A P13-12A P13-5B P13-6B P13-7B P13-8B P13-9B P13-10B P13-11B P13-12B

Q13-21 Q13-23 Q13-24 E13-8

BE13-10 BE13-11 BE13-12 BE13-13 E13-9 E13-10 P13-5A P13-6A P13-7A

BYP13-1 BYP13-3

BYP13-2 Continuing Cookie Chronicle

E13-11

BYP13-4

BYP13-5 BYP13-6

Evaluation

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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 The Forzani Group 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) Bonus payments from a corporation must take the form of either dividends or salaries. If the payment is considered a dividend then the corporation must pay the same amount for each share. The amount an individual shareholder will receive depends on the number of shares he or she owns. Although efficient, a divided might not result in the amounts distributed to the owners to be in the proportion management intended. In order for the bonus to be treated as salaries it must be paid as part of an employment or “payment for services” relationship. It is not clear if all the owners participate in the running of the business. A bonus might not be allowed for all owners under taxation rules.

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QUESTIONS (Continued) Question 3 (Continued) (b) A bonus from a corporation, whether paid as a dividend or salaries, would be added to the owners’ tax return as part of their profit from various sources and would be fully taxable. Drawings from a partnership are not taxable; rather the profit generated by the partnership, and allocated to the partners in accordance with their agreement, is taxable on his/her tax return, regardless of the amount of drawings taken during the year. 4.

Small, privately held corporations are riskier than large publicly held ones. As a result, 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.

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. 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.

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. 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.

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QUESTIONS (Continued) 7.

(a) Retained earnings is earned capital that has been retained for future use and is kept in the corporation. Retained earnings is the maximum amount that can be paid as dividends. (b) Contributed capital or share capital is capital that has been contributed by the shareholders that must remain in the corporation, unless shares are reacquired, to protect creditors. It is unavailable for dividends.

Articles of incorporation usually include the name and purpose of the corporation, the amounts and kinds of share capital to be authorized and the number of shares (usually an unlimited number of shares), the characteristics and restrictions on the classes of share capital (i.e. cumulative, convertible, redeemable, retractable), the names and addresses of the incorporators, and the location of the corporation’s head office.

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.

10. There will be no impact on Open Text Corp.’s financial statements at the time of the share price increase. However, should Open Text decide it would like to raise capital in the securities market, the price increase means it will need to sell fewer shares to raise the same amount of money. 11. When shares are issued for services or noncash assets, the cost should be measured at the fair market value of the asset received (the truck). If that value cannot be reasonably determined, then the fair market value of the consideration given should be used (the shares). Therefore, the truck should be recorded at $22,000.

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QUESTIONS (Continued) 12. A corporation may acquire its own shares: (1) to increase trading of the company's shares in the securities market in the hope of enhancing its market value, (2) to increase earnings per share by reducing the number of shares issued, (3) to eliminate hostile shareholders by buying them out, (4) to have additional shares available to be reissued to officers and employees under bonus and stock compensation plans, or for use in the acquisition of other companies, and (5) to comply with percentage share ownership requirements. 13. This transaction: (a) decreases total assets, (b) has no effect on total liabilities and, (c) decreases total shareholders' equity. 14. If the reacquisition price is less than the average cost, the difference is considered “paid-in” capital belonging to the remaining shareholders. This amount is reported as contributed capital from share reacquisition in the share capital section of shareholders’ equity. If the reacquisition price is more than the average cost, the difference can be paid out of contributed capital from the same class of shares to the extent of any pre-existing balance in the contributed capital account, and then from retained earnings. 15. If there have been gains from similar transactions in the past, the resulting credit balance of the contributed capital account is available to absorb some or all of the loss on reacquisition. However, the balance of the contributed capital account cannot go below zero. If the loss exceeds the balance in the contributed capital account, the excess amount is debited to retained earnings. 16. Preferred shareholders typically have a preference as to dividends and as to assets in the event of liquidation. They may also have priority for reacquisition if they are redeemable or retractable. 17. 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. 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.

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QUESTIONS (Continued) 18. (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. 19. 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 into the appropriate 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. 20. The three main components of shareholders' equity are: Contributed capital, Retained earnings, and Accumulated other comprehensive income (loss). Contributed capital represents the amounts contributed by the shareholders. Share capital and additional contributed capital (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 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.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 21. The answers are summarized in the table below: Account (a) (b) (c) (d) (e)

Common Shares Retained Earnings Contributed Capital – Reacquisition of Shares Accumulated Other Comprehensive Income Preferred Shares

Classification Share capital—common shares Retained earnings Additional contributed capital Accumulated other comprehensive income Share capital—preferred shares

22. Comprehensive income includes all changes in shareholders’ equity during a period except for changes that result from the sale or repurchase of shares or from the payment of dividends. Accumulated other comprehensive income is reported separately from retained earnings to distinguish unrealized gains and losses from realized gains and losses and other sources of earned profit that are accumulated in retained earnings. Reporting this information separately insulates profit, and consequently retained earnings, from fluctuations in fair value while still informing users of the gain or loss that could have occurred had the investment been sold. 23. Company 1 would be a better investment since it can generate the same amount of profit using a small 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% and Company 2: $100,000 / $350,000 = 28.6%. 24. 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, Fifth 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. Income taxes X 5. Ability to acquire X X capital 6. Shared skills and X resources 7. Fewer government X X regulations 8. Separation of ownership and X management 9. Owners’ acts are X X binding 10. Ease of transfer of X ownership rights

BRIEF EXERCISE 13-2 The Vice President is incorrect. The increase in share price will have no impact on Victory Sports Ltd.’s financial position. The balance sheet will be unchanged since the shares are listed at their issue price, not their current fair value. On the other hand, the increased market valuation of the business would enable Victory Sports to raise funds more easily. The shareholders would see the value of their investment increase and could realize gains by selling some or all of their shares.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 13-3 (a) Aug.

Sep. 10

Cash (1,000 × $15) ......................... Common Shares .......................

15,000

Cash (500 × $17) ............................ Common Shares .......................

8,500

15,000

8,500

(b) Average cost per share: ($15,000 + $8,500) ÷ (1,000 + 500) = $15.67

BRIEF EXERCISE 13-4 (a) Mar.

Apr. 20

Cash (3,000 × $18) ......................... Common Shares .......................

54,000

Land ............................................... Common Shares .......................

125,000

54,000

125,000

(b) Yes. If the fair value of the land received cannot be reliably measured, the fair value of the shares would be used. Land would therefore be valued at 5,500 shares × $22 = $121,000.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 13-5 (a) Average Repurchase Price = $6.72 ($3,000,000 + $1,000,000) ÷ 595,500 shares (b) Initial Average Issue Price = $5.04 $3,000,000 ÷ 595,500 shares (c) Cascades may have repurchased some of its own shares (1) to increase trading of the company's shares in the stock market, in the hopes of enhancing its market value, (2) to reduce the number of shares issued and increase earnings per share, or (3) to comply with percentage share ownership requirements. Some companies have been repurchasing their own shares lately because they have excess cash on hand and no better investments available.

BRIEF EXERCISE 13-6 (a) Feb. 15

(b) Feb. 15

Common Shares (4,000 × $4.00*) .... 16,000 Contributed Capital— Reacquisition of Common Shares Cash .............................................

2,000 14,000

Common Shares (4,000 × $4.00*) .... 16,000 Retained Earnings............................ 2,000 Cash .............................................

18,000

*Average share price = $100,000 ÷ 25,000 shares = $4.00

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 13-7 (a) Mar. 18

Apr.

Cash (1,000 × $100) ...................... Preferred Shares......................

100,000

Cash (1,500 × $125) ...................... Preferred Shares......................

187,500

100,000

187,500

(b) Average cost per share: $115.00 ($100,000 + $187,500) ÷ (1,000 + 1,500)

BRIEF EXERCISE 13-8 (a) May 10

(b) Nov. 21

Cash (25,000 × $25) ...................... Preferred Shares......................

625,000

Preferred Shares (5,000 × $25) .... Common Shares ...................... (10,000 shares)

125,000

625,000

125,000

BRIEF EXERCISE 13-9 (a) Dividends are in arrears by $80,000 (40,000 × $2). (b) If the shares were noncumulative, there would be no dividends in arrears.

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BRIEF EXERCISE 13-10 TRUE GREEN NURSERIES LTD. Balance Sheet (Partial) December 31, 2011

Shareholders' equity Contributed capital Share capital $7-noncumulative preferred shares, no par value, unlimited number of shares authorized, 900 shares issued $ 23,400 Common shares, no par value, unlimited number of shares authorized, 10,000 shares issued 100,000 Total share capital 123,400 Additional contributed capital Contributed capital—reacquisition of common shares 8,000 Total contributed capital 131,400 Retained earnings 45,000 Total shareholders' equity $176,400

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BRIEF EXERCISE 13-11 (a) TRUE GREEN NURSERIES LTD. Balance Sheet (Partial) December 31, 2011

Shareholders' equity Contributed capital Share capital $7-noncumulative preferred shares, no par value, unlimited number of shares authorized, 900 shares issued ............................................... $ 23,400 Common shares, no par value, unlimited number of shares authorized, 10,000 shares issued .......................................... 100,000 Total share capital ............................................ 123,400 Additional contributed capital Contributed capital—reacquisition of common shares.................................................... 8,000 Total contributed capital ................................................ 131,400 Retained earnings .......................................................... 45,000 Accumulated other comprehensive income ................ 12,000 Total shareholders' equity ........................................ $188,400 (b) Total shareholders’ equity would be $164,400 ($176,400 − $12,000)

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 13-12 Dec. 31

Revenues ...................................... Income Summary.....................

850,000

Income Summary ......................... Expenses..................................

600,000

Income Summary ......................... Retained Earnings ...................

250,000

Retained Earnings........................ Dividends .................................

75,000

850,000

600,000

250,000

75,000

BRIEF EXERCISE 13-13 (a) Return on equity $64,936 ($635,043 + $708,340) ÷ 2 (b)

= 9.67%

It would be the same.

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SOLUTIONS TO EXERCISES EXERCISE 13-1 (a) High $12.00 Low $6.54 (b) $0.16 (c) 1,000 × $8.48 = $8,480 (d) $8.48 + $0.04 = $8.52 (closing price + change) (e) 317 × 100 = 31,700 shares (f)

Since the share price is up $1.94 over the 365-day low ($8.48 − $6.54), a 29.7% increase, investors are probably looking primarily for capital appreciation. Also the dividend yield is 1.9% which is relatively low. This indicates that shareholders are less likely to purchase this stock for the purpose of dividend income.

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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 the hiring of professional managers will signify a less active role in the business on your part as is currently the case.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 13-3 1.

Aug. 7 Equipment (10,000 × $12) ........ Common Shares .................

120,000

Sept. 21 Land.......................................... Common Shares .................

220,000

120,000

220,000

EXERCISE 13-4 (a) June 12 Cash (50,000 × $5) ................... Common Shares .................

250,000

July 11 Cash (1,000 × $25) ................... Preferred Shares .................

25,000

Oct.

1 Land.......................................... Common Shares .................

65,000

Nov. 15 Cash (1,500 × $30) ................... Preferred Shares .................

45,000

250,000

25,000

65,000

45,000

(b) (1) The average cost for the preferred shares is $28 ($25,000 + $45,000)  (1,000 + 1,500). (2) The average cost for the common shares is $5.25 ($250,000 + $65,000)  (50,000 + 10,000).

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EXERCISE 13-5 (a) Jan. 6 Cash ......................................... Common Shares ................. (200,000 shares × $1.50)

300,000

12 Cash ......................................... Common Shares ................. (50,000 shares × $1.75)

87,500

Mar. 17 Cash ......................................... Preferred Shares ................. (1,000 shares × $105)

105,000

300,000

87,500

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 Capital— 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 13-5 (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

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 (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 ÷ 8 = $13.75 each. This occurs on June 16th. On June 20th, the fair value of the common shares is in excess of $13.75. Therefore if the preferred shares had not already converted, they would also be willing to convert on that day. (b) June 16 Preferred Shares...................... 11,000,000 Common Shares ................. 11,000,000 100,000 × $110 = $11,000,000

EXERCISE 13-8 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m)

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

Retractable preferred shares Publicly held corporation Redeemable preferred shares Authorized shares Issued shares Initial public offering Secondary market Retained earnings Liquidation preference Comprehensive income Contributed capital Convertible Cumulative

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EXERCISE 13-9 Shareholders’ Equity Account Share Capital

Additional Contributed Capital

Retained Earnings

Other Accumulated Other Comprehensive Income

1. Cash 2. Common shares 3. Contributed capital— reacquisition of common shares 4. Gain on sale of property, plant, and equipment 5. Long-term equity investments 6. Gain on equity investments (other comprehensive income) 7. Preferred shares 8. Retained earnings 9. Legal fees expense 10. Dividends Solutions Manual

Financial Statement

Classification

Balance Sheet

Current Assets

Income Statement

Other Revenue (Gain)

Balance Sheet

Long-term Investments

Income Statement

Operating Expense

X X

Chapter 13

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EXERCISE 13-10 OZABAL INC. Partial Balance Sheet December 31, 2011

Shareholders' equity Contributed capital Share capital Preferred shares $4-noncumulative, no par value, 100,000 shares authorized, 30,000 issued ..................................................... $ 150,000 Common shares, no par value, unlimited number of shares authorized, 300,000 shares issued ..................................................... 150,000 Total share capital ........................................... 300,000 Contributed capital—reacquisition of common shares ...................................................... 25,000 Total contributed capital ............................................... 325,000 Retained earnings ......................................................... 900,000 Accumulated other comprehensive income ............... 75,000 Total shareholders’ equity ....................................... $1,300,000

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EXERCISE 13-11 (a) The average cost of the preferred shares is $55 ($825,000  15,000 = $55). The average cost of the common shares is $4 ($2,600,000  650,000 = $4). (b) It will be able to sell an additional 150,000 common shares (800,000 authorized − 650,000 issued). (c) The company paid $2.50 per share, for a total of $250,000. $150,000  100,000 = $1.50 per share was credited to contributed capital. The average issue price of $4 per share was debited to the common shares account. The difference, $2.50 was the price paid per share. Common Shares ..................................... 400,000 Contributed Capital—Reacquisition of Common Shares ............................ Cash ..................................................

150,000 250,000

(d) $4 × 15,000 = $60,000. (e) The retained earnings balance would be $2,019,000 ($1,959,000 + $60,000 dividends which were not paid nor declared). Dividends in arrears are only disclosed in the notes to the financial statements.

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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, Fifth 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-2A (a) Shares authorized Shares issued

1,000,000 437,000

(b) Common shares Contributed capital—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. capital Number issue —reacq. of of shares price common (b) (a) ÷ (b) shares

$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 000000 0 $719,420

3.08 3.09 3.09 3.09

720,000

(1) (10,000 x $3.08) − (10,000 ×$3) = $30,800 − $30,000 = $800 (2) (18,000 x $3.09) − (18,000 x $4) = $55,620 − $72,000 = $(16,380). A maximum of $15,800 is deducted from contributed capital; the remainder, $580, is deducted from retained earnings. (3) (75,000 x $3.09) – (75,000 x $3) = $231,750 − $225,000 = $6,750

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-1B (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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-4A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

2010 Jan. 10 Cash Dividends—Preferred ............... 12,000 Cash................................................

12,000

2011 Jan. 10 Cash Dividends—Preferred* .............. 68,000 Cash Dividends—Common ............... 4,000 Cash................................................

72,000

* Arrears from 2010: 2010 Dividend: (8,000 × $5) ............ $40,000 Less: Dividend paid in 2010 ............ 12,000 Current year dividend (8,000 × $5) ........... Cash Dividend to Preferred.......................

$28,000 40,000 $68,000

Mar. 1 Preferred Shares ............................... 528,000 Common Shares ............................ (8,000 × $66)

528,000

(b) The company needs to disclose dividends in arrears in the amount of $28,000 in 2010 in the notes to the financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-4A (Continued) Taking It Further: 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 shareholders 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 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-5A Shareholders' Equity Assets

Liabilities

Preferred Shares

+$23,550

n/a

Accumulated Other Common Retained Other Contributed Shares Earnings Comprehensive Capital Income +$23,550 n/a n/a n/a

−200,000

n/a

−160,500

−$30,000

−$9,500

n/a

−$70,000

+70,000

n/a

+25,500

n/a

+25,500

n/a

+7,500

n/a

+7,500

n/a

−15,000

n/a

−15,000

n/a

+2,500

n/a

+$2,500

2. Average share price = ($2,400,000 + $23,550) ÷ (150,000 + 1,000) = $16.05 3. $350,000 ÷ 5,000 = $70; $70 × 1,000 = $70,000 At the end of the fiscal year there are dividend arrears in the amount of $1,400. (5,000 – 1,000 + 100) = 4,100 preferred shares x $4 = $16,400 – $15,000 = $1,400

Solutions Manual

Chapter 13

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-5A (Continued) Taking It Further: 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. The conversion feature gives investors the choice to participate in the company’s growth by converting their preferred shares into common shares. Since these two features make the shares more attractive, they also result in a higher price for the shares.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6A

(a) Date

GENERAL JOURNAL 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 .................................................... 95,000 Common Shares ............................

95,000

Jun. 20 Cash (78,000 × $4.50) ......................... 351,000 Common Shares ............................

351,000

Aug. 1 Legal Fees Expense ........................... 50,000 Common Shares ............................

50,000

Sep. 1 Cash (10,000 × $5) .............................. 50,000 Common Shares ............................

50,000

Nov. 1 Cash (1,000 × $117) ............................ 117,000 Preferred Shares ............................

117,000

Jan. 31 Income Summary ............................... 500,000 Retained Earnings .........................

500,000

31 Dividends—Preferred......................... 24,000 Cash................................................

24,000

31 Retained Earnings .............................. 24,000 Dividends—Preferred ....................

24,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6A (Continued) (b) Preferred Shares Date Mar. Nov.

Explanation 1 1

Ref.

Debit

J1 J1

Credit

Balance

575,000 117,000

575,000 692,000

Credit

Balance

320,000 95,000 351,000 50,000 50,000

320,000 415,000 766,000 816,000 866,000

Credit

Balance

Common Shares Date

Explanation

Feb. 10 Apr. 1 June 20 Aug. 1 Sept. 1

Ref.

Debit

J1 J1 J1 J1 J1

Dividends—Preferred Date Jan. 31 31

Explanation

Ref.

Debit

Closing entry

J1 J1

24,000

Debit

24,000

24,000 0

Retained Earnings Date

Explanation

Ref.

Jan. 31 31

Closing entry Closing entry

J1 J1

24,000

Credit

Balance

500,000

500,000 476,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6A (Continued)

(c) WETLAND CORPORATION Balance Sheet (Partial) January 31, 2011 _____________________________________________________ Shareholders' equity Share capital $6-noncumulative preferred shares, no par value, unlimited number of shares authorized, 6,000* shares issued ............................................ $ 692,000 Common shares, no par value, unlimited number of shares authorized, 200,000** shares issued 866,000 Total share capital ...................................................... 1,558,000 Retained earnings....................................................... 476,000 Total shareholders’ equity ....................................... $2,034,000 *5,000 + 1,000 = 6,000 shares **80,000 + 22,000 + 78,000 + 10,000 + 10,000 = 200,000 shares

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6A (Continued) Taking It Further: Investors that buy preferred shares usually do so with the expectation of receiving annual dividends. The dividend feature of preferred shares is considered the advantage gained in exchange for voting rights. Non-payment of dividends on preferred shares would reduce a company’s preferred share price since investors would not have confidence in the company’s ability to pay future dividends. The impact would not necessarily be the same on common shares since investments in common shares also increase in value based on the company’s growth and economic conditions. For companies with regular dividends, non-payment of dividends would likely decrease the stock price of common shares, but not as significantly as for preferred shares. Examples of situations where dividends would not be paid are as follows: • if the company has a shortage of cash; • if paying the dividend breached covenants of loan agreements: • if the company did not have sufficient retained earnings from which to pay dividends.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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

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

Closing entry j

J1 J1 J1 J1

100,000 100,000 100,000 300,000

100,000 200,000 300,000 0

Explanation

Ref.

Debit

Credit

Balance

275,000

Closing entry

J1 J1

275,000 0

Cash Dividends—Common Date Nov. 1 Dec. 31

275,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-7A (Continued) (b) (Continued) Retained Earnings Date

Explanation

Ref.

Jan. 1 Dec. 31 31

Balance Closing entry Closing entry

✓ J1 J1

Debit

Credit

100,000 575,000

Balance 1,800,000 1,700,000 1,125,000

(c) SCHIPPER LTD. Balance Sheet (Partial) December 31, 2011 _______________________________________________________ Shareholders' equity Share capital $4-noncumulative preferred shares, no par value, unlimited number of shares authorized, 100,000 shares issued ..................................... $5,000,000 Common shares, no par value, unlimited number of shares authorized, 1,100,000* shares issued 1,670,000 Total share capital ................................................ 6,670,000 Retained earnings..................................................... 1,125,000 Accumulated other comprehensive income (loss). (25,000) Total shareholders’ equity .............................. $7,770,000 *1,000,000 + 100,000 = 1,100,000 common shares No disclosure of arrears is required since the preferred shares are noncumulative. Taking It Further: The final decision about the payment and amount of dividends is the responsibility of the board of directors of the corporation.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

Feb. 28 Cash ................................................. Preferred Shares ..........................

J1 Debit

Credit

150,000 150,000

Apr. 12 Cash ................................................. 3,200,000 Common Shares .......................... 3,200,000 May 25 Land ................................................. Common Shares ..........................

75,000 75,000

Sep. 12 Common Shares (75,000 × $15.73*) 1,179,750 Retained Earnings ........................... 95,250 Cash .............................................. 1,275,000 * Average cost of common shares: ($1,050,000 + $3,200,000 + $75,000)  (70,000 + 200,000 + 5,000) = $15.73 Jan. 1 Cash Dividends—Preferred ............ Cash [(8,000 + 2,400) × $2.50]......

26,000

Jan. 31 Retained Earnings ........................... Income Summary .........................

5,000

Jan. 31 Retained Earnings ........................... Cash Dividends—Preferred .........

26,000

5,000

26,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8A (Continued) (b) Preferred Shares Date

Explanation

Ref.

Feb. 1 Feb. 28

Balance

✓ J1

Debit

Credit

Balance

440,000 150,000 590,000

Common Shares Date

Explanation

Ref.

Feb. 1 Apr. 12 May 25 Sep. 12

Balance

✓ J1 J1 J1

Debit

Credit

Balance

1,050,000 3,200,000 4,250,000 75,000 4,325,000 3,145,250 1,179,750

Contributed Capital—Reacquisition of Preferred Shares Date Feb.

Explanation

Ref.

Balance

✓

Debit

Credit

Balance 75,000

Retained Earnings Date

Explanation

Ref.

Feb. 1 Balance Sep. 12 Jan. 31 Closing Entry Jan. 31 Closing Entry

✓ J1 J1 J1

Debit

Credit

Balance 1,000,000 904,750 899,750 873,750

95,250 5,000 26,000

Accumulated Other Comprehensive Income Date Feb.

Explanation

Ref.

Balance

✓

Debit

Credit

Balance 65,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8A (Continued) (b) (Continued) Cash Dividends—Preferred Date Jan. 1 Jan. 31

Explanation

Ref.

Debit 26,000

Closing entry

J1 J1

Credit

Balance 26,000 0 26,000

(c) CATTRALL CORPORATION Balance Sheet (Partial) January 31, 2012 ______________________________________________________ Shareholders' equity Contributed capital Share capital $5 noncumulative preferred shares, no par value, unlimited shares authorized, 10,400* shares issued ........................................ $ 590,000 Common shares, no par value, unlimited shares authorized, 200,000** shares issued ................. 3,145,250 Total share capital ................................................ 3,735,250 Additional contributed capital Contributed capital − reacquisition of preferred shares ................................................. 75,000 Total contributed capital .......................................... 3,810,250 Retained earnings..................................................... 873,750 Accumulated other comprehensive income ........... 65,000 Total shareholders’ equity ............................................ $4,749,000 * 8,000 + 2,400 = 10,400 preferred shares ** 70,000 + 200,000 + 5,000 − 75,000 = 200,000 common shares No disclosure of arrears is required since the preferred shares are noncumulative.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8A (Continued) Taking It Further: Redeemable preferred shares give the issuing corporation the right to repurchase the shares from the shareholders. Retractable shares give the shareholder the right to demand repurchase of the shares. These transactions usually take place at specified dates and prices. Investor would usually pay more for retractable preferred shares since the shareholder requests the repurchase; this gives the shareholder the option of keeping the preferred shares in order to receive future dividends and any capital appreciation on the market price of the shares.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-9A (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Dec. 31 Sales Revenue ................................. Income Summary .........................

614,600

31 Income Summary ............................ Salaries Expense ......................... Cost of Goods Sold ..................... Depreciation Expense.................. Interest Expense .......................... Rent Expense ............................... Income Tax Expense ................... Utilities Expense .......................... Insurance Expense ...................... Supplies Expense ........................

521,800

31 Income Summary ............................ Retained Earnings .......................

92,800

31 Retained Earnings ........................... Dividends......................................

12,000

Credit 614,600

161,000 159,000 80,000 29,500 37,000 26,700 15,200 7,800 5,600

92,800

12,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-9A (Continued) (b) MUSKOKA MANUFACTURING LTD. Balance Sheet December 31, 2011 ______________________________________________________ Assets Current assets Cash............................................................................. $ 18,000 Accounts receivable ................................................... 55,000 Inventory ..................................................................... 82,000 Prepaid insurance....................................................... 4,000 Supplies....................................................................... 5,000 Total current assets ............................................... 164,000 Property, plant, and equipment Land ............................................................ $120,000 Building .................................. $550,000 Accumulated depreciation .... (80,000) 470,000 Equipment .............................. $300,000 Accumulated depreciation .... (87,000) 213,000 Total property, plant, and equipment ................... 803,000 Total assets ........................................................ $967,000 Liabilities and Shareholders’ Equity Current liabilities Accounts payable ....................................................... $ 52,000 Salaries payable.......................................................... 7,500 Interest payable .......................................................... 3,200 Income tax payable ..................................................... 8,300 Unearned sales revenue............................................. 21,000 Current portion of long-term debt ............................. 12,000 Total current liabilities ........................................... 104,000 Long-term debt Long-term mortgage, net of current portion ............. 318,000 Total liabilities ........................................................ 422,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-9A (Continued) (b) (Continued) MUSKOKA MANUFACTURING LTD. Balance Sheet December 31, 2011 ______________________________________________________ Shareholders’ equity Contributed capital Share capital $4 noncumulative preferred shares, unlimited authorized, 4,000 issued ...................................... 80,000 Common shares, unlimited authorized, 120,000 issued ...................................................... 180,000 Total share capital .................................................. 260,000 Contributed capital Reacquisition of common shares ......................... 9,000 Total contributed capital ............................................... 269,000 Retained earnings* ........................................................ 253,800 Accumulated other comprehensive income ................ 22,200 Total shareholders’ equity .............................................. 545,000 Total liabilities and shareholders’ equity ............. $967,000

*Retained earnings Balance, Jan. 1..................................... $173,000 Add: Profit ............................................ 92,800 Less: Dividends ................................... (12,000) Balance, Dec. 31 .................................. $253,800

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-10A (a) BRICK BREWING CO. LIMITED Balance Sheet January 31, 2009 ______________________________________________________ Assets Current assets Cash ......................................................................... $ 209,291 Accounts receivable ................................................ 2,096,781 Inventories ............................................................... 5,309,474 Future income taxes recoverable ........................... 522,338 Prepaid expenses .................................................... 507,518 Total current assets ............................................ 8,645,402 Property, plant, and equipment ....... $32,324,718 Less: Accumulated depreciation ..... (18,801,998) Total property, plant, and equipment 13,522,720 Trademarks and other intangibles .............................. 5,401,314 Deferred costs and other assets ................................. 419,220 Future income taxes ................................................... 547,030 Total assets .............................................................. $28,535,686 Liabilities and Shareholders’ Equity Current liabilities Accounts payable and accrued liabilities .............. $ 3,846,187 Other current liabilities............................................ 270,758 Current portion of long-term debt and obligations under capital lease .............................................. 1,343,282 Total current liabilities ........................................ 5,460,227 Long-term debt ............................................................. 2,067,900 Total liabilities .......................................................... 7,528,127

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-10A (Continued) (a) (Continued) BRICK BREWING CO. LIMITED Balance Sheet January 31, 2009 ______________________________________________________ Shareholders’ equity Contributed capital Common shares, unlimited authorized, 28,057,010 issued ........................................... $34,657,984 Contributed surplus ............................................ 673,593 Total contributed capital............................ 35,331,577 Deficit* ...................................................................... (14,324,018) Total shareholders’ equity .................................. 21,007,559 Total liabilities and shareholders’ equity ............... $28,535,686 *$(6,852,240) + $(7,471,778) = $(14,324,018) (b) Return on equity = Profit ÷ Average shareholders’ equity $(7,471,778) ($25,311,285 + $21,007,559) ÷ 2

= (32.26)%

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-11A (a) Return on equity = Profit ÷ Average shareholders’ equity 2009

$374.2 ($3,568.1 + $3,108.1) ÷ 2

= 11.21%

2008

$411.7 ($3,108.1 + $2,785.2) ÷ 2

= 13.97%

Canadian Tire’s return on equity has deteriorated during the last year. (b) Canadian Tire’s return on equity exceeds the industry average during both years.

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. No change to the formula would be required. If however, shareholders’ equity is in a deficit position (a negative balance) and the company is generating losses rather than profit, the return on equity would show a positive number. This can be misleading to users. The formula is no longer useful as a measurement since the company is generating losses that increase the deficit position.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-12A (a) $1,200,000 ÷ 12,000 = $100 average cost of the preferred shares. $1,000,000 ÷ 100,000 = $10 average cost of the common shares. (b) It appears that there were no dividends declared in 2011 since there was no decrease in retained earnings during the year. (c) Since the preferred shares are noncumulative, there are no dividends in arrears. (d) The shares were issued for an average selling price of $10 (see (a) above) which means the company would have reduced the common share account by $200,000 (20,000 × $10). Since the company has established a contributed capital account related to this reacquisition for $40,000, this indicates the company only had to pay $160,000 ($200,000 − $40,000) to reacquire the 20,000 shares. (e) It is income that bypasses the income statement. An example of accumulated other comprehensive income is unrealized gains on certain types of equity investments.

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 13-2B (a) Shares authorized Shares issued

150,000 15,300

(b) Common shares Contributed capital − reacquisition of common shares Retained earnings

$597,292 $4,560 $203,848

Calculations: Contributed Number Average capital— Common of issue reacquisition shares shares price of common (a) (b) (a) ÷ (b) shares Bal 1. 2. 3. 4. 5.

$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

Retained earnings $220,000

35.00

$12,000 (1) (5,400) 6,600

37.54

6,600

220,000

39.04

6,600 (2) (6,600) 0 (3) 4,560 $ 4,560

220,000 (16,152) 203,848 0000000 $203,848

39.04 39.04

220,000

(1) (600 × $35) – (600 x $44) = $21,000 – $26,400 = $(5,400) (2) (1,200 x $39.04) – (1,200 x $58) = $46,848 − $69,600 = $(22,752). A maximum of $6,600 is deducted from contributed capital; the remainder, $16,152, is deducted from retained earnings. (3) (1,500 x $39.04) – (1,500 x $36) = $58,560 − $54,000 = $4,560

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-2B (Continued) Taking It Further: The number of shares authorized reflects the company’s plans for the future. If a company is organized and plans to remain a small closely-held corporation, there is no need to authorize an unlimited number of shares.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-3B (a)

(b)

Dividend Noncumulative Cumulative Year Paid Preferred 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 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, Fifth Canadian Edition

PROBLEM 13-4B

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

2010 Jan. 10 Cash Dividends—Preferred ............... 12,000 Cash ................................................

12,000

2011 Jan. 10 Cash Dividends—Preferred* .............. 28,000 Cash Dividends—Common ............... 4,000 Cash ................................................

32,000

* Arrears from 2010: 2010 Dividend: (5,000 × $4) ............. $20,000 Less Dividend paid in 2010 ............. 12,000 Current year dividend (5,000 × $4)............ Cash Dividend to Preferred .......................

$ 8,000 20,000 $28,000

Mar. 1 Preferred Shares ............................... 320,000 Common Shares ............................ (4,000 × $80)

320,000

(b) The company needs to disclose dividends in arrears in the amount of $8,000 in 2010 in the notes to the financial statements.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-4B (Continued) 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 shareholders 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, Fifth Canadian Edition

PROBLEM 13-5B Shareholders' Equity Common Shares

Other Contributed Capital

Retained Earnings

Accumulated Other Comprehensive Income

Assets

Liabilities

Preferred Shares

+$100,000

n/a

+$100,000

n/a

+6,000

n/a

+6,000

n/a

–$300,000

+300,000

n/a

+150,000

n/a

+150,000

n/a

–72,500

n/a

–75,000

n/a

+$2,500

n/a

–10,000

n/a

–$10,000

n/a

–5,000

n/a

–$5,000

3. 5.

$600,000 ÷ 4,000 = $150 $150 × 2,000 = $300,000 ($600,000 − $300,000 + $150,000) ÷ (4,000 − 2,000 + 1,000) = $150 $150 × 500 = $75,000 $75,000 − (500 x $145) = $2,500 (4,000 − 2,000 + 1,000 − 500) = 2,500 × $4 = $10,000

Solutions Manual

Chapter 13

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-5B (Continued) Taking It Further: 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 dividend feature makes the shares more attractive, its absence results in a lower fair value.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6B

(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

1 Land ................................................ Common Shares ........................

67,000

1 Cash (75,000 × $3) .......................... Common Shares ........................

225,000

July 24 Cash ............................................... Equipment....................................... Common Shares ........................

60,000 8,000

Nov.

1 Cash (2,000 × $48) .......................... Preferred Shares ........................

96,000

Dec. 31 Income Summary ........................... Retained Earnings .....................

650,000

31 Dividends—Preferred ..................... Cash ............................................

36,000

31 Retained Earnings .......................... Dividends—Preferred ................

36,000

Apr.

May

Credit

200,000

420,000

67,000

225,000

68,000

96,000

650,000

36,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6B (Continued) (b) Preferred Shares Date Mar. Nov.

Explanation 1 1

Ref.

Debit

J1 J1

Credit

Balance

420,000 420,000 96,000 516,000

Common Shares Date

Explanation

Jan. 10 Apr. 1 May 1 July 24

Ref.

Debit

J1 J1 J1 J1

Credit

Balance

200,000 67,000 225,000 68,000

200,000 267,000 492,000 560,000

Credit

Balance

Dividends—Preferred Date Dec. 31 31

Explanation

Ref.

Debit 36,000

Closing entry

J1 J1

Explanation

Ref.

Debit

Credit

Closing entry Closing entry

J1 J1

36,000

650,000 650,000 614,000

36,000

36,000 0

Retained Earnings Date Dec

31 31

Balance

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-6B (Continued) (c) HIGHLAND CORPORATION Balance Sheet (Partial) December 31, 2011

Shareholders' equity Share capital Preferred shares, no par value, $3-noncumulative, unlimited number of shares authorized,12,000* shares issued .................. $ 516,000 Common shares, no par value, unlimited number of shares authorized, 216,800** shares issued 560,000 Total share capital .................................................. 1,076,000 Retained earnings ................................................. 614,000 Total shareholders’ equity ................................ $1,690,000 * 10,000 + 2,000 = 12,000 shares ** 100,000 + 25,000 + 75,000 + 16,800 = 216,800 shares Taking It Further: Different features may be added to preferred shares to make them more attractive to investors. Features such as cumulative dividends, conversion privileges, and redemption or retraction privileges are examples of features that make the preferred shares more attractive and increase the investment capital that can be obtained from the sale of the shares.

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Accounting Principles, Fifth Canadian Edition

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 Apr. 1 Cash Dividends—Preferred Shares Cash ............................................. (100,000 × $6  4)

150,000 150,000

Apr. 18 Cash (250,000 × $13) ...................... 3,250,000 Common Shares ......................... 3,250,000 Jul.

Oct.

1 Cash Dividends—Preferred Shares Cash .............................................

150,000

1 Cash Dividends—Preferred Shares Cash .............................................

150,000

Dec. 31 Income Summary ........................... 3,600,000 Retained Earnings ...................... 3,600,000 Dec. 31 Retained Earnings .......................... 450,000 Cash Dividends—Preferred Shares

450,000

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Accounting Principles, Fifth Canadian Edition

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

16,500,000 3,250,000 19,750,000

Cash Dividends—Preferred Shares Date Apr. 1 Jul. 1 Oct. 1 Dec. 31

Explanation

Ref.

Debit

Credit

Balance

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

Explanation Balance Closing entry Closing entry

Ref. ✓ J1 J1

Debit

Credit

Balance 1,900,000 3,600,000 5,500,000 450,000 5,050,000

Accumulated Other Comprehensive Income Date Jan.

Explanation 1 Balance

Ref. ✓

Debit

Credit

Balance 25,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-7B (Continued) (c) CONWAY LTD. Balance Sheet (Partial) December 31, 2011 ______________________________________________________ Shareholders' equity Share capital $6 preferred shares, cumulative, no par value, unlimited shares authorized, 100,000 shares issued..................................... $ 6,600,000 Common shares, no par value, unlimited number of shares authorized, 1,750,000* shares issued 19,750,000 Total share capital ....................................... 26,350,000 Retained earnings................................................. 5,050,000 Accumulated other comprehensive income ....... 25,000 Total shareholders' equity ........................................ $31,425,000 Dividends on preferred shares totalling $150,000 [10,000 × $1.50 per share] are not yet in arrears since the payment date is January 1, 2012. *1,500,000 + 250,000 = 1,750,000 shares

Taking It Further: The final decision about the payment and amount of dividends is the responsibility of the board of directors of the corporation.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8B

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 10 Common Shares (20,000 × $15.00*) 300,000 Contributed Capital—Reacquisition of Common Shares ................ 60,000 Cash .............................................. 240,000 * $1,050,000 ÷ 70,000 = $15.00 Feb. 6 Cash ................................................. Preferred Shares ..........................

600,000

Apr. 14 Cash ................................................. Common Shares ..........................

560,000

Jul.

1 Cash Dividend—Preferred Shares . Cash .............................................. (8,000 + 10,000) × ($4.00 ÷ 2)

36,000

Aug. 22 Building ........................................... Common Shares ..........................

165,000

Dec 31 Income Summary .............................. Retained Earnings........................

582,000

31 Retained Earnings ............................ Cash Dividend—Preferred Shares

36,000

600,000

560,000

36,000

165,000

582,000

36,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8B (Continued) (b) (Continued) Preferred Shares Date Jan. Feb.

1 6

Explanation

Ref.

Balance

✓ J1

Debit

Credit

Balance

440,000 600,000 1,040,000

Common Shares Date

Explanation

Ref.

Jan. 1 Jan. 10 Apr. 14 Aug. 22

Balance

✓ J1 J1 J1

Debit 300,000

Credit

Balance

1,050,000 750,000 560,000 1,310,000 165,000 1,475,000

Contributed Capital—Reacquisition of Preferred Shares Date Jan.

Explanation 1

Ref.

Debit

Credit

Balance

✓

Balance

25,000

Contributed Capital—Reacquisition of Common Shares Date

Explanation

Jan. 10

Ref.

Debit

Credit

Balance 60,000

Retained Earnings Date

Explanation

Ref.

Debit

Credit

Balance

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8B (Continued) (b) (Continued) Accumulated Other Comprehensive Income Date Jan. (c)

Explanation

Ref.

Balance

✓

Debit

Credit

Balance 10,000

LARGENT CORPORATION Balance Sheet (Partial) December 31, 2011

Shareholders' equity Contributed capital Share capital Preferred shares, no par value, $4-cumulative, 200,000 shares authorized, 18,000* shares issued .................................... $ 1,040,000 Common shares, no par value, unlimited number of shares authorized, 100,000** shares issued................................................... 1,475,000 Total share capital .................................................... 2,515,000 Additional contributed capital Contributed capital—reacquisition of preferred shares ................................................. 25,000 Contributed capital—reacquisition of common shares.................................................. 60,000 Total contributed capital .......................................... 2,600,000 Retained earnings..................................................... 1,346,000 Accumulated other comprehensive income ........... 10,000 Total shareholders' equity ............................................ $3,956,000 *8,000 + 10,000 = 18,000 shares **70,000 − 20,000 + 40,000 + 10,000 = 100,000 shares Dividends of $36,000 [18,000 × ($4 ÷ 2)] are not in arrears since the payment date is January 1, 2012.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-8B (Continued) Taking It Further: The fair value of a company’s common shares may not be determinable if the company is closely-held with few shareholders and few or no transactions involving common shares.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-9B (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

July 31 Commission Revenue ...................... 125,500 Construction Revenue ..................... 189,375 Income Summary .........................

314,875

31 Income Summary ............................. 272,475 Salaries Expense .......................... Rent Expense................................ Depreciation Expense .................. Supplies Expense ......................... Utilities Expense ........................... Interest Expense ........................... Income Tax Expense ....................

160,180 28,000 33,020 18,200 11,475 2,100 19,500

31 Income Summary ............................. Retained Earnings ........................

42,400 42,400

31 Retained Earnings ............................ Dividends ......................................

2,300 2,300

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-9B (Continued) (b) RAMSDEN ENVIRONMENTAL CORPORATION Balance Sheet July 31, 2011 ______________________________________________________ Assets Current assets Cash ..................................................................... Accounts receivable............................................. Inventory ............................................................... Supplies ................................................................ Total current assets....................................... Property, plant, and equipment Equipment .......................................... $148,000 Less: Accumulated depreciation...... (66,000) Total property, plant, and equipment Total assets ....................................................

$ 46,600 67,400 195,000 10,100 319,100

82,000 $401,100

Liabilities and Shareholders’ Equity Current liabilities Accounts payable ................................................. Salaries payable ................................................... Interest payable .................................................... Income tax payable .............................................. Unearned commission revenue .......................... Current portion of long-term debt ....................... Total current liabilities .................................. Long-term debt Long-term note payable ....................................... Total liabilities................................................

$ 32,000 8,200 900 4,500 8,900 10,000 64,500 60,000 124,500

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PROBLEM 13-9B (Continued) (b) (Continued) RAMSDEN ENVIRONMENTAL CORPORATION Balance Sheet July 31, 2011 ______________________________________________________ Shareholders’ equity Contributed capital Share capital $3.75 noncumulative preferred shares, unlimited number authorized, 500 issued ....... Common shares, unlimited number authorized, 35,000 issued ................................. Total share capital ................................................... Other contributed capital Contributed capital—reacquisition of preferred shares ................................................................. Total contributed capital ............................................ Retained earnings* ..................................................... Total shareholders’ equity ........................................... Total liabilities and shareholders’ equity .......... *Retained earnings Balance, Aug. 1, 2010 ............................. Add: Profit ............................................... Less: Dividends ...................................... Balance, July 31, 2011 ............................

$ 40,000 120,000 160,000

1,500 161,500 115,100 276,600 $401,100

$ 75,000 42,400 (2,300) $115,100

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PROBLEM 13-9B (Continued) 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 that flow through the income statement as well as dividends that flow through retained earnings. In a sole proprietorship, payments to the owner consist only of drawings that are closed directly to the owner’s capital account rather than flow through the income statement. In addition, the capital of a sole proprietor or partner is an accumulation of profit that has not been taxed, plus any investments, less any drawings. 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-10B (a) ANDREW PELLER LIMITED Balance Sheet March 31, 2009 (in thousands) ______________________________________________________ Assets Current assets Accounts receivable ................................................ $ 22,430 Inventories ............................................................... 104,157 Income taxes recoverable ....................................... 5,892 Prepaid expenses and other assets ....................... 2,339 Total current assets ............................................ 134,818 Property, plant, and equipment ..................... $174,832 Less: Accumulated depreciation ................. (72,465) Total property, plant, and equipment .. ............. 102,367 Goodwill ....................................................................... 39,384 Other long-term assets ............................................... 16,938 Total assets .............................................................. $293,507 Liabilities and Shareholders’ Equity Current liabilities Bank indebtedness .................................................. Accounts payable and accrued liabilities .............. Dividends payable ................................................... Current portion of long-term debt .......................... Total current liabilities ........................................ Long-term liabilities Long-term debt .......................................... $71,549 Future income tax liability ......................... 10,765 Other long-term liabilities ......................... 8,787 Total liabilities .....................................................

$ 52,192 43,349 1,197 8,877 105,615

91,101 $196,716

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-10B (Continued) (c)

(Continued)

ANDREW PELLER LIMITED Balance Sheet March 31, 2009 (in thousands) ______________________________________________________ Shareholders’ equity Share capital Class A shares, nonvoting, unlimited authorized, 11,888 issued .................................................. $ 6,975 Class B shares, voting, convertible into Class A shares, unlimited authorized, 3,004 issued . 400 Total share capital...................................... 7,375 Retained earnings* .................................................. 89,416 Total shareholders’ equity .................................. 96,791 Total liabilities and shareholders’ equity ............... $293,507 *$94,328 − $4,787 − $125 = $89,416 (b) Return on equity = Profit ÷ Average shareholders’ equity $(125) = (0.13)% ($96,791 + $95,522) ÷ 2 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, shareholders’ equity is in a deficit position (a negative balance) and the company is generating losses rather than profit, the return on equity would show a positive number. This can be misleading to users. The formula is no longer useful as a measurement since the company is generating losses that increase the deficit position. Solutions Manual 13-79 Chapter 13 Copyright © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is prohibited.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-11B (a) Return on equity = Profit ÷ Average shareholders’ equity 2008

$289 ($1,508 + $1,093) ÷ 2

= 22.22%

2007

$306 ($1,093 + $785) ÷ 2

= 32.59%

Sears’ return on equity has deteriorated significantly during the last year. (b) Sears was exceeding industry performance in 2007 but it is now slightly under the industry average for 2008. The industry’s return on equity has decreased slightly from 26.4% to 23.2%, but Sears has worsened significantly in the same time period.

Taking It Further: The return on equity ratio could be improved by calculating the return on average common shareholders’ equity. This would provide more meaningful information since the common shareholders own the residual profit after the preferred shareholder claims have been satisfied. The use of fair values versus average shareholders’ equity would provide useful information about the efficiency of a current investment in the shares of the company. The resulting formula of profit divided by market value of shareholders’ equity would provide similar information to the P/E ratio. The P/E ratio measures the market price of a company’s share for a dollar of earnings: its formula is market price of a share divided by the earnings per share.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-12B (a) Preferred dividends ÷ Preferred dividend per share $150,000 ÷ $5 = 30,000 preferred shares (b) Preferred share average price = $3,150,000 ÷ 30,000 shares issued = $105 per share Common share average price = $1,000,000 ÷ 250,000 shares issued = $4 per share (c) The shares were issued for an average selling price of $4 (see (b) above) which means the company would have reduced the Common Shares account by $100,000 (25,000 × $4). Since a reduction to retained earnings is shown relating to this reacquisition for $56,250, this indicates the company had to pay $156,250 ($100,000 + $56,250) to reacquire the 25,000 shares, or $6.25 per share. (d) Limited liability for preferred shareholders = $3,150,000 Limited liability for common shareholders = $4,150,000 − $3,150,000 = $1,000,000 (e) It is a loss that bypasses the income statement because it has not yet been realized. An example is an unrealized loss on certain types of equity investments.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 13-12B (Continued) Taking It Further: Preferred shares that share the same characteristics as debt are considered financial instruments and are reclassified as debt on a company’s balance sheet. The characteristics of debt include non-avoidable payments of interest (payments of cumulative dividends) and repayment of capital. If preferred shares have cumulative dividends and are redeemable or retractable, they are considered financial instruments and are shown as debt. Preferred shares that have non-cumulative dividends do not provide for a return to the creditor since missed dividends are not paid out, and if they are not retractable or redeemable, there is no repayment of the capital. They are shown as equity on the company’s balance sheet.

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CONTINUING COOKIE CHRONICLE (a) 1. One of the major advantages of issuing preferred shares is that the preferred shareholder does not have voting rights. In this case, Curtis’s dad and Natalie’s grandmother can participate in the future success of Cookie & Coffee Creations Ltd. (by receiving annual dividends) without attempting to influence any decisions that would require shareholder approval. Both will receive an annual dividend as long as the dividend is declared. Any additional dividends declared and paid will be paid to the common shareholders. This could prove to be another advantage to both Natalie and Curtis if the company is successful and has excess cash to pay out dividends. 2. It is possible to pay for the $1,200 legal bill by issuing common shares. You might not feel that 1,300 common shares is right number of shares that should be issued in exchange for the services valued at $1,200. After all, you both received $1 of common share for each dollar of assets you invested into the business. On the other hand, you might benefit from retaining the cash at this time instead of paying for the invoice in cash. The amount that will be recorded for the issuance of the 1,300 common shares your lawyer will be willing to take in exchange for the legal services will be the fair value of the consideration received, which is $1,200 in this case.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) GENERAL JOURNAL Date (b) Nov.

Account Titles and Explanation

Debit

1 Cash ................................................. Accounts Receivable ...................... Merchandise Inventory ................... Kitchen Equipment.......................... Common Shares ..........................

17,500 900 1,650 3,500

1 Cash ................................................. Preferred Shares ..........................

10,000

1 Legal Expense ................................. Common Shares ..........................

1,200

Credit

23,550

10,000

1,200

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (d) COOKIE & COFFEE CREATIONS LTD. Balance Sheet November 1, 2011 ______________________________________________________ Assets Current assets Cash ........................................................................... $27,500 Accounts receivable................................................... 900 Merchandise inventory .............................................. 1,650 Total current assets............................................. 30,050 Property, plant, and equipment Kitchen Equipment ..................................................... 3,500 Total assets .......................................................... $33,550 Shareholders' Equity Share capital $0.50 preferred shares, no par value, noncumulative, 10,000 authorized, 2,000 shares issued ............. $10,000 Common shares, no par value, unlimited number of shares authorized, 24,850 shares issued........... 24,750 Total share capital ............................................... 34,750 Deficit ................................................................................. (1,200) Total shareholders' equity .................................. $33,550

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Accounting Principles, Fifth Canadian Edition

BYP 13-1 FINANCIAL REPORTING PROBLEM (a) Per note 11 to the financial statements, The Forzani Group Ltd. has 2 classes of shares. There is an unlimited number of Class A shares authorized and 30,468,000 issued; and an unlimited number of preferred shares authorized but none issued. (b) During the 2009 fiscal year, Forzani issued 192,000 common shares for $2,384,000 upon employees exercising stock options. (c)

During the 2009 fiscal year, Forzani repurchased 2,694,000 common shares. In the repurchase, the common shares account reduced by $12,964,000 and based on the amount reported in the statement of cash flows, Forzani paid $44,027,000 for the repurchase. The remaining amount in the transaction results in a charge to retained earnings in the year of $31,063,000, as appears in the consolidated statement of retained earnings.

(d) The average cost of the common shares is $4.83 ($147,161,000 ÷ 30,468,000). (e)

Return on equity = Profit ÷ Average shareholders’ equity (figures in thousands) Return on equity = $47,451 ÷ ($355,483 + $327,813) 2 = 13.9% The company’s return on equity has deteriorated over the past year from 13.9% in fiscal 2008 to 8.5% in fiscal 2009.

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Accounting Principles, Fifth Canadian Edition

BYP 13-2 INTERPRETING FINANCIAL STATEMENTS (a) A corporation may acquire its own shares (1) to increase trading of the company's shares in the securities market in the hope of enhancing the company’s fair value, (2) to reduce the number of shares issued in order to increase earnings per share, (3) to eliminate hostile shareholders by buying them out, (4) to have additional shares available so they can be reissued to officers and employees through bonus and stock compensation plans, or used to acquire other companies, and (5) to comply with percentage share ownership requirements. (b) The debit to retained earnings indicates that Talisman Energy paid more to repurchase their common shares than their average cost. Common Shares ($951,000,000 – $839,000,000) ...... 112,000,000 Retained Earnings ......................... 839,000,000 Cash ........................................... 951,000,000 (c) Talisman’s profitability has improved in 2008. The company’s profit margin, return on assets, and return on equity are better than in 2007. (d) 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. In spite of the strong improvement in profitability the market price of the shares had declined significantly from 2007 to 2008. Although inconsistent with the results, the share price is likely more a reflection on anticipated earnings that are influenced directly by the expected oil prices.

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BYP 13-3

Accounting Principles, Fifth 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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Accounting Principles, Fifth Canadian Edition

BYP 13-4 COMMUNICATION ACTIVITY

Memorandum To: From: Re:

Chief Financial Officer Accountant Comprehensive Income reporting

IFRS requires the recording and reporting of comprehensive income. Comprehensive income will affect the balance sheet. Comprehensive income includes all changes in shareholders’ equity during a period except for changes that result from the sale or repurchase of shares or from the payment of dividends. It includes the revenues, expenses, gains and losses included in profit, as well as the gains and losses that bypass profit but affect shareholders’ equity. The latter gains and losses are known as “other comprehensive income (loss)”. The most common example of other comprehensive income is gains and losses on fair value adjustments for certain types of equity investments. These investments must be shown at fair value on the balance sheet. Any resulting cumulative amounts of gains or losses on fair value adjustments will be shown in the shareholders’ equity section of the balance sheet, immediately beneath Retained Earnings and is designated: Accumulated Other Comprehensive Income. Reporting comprehensive income will benefit current and potential shareholders. Profit is protected from fluctuations in fair value. But readers will still be shown the gain or loss that would have occurred if the investment had actually been sold. These additional amounts would not be reported if the company used Canadian GAAP for Private Enterprises. There would be no accumulated other comprehensive income recorded or reported as part of the shareholders’ equity section of the balance sheet. Solutions Manual 13-89 Chapter 13 Copyright © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is prohibited.

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Accounting Principles, Fifth Canadian Edition

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 risking the environment, and everything and everybody in it exposed 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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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

BYP13-6 (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. Generally Accepted Accounting Principles are set out in the Canadian Institute of Chartered Accountants Handbook. Shareholders may decide by a unanimous resolution (voting and non-voting shares) not to appoint an auditor. 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: •

• • •

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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Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

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Accounting Principles, Fifth Canadian Edition

CHAPTER 14 Corporations: Income and Equity Reporting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems Set A

Problems Set B

Study Objectives

Questions

1. Prepare the entries for cash dividends, stock dividends, and stock splits, and compare their financial impact.

1, 2, 3, 4, 5, 6

1, 2, 3, 4

1, 2, 5, 6, 7, 8

1, 2, 3, 6, 7

2. Prepare a corporate 7, 8, 9, 10, income statement 11, 16 and statement of comprehensive income.

5, 6, 7, 12

3, 4, 6, 9

3, 4, 5, 6, 9, 12

3. Prepare a statement of retained earnings including prior period adjustments.

12, 13, 14

8, 9, 10

4, 5, 6

4, 5, 6, 7

4. Prepare a statement of changes in shareholders’ equity.

8, 14, 15

11, 12

7, 8, 9, 10

7, 8, 9

5. Evaluate earnings and dividend performance.

17, 18, 19, 20

13, 14, 15

10, 11, 12, 10, 11, 13 12

10, 11, 12

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Indicate impact of share and dividend transactions.

Simple

20-25

Compare impact of cash dividend, stock dividend, and stock split.

Simple

20-25

Record and post transactions; prepare shareholders’ equity section.

Moderate

25-30

Prepare income statement and statement of retained earnings

Moderate

25-30

Prepare income statement and statement of retained earnings.

Moderate

25-30

Reproduce accounts and prepare statement of retained earnings.

Complex

30-40

Record and post transactions; prepare statement of changes in shareholders’ equity and shareholders’ equity section.

Complex

60-70

Prepare statement of changes in shareholders’ equity.

Complex

25-35

Prepare statement of comprehensive income, statement of changes in shareholders’ equity, and shareholders’ equity section.

Moderate

30-40

10A

Calculate earnings per share.

Moderate

30-35

11A

Calculate ratios and comment.

Simple

25-30

12A

Calculate and evaluate ratios with discontinued operations.

Moderate

30-35

Indicate impact of share and dividend transactions.

Simple

20-25

Compare impact of cash dividend, stock dividend, and stock split.

Simple

20-25

Record and post transactions; prepare shareholders’ equity section.

Moderate

25-30

Prepare income statement and statement of retained earnings.

Moderate

25-30

Prepare income statement and statement of retained earnings.

Moderate

25-30

Reproduce accounts and prepare statement of retained earnings.

Complex

30-40

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record and post transactions; prepare statement of changes in shareholders’ equity and the shareholders’ equity section of the balance sheet.

Complex

60-70

Prepare statement of changes in shareholders’ equity.

Complex

25-35

Prepare statement of comprehensive income, statement of changes in shareholders’ equity, and shareholders’ equity section.

Moderate

30-40

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, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-ofChapter Material Study Objectives 1. Prepare the entries for cash dividends, stock dividends, and stock splits, and compare their financial impact.

Knowledge Q14-1 Q14-3 Q14-4

Comprehension Q14-2 Q14-5 Q14-6

Application BE14-1 P14-1A BE14-2 P14-2A BE14-3 P14-3A BE14-4 P14-6A E14-1 P14-7A E14-2 P14-1B E14-5 P14-2B E14-6 P14-3B E14-7 P14-6B E14-8 P14-7B

2 Prepare a corporate income statement and statement of comprehensive income.

Q14-8 Q14-16

Q14-7 Q14-9 Q14-10 Q14-11 Q14-16

BE14-5 BE14-6 BE14-7 BE14-12 E14-3 E14-4 E14-6 E14-9

3. Prepare a statement of retained earnings including prior period adjustments.

Q14-13 Q14-14

Q14-12

BE14-8 BE14-9 BE14-10 E14-4 E14-5 E14-6

Q14-8 Q14-14 Q14-15

Prepare a statement of changes in shareholders’ equity.

Analysis

Synthesis Evaluation

P14-3A P14-4A P14-5A P14-6A P14-9A P14-12A P14-3B P14-4B P14-5B P14-6B P14-9B P14-12B P14-4A P14-5A P14-6A P14-7A P14-4B P14-5B P14-6B P14-7B

BE14-11 BE14-12 E14-7 E14-8 E14-9 E14-10

P14-7A P14-8A P14-9A P14-7B P14-8B P14-9B P14-10A P14-12A P14-10B P14-12B

5. Evaluate earnings and dividend performance.

Q14-17 Q14-18 Q14-20

Q14-19 BE14-13 BE14-14 BE14-15 E14-10 E14-11 E14-12 E14-13

Broadening Your Perspective

BYP14-1

Continuing Cookie Chronicle

P14-11A P14-11B

BYP 14-2 BYP14-3

BYP14-4

BYP14-5 BYP14-6

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 01.

Pro rata means proportional. If you own 5% of the shares, you are entitled to 5% of the dividends that are declared.

02.

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.

The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends. Restrictions may be either contractual or voluntary. A debt covenant (the contract between the creditor and the borrowing company) may specify a restriction on retained earnings to ensure that available cash is first applied to debt reduction. For example, a debt covenant may specify that no dividends can be paid until the debt is paid off or reduced below a certain level. In this case, the entire balance of retained earnings is restricted.

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.

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.

6. 6.

(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

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 7.

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 0150,000 $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. 8.

Interperiod tax allocation is the allocation of income tax between periods, due to timing differences that exist between GAAP and the Income Tax Act. Intraperiod tax allocation is the allocation of income tax within the period, to items that attracted the tax. For example, the tax associated with continuing operations is shown separately from the tax associated with discontinued operations.

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 this item in their analysis of future earnings potential because it is not expected to occur on an ongoing basis.

10.

Comprehensive income includes all increases and decreases to shareholders’ equity during a period except those resulting 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 kinds of income transactions, such as unrealized gains and losses from some long-term equity investments and foreign currency translation gains or losses that currently bypass the income statement and are reported in the statement of comprehensive income.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 11. (a)

The statement of comprehensive income begins with profit, as reported on the income statement, then adds items such as unrealized gains or losses from investments that are available for sale, and foreign currency translation gains or losses.

(b)

Accumulated other comprehensive income is reported in the shareholders’ equity section of the balance sheet, below retained earnings.

12.

A correction of a prior period error is made when a mistake was made in a previous period which resulted in the publication of erroneous financial statements. The correction will restore the account balances 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 aftertax impact of the error. Prior year statements that are issued with the current statement will be restated to eliminate the error, if needed. A change in accounting policy occurs when the principle used in the current period is different from the policy used in prior periods. Because of this, any financial statements presented from prior years must be adjusted to reflect the effect of the change in accounting policy. A cumulative amount resulting from the change should be reflected in the opening balance of retained earnings related to the earliest period presented. As well, an appropriately cross-referenced note to the statements should detail the impact of the change and the fact that prior years have been restated.

13.

An adjustment of the financial results of a prior period is appropriate in two circumstances: (1) when correcting an error related to a prior period, and (2) when changing an accounting policy. The correction of an error is reported as an adjustment directly to opening retained earnings. A change in accounting policy requires that any financial statements being presented from prior years be adjusted to reflect the effect of the change in policy. A cumulative amount resulting from the change, net of any tax effect should be reflected in the opening balance of retained earnings related to the earliest period presented. As well, an appropriately crossreferenced note to the statements should detail the impact of the change and the fact that prior years have been restated.

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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 14.

The statement of changes in shareholders’ equity contains all of the information in the statement of retained earning plus information about changes to other equity accounts such as share capital and accumulated other comprehensive income.

15.

Transactions that increase shareholders’ equity: • Issuance of share capital • Profit • Other comprehensive income Transactions that decrease shareholders’ equity: • Reacquisition of share capital • Loss • Other comprehensive loss • Declaration of cash dividend Transactions that may increase or decrease shareholders’ equity depending on the nature of the underlying transaction: • Correction of a prior period error • Cumulative effect of a change in accounting policy.

16.

The reporting of comprehensive income improves the usefulness because it reports information, such as unrealized gains and losses from some long-term equity investments and foreign currency translation gains or losses, not contained in the income statement, that is relevant to users of financial statements. This information is presented on a cumulative basis in the balance sheet in accumulated other comprehensive income rather than retained earnings because it is not available for the payment of dividends.

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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Accounting Principles, Fifth Canadian Edition

Questions (Continued) 18.

Earnings per share calculates the amount of profit earned during the year that belongs to the common shareholders. If the preferred shares are not cumulative, the accountant is correct because the right of preferred shareholders to receive a dividend in the current year expires if none are declared. Current year earnings become available for dividend declaration to the common shareholders in a future year. If the preferred shares are cumulative, then the dividends will have to be paid at some point in the future, so they should be subtracted from profit for the purpose of calculating the earnings per share.

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. (d) Favourable

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Dec. 12 Cash Dividends—Preferred ............... 120,000 Dividends Payable (30,000 × $4) ...

120,000

Jan. 23 Dividends Payable .............................. 120,000 Cash ................................................

120,000

BRIEF EXERCISE 14-2 Apr. 1 Stock Dividends (100,000 × 5% × $7) ... 35,000 Stock Dividends Distributable..........

35,000

30 Stock Dividends Distributable .............. 35,000 Common Shares................................

35,000

BRIEF EXERCISE 14-3 (a) (b) (c) (d)

Share capital Retained earnings Total shareholders’ equity Number of shares

Before $2,000,000 600,000 $2,600,000 175,000

After $2,210,000 390,000 $2,600,000 192,500

Stock dividend: 175,000 × 10% × $12 = $210,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-4 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 14-5 (a) June 30 Income Tax Expense .................... 60,000 Income Tax Payable ................... ($4,000,000 − $3,200,000) × 30% − $180,000

60,000

(b) VICERON INC. Income Statement Year Ended June 30, 2011

Revenues ................................................................ $4,000,000 Expenses................................................................. 03,200,000 Profit before income tax......................................... 800,000 Income tax expense ............................................... 240,000 Profit ........................................................................ $ 560,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-6 (a)

Income tax expense on continuing operations = Profit before income tax × income tax rate = $500,000 × 25% = $125,000

(b)

Income tax savings on loss from operations = $(154,000) × 25% Income taxes on gain on disposal of assets = $60,000 × 25% Income tax savings on discontinued operations

(c)

$(38,500) 15,000 $(23,500)

Profit before income tax $500,000 Income tax expense 125,000 Profit from continuing operations 375,000 Discontinued operations: Loss from operations of discontinued operations, net of $38,500 income tax savings $115,500 Gain on disposal of assets of discontinued operations, net of $15,000 income tax expense 45,000 70,500 Profit $304,500

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-7 (a) JET SET AIRLINES Statement of Comprehensive Income Year Ended December 31, 2011

Profit ............................................................... Other comprehensive income Gain on equity investments, net of $12,0001 income tax expense ........ Comprehensive income ................................ 1 $40,000 × 30% = $12,000

$180,000

(b) Accumulated other comprehensive income [$(11,914) + $28,000]

$16,086

28,000 $208,000

BRIEF EXERCISE 14-8 GRAYFAIR INC. Statement of Retained Earnings Year Ended December 31, 2011

Retained earnings, January 1 ......................................... $190,000 Add: Profit...................................................................... 0250,000 440,000 Less: Cash dividends .................................................... 90,000 Retained earnings, December 31 ................................... $350,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-9 Jan. 1 Inventory ..................................................... 120,000 Income Tax Payable .............................. 38,400 Retained Earnings [$120,000 × (1 − 32%)] 81,600

BRIEF EXERCISE 14-10 BROADFOOT BAKERIES, INC. Statement of Retained Earnings Year Ended December 31, 2011

Balance, January 1, 2011 as previously reported ......... $280,000 Add: Correction for overstatement of cost of goods sold in 2010, net of $38,400 income tax expense 0 81,600 Balance, January 1, 2011 as restated ............................ 361,600 Add: Profit ..................................................................... 85,000 446,600 Less: Dividends.............................................................. 0012,000 Balance, December 31 .................................................... $434,600

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Accounting Principles, Fifth Canadian Edition

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, 2010 (c) $(28,750) = $603,750 − $600,000 − $32,500 (d) $23,000 = $15,000 + $8,000 (e) $(30,000) = $190,000 − $197,500 − $22,500 (f) $17,000 = $68,000 − $51,000 (g) $884,750 = $603,750 + $23,000 (from (d) above) + $190,000 + $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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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-12 (a) PENINSULA SUPPLY CORPORATION Statement of Comprehensive Income Year Ended December 31, 2011

Profit .......................................................................... Other comprehensive income ................................. Comprehensive income ...........................................

$22,500 17,000 $39,500

(b) PENINSULA SUPPLY CORPORATION Partial Balance Sheet December 31, 2011

Shareholders' equity Share capital Common shares, no par value, unlimited shares authorized, 525,000 shares issued ....... Contributed capital—reacquired common shares .. Total contributed capital .............................................. Retained earnings ........................................................ Accumulated other comprehensive income ............... Total shareholders' equity ...................................

$603,750 23,000 626,750 190,000 68,000 $884,750

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 14-13 (a)

25,000 − 5,000 + 6,000 + 10,000 = 36,000 shares

(b)

Weighted average number of shares:

Date Jan. 1 Mar. 15 Jul. 29 Sep. 30

Actual Number 25,000 (5,000) 6,000 10,000 36,000

Fraction of Year × 12/12 = × 9.5/12 = × 5/12 = × 3/12 =

Weighted Average 25,000 (3,958) 2,500 2,500 26,042

BRIEF EXERCISE 14-14 (a) Earnings per share = $2.06 ($454,000  220,000) (b) Earnings per share = $1.95 [($454,000 − $24,000)  220,000] (c)

There would be no difference. Since the preferred shares are cumulative, they 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.

BRIEF EXERCISE 14-15 Price-earnings ratio = Market price per share ÷ Earnings per share = $24.10 ÷ $3.00 = 8.03 times Payout ratio

= Cash dividends per share ÷ Earnings per share = $0.40 ÷ $3.00 = 13%

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

EXERCISE 14-2 1. Dec. 31 Cash Dividends (20,000 × $4 ÷ 4) Dividend Expense..................

20,000

12,000 12,000

31 Stock Dividends—Common ...... Dividends Payable ..................... Common Stock Dividend Distributable ........ Retained Earnings .................

20,000

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 TOP BRANDS LIMITED Income Statement Year Ended March 31, 2011

Revenues Fees earned........................................... Rent revenue ......................................... Operating expenses Advertising expense ............................ Depreciation expense ........................... Training programs expense ................. Profit from operations .............................. Other revenue Gain on sale 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, 2011

Profit.......................................................... Other comprehensive income (loss) Loss on equity investments, net of $900 in income tax savings ........ Comprehensive income ...........................

$39,200

2,100 $37,100

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EXERCISE 14-4 (a) SHRINK LTD. Partial Income Statement Year Ended December 31, 2011

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..........................................................

$320,000

42,000 $362,000

* $90,000 × 30% = $27,000 ** $30,000 × 30% = $9,000 (b) The error in the prior year’s cost of goods sold will be presented as a decrease in opening retained earnings in the statement of retained earnings (or changes in shareholders’ equity) on a net-of-tax basis.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 14-5

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 NE

Accumulated Other Comprehensive Income NE NE NE NE NE NE NE I NE NE

Total Shareholders’ Equity D NE I NE NE NE I I D NE

Chapter 14

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Accounting Principles, Fifth Canadian Edition

EXERCISE 14-6 FYRE LITE CORPORATION Statement of Retained Earnings Year Ended December 31, 2011

Balance, January 1, as previously reported .................. $650,000 Add: Correction for understatement of 2010 profit due to error, net of $8,400 income tax expense . 33,600 Balance, January 1, as adjusted .................................... 683,600 Add: Profit ..................................................................... 160,0001 843,600 Less: Excess cost of reacquired shares ...... $ 20,000 Cash dividends .................................... 125,000 145,000 Balance, December 31 .................................................... $698,600

Note X: Debt covenant with credit restricts the declaration of cash dividends if that would reduce retained earnings below $200,000. 1

$200,000 × (1 − 20%) = $160,000

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EXERCISE 14-7 (a) May 15 Cash (6,000 × $10) ....................... Common Shares......................

60,000

June 22 Cash Dividends (86,000 × $0.30) . Dividends Payable ..................

25,800

July 12 Dividends Payable ....................... Cash .........................................

25,800

Aug. 19 Stock Dividends—Common (86,000 × 5% × $10) ...................... Common Stock Dividends Distributable ........ Sept. 18 Common Stock Dividends Distributable ............... Common Shares...................... Nov. 21 Cash (4,000 × $16) ....................... Common Shares...................... Dec. 15 Cash Dividends (94,300* × $0.22) ........................... Dividends Payable ..................

60,000

25,800

43,000 43,000

43,000 43,000 64,000 64,000

20,746 20,746

*80,000 + 6,000 + 4,300 (stock dividend) + 4,000 = 94,300 (b) Dec. 31 Retained Earnings ....................... Cash Dividends ....................... Stock Dividends—Common ...

89,546 46,546 43,000

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EXERCISE 14-7 (Continued)

(c) (1) Cash: Current assets section of balance sheet (2) Common shares: Share capital section of balance sheet (3) Dividends: Statement of shareholders’ equity (4) Dividends payable: Current liabilities section of balance sheet (5) Retained earnings: Statement of shareholders’ equity and ending balance in shareholders’ equity section of the balance sheet

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EXERCISE 14-8 (a) Jul. 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 (b) HOPKINS CORPORATION Statement of Changes in Shareholders’ Equity Year ended December 31, 2011

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 ................................................. 750,000 Profit ................................................................... 390,000 Stock dividends.................................................. (297,000) Balance, December 31 ............................................ 843,000 Total shareholders' equity .......................................... $3,240,000

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EXERCISE 14-9 AGRIUM INC. Statement of Comprehensive Income Year Ended December 31, 2008 (US$ millions)

Profit................................................................................. Other comprehensive income Other loss items (net of $XXX income tax savings) ... Comprehensive income ..................................................

$1,322 (256) $1,066

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EXERCISE 14-9 (Continued) AGRIUM INC. Statement of Changes in Shareholders’ Equity Year ended December 31, 2008 (US$ millions)

Share capital, common shares Balance, January 1, 158 million shares issued .... Reacquired 1 million shares .............................. Stock compensation plan .................................. Balance, December 31, 157 million shares issued

$1,972 (15) 4 1,961

Contributed capital Balance, January 1 ................................................. Balance, December 31 ............................................

8 8

Retained earnings Balance, January 1, as previously reported ......... Cumulative effect of a change in inventory accounting policy, net of $X income tax expense ............................................................ Balance, January 1, as restated ............................. Profit ................................................................... Reacquired common shares ............................. Dividends ............................................................ Balance, December 31 ............................................

1,024

4 1,028 1,322 (20) (17) 2,313

Accumulated other comprehensive income (loss) Balance, January 1 ................................................. Other comprehensive income (loss), net of $XX income tax savings .................................. Balance, December 31 ............................................

(256) (172)

Total shareholders' equity ..........................................

$4,110

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EXERCISE 14-10 (a) RUBY RED RENTAL CORPORATION Statement of Changes in Shareholders’ Equity Year ended December 31, 2011

Share capital, common shares Balance, January 1, 32,000 shares issued ............ Reacquired 1,000 shares (1) .............................. Issued for cash, 2,000 shares............................ Balance, December 31, 33,000 shares issued ......

$800,000 (25,000) 104,000 879,000

Contributed capital—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 − $25,000)................................. Dividends ............................................................ Balance, December 31 ............................................

1,500,000 400,000 (70,000) 1,830,000

Accumulated other comprehensive income Balance, January 1 ................................................. Other comprehensive income, net of $XX income tax expense ......................................... Balance, December 31 ............................................

40,000 25,000 65,000

Total shareholders' equity .......................................... $3,294,500 (1) ($800,000 ÷ 32,000) x 1,000 = $25,000 $44,500 – $25,000 = $19,500

(b) Payout ratio = $70,000 ÷ $400,000 = 17.5%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 14-11 (a)

Profit available to common shareholders = Profit − Preferred share dividends = $343,125 − $45,000 = $298,125

(b) Weighted average number of shares December 1, 2010 Feb. 28, 2011 May 31, 2011 Nov. 1, 2011

(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 = $298,125 ÷ 66,250 = $4.50

(d) A weighted average number of shares is used in the earnings per share calculation because the issue of shares and other activities affecting the number of shares issued during the period changes the amount of net assets upon which profit can be earned.

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EXERCISE 14-12 (a) (1) [$547,000 − (2,000 x $4)] ÷ 100,000 = $5.39 (2) ($547,000 − $8,000) ÷ 100,000 = $5.39 (b) (1) ($547,000 − $8,000) ÷ 100,000 = $5.39 (2) $547,000 ÷ 100,000 = $5.47

EXERCISE 14-13 (a)

Earnings per share Price-earnings ratio Payout ratio

2008

2007

2006

$3.79 11.3X 73.8%

$4.18 15.1X 63.0%

$5.26 13.1X 40.5%

Calculations: Earnings per share (in millions) 2008: ($1,978 − $73) ÷ 502 = $3.79 2007: ($2,131 − $43) ÷ 500 = $4.18 2006: ($2,663 − $30) ÷ 501 = $5.26 Price-earnings ratio 2008: $43.02 ÷ $3.79 = 11.3 times 2007: $63.00 ÷ $4.18 = 15.1 times 2006: $68.99 ÷ $5.26 = 13.1 times Payout ratio 2008: $2.80 ÷ $3.79 = 73.8% 2007: $2.63 ÷ $4.18 = 63.0% 2006: $2.13 ÷ $5.26 = 40.5%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 14-13 (Continued) (b) Earnings per share have deteriorated 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 2008 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 PE ratio has declined slightly over the past three years. There are many factors affecting PE 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 PE ratio should be compared to other companies in the industry to see if a multiple of around thirteen is good for this type of business. (Note to instructor: The average PE ratio for the banking industry in Canada in 2008 was 12.0 times.) The company’s dividends have increased each year and the payout ratio has increased 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, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 14-1A

(a)

(b) Number of Common Shares

(d) Number of Shares held by J. Tolentino

(e) Share Price

(f) Fair Value of Juanita’s Portfolio

Date

Common Shares

Nov. 1 Jan. 2 Jan. 2

$1,000,000 500,000 $1,500,000

200,000 50,000 250,000

$500,000 000 0000 $500,000

40,000 10,000 50,000

$ 8 10 10

$320,000

May 1 $1,500,000 (before split) May 1 000000000 May 1 (after) 1,500,000 Aug. 31 (2) 101,250 Aug. 31 $1,601,250

250,000

$500,000

50,000

600,000

125,000 375,000 (1) 11,250 386,250

0000000 500,000 (101,250) $398,750

25,000 75,000 (3) 2,250 77,250

600,000

695,250

386,250

$398,750

77,250

849,750

Oct. 31

$1,601,250

(1) 375,000 x 3% = 11,250

Solutions Manual

(2) 11,250 x $9 = $101,250

500,000

(3) 75,000 x 3% = 2,250

Chapter 14

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PROBLEM 14-1A (Continued) Taking It Further Companies issue stock dividends for reasons such as: • A gesture to give something to shareholders if cash is not available to give a cash dividend to shareholders; • To decrease the share price by issuing more shares; • To capitalize a portion of retained earnings and make it permanently retained in the business. In the case of Savary, the number of shares issued as a stock dividend is low, so it is unlikely the company is trying to reduce the share price. It is most likely to satisfy dividend expectations of shareholders since cash dividends were not paid out during the year.

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PROBLEM 14-2A (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 equity = $7,400,000

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

No effect = 400,000

a 400,000 × $1.50 = $600,000 b 400,000 × 5% × $30 = $600,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-2A (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. 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 14-2A (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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PROBLEM 14-3A

(a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 15 Cash Dividends (90,000 × $1) ............... 90,000 Dividends Payable ............................

90,000

Feb. 15 Dividends Payable ................................. 90,000 Cash ...................................................

90,000

July 01 Memo: three-for-two stock split increases the number of shares to 135,000 (90,000 × 3 ÷ 2) Dec.015 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 x (1 – 30%)] 31 Retained Earnings ................................. 225,000 Cash Dividends ................................. 90,000 Common Stock Dividends ................ 135,000

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PROBLEM 14-3A (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 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

✓ J1 J1

Credit 315,000

225,000

Balance 540,000 855,000 630,000

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PROBLEM 14-3A (Continued)

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 ..................................................... 00,630,000 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 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, on account of investor interest.

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PROBLEM 14-4A (a) ZURICH CORPORATION Income Statement Year Ended December 31, 2011

Net sales ......................................................................... $1,700,000 Cost of goods sold ......................................................... 1,100,000 Gross profit..................................................................... 600,000 Operating expenses ....................................................... 260,000 Profit from operations .................................................... 340,000 Other revenues ................................................ $20,000 Other expenses ............................................... 028,000 0 (8,000 Profit before income tax ................................................ 332,000 Income tax expense ($332,000 × 20%) .......................... 66,400 Profit from continuing operations ................................. 265,600 Discontinued operations Profit from operations of discontinued division, net of $4,000 income tax expense ............. $16,000 Loss on sale of discontinued division, net of $15,000 income tax saving .............. (60,000) (44,000) Profit................................................................................ $221,600

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PROBLEM 14-4A (Continued) (b) ZURICH CORPORATION Statement of Retained Earnings Year Ended December 31, 2011

Balance, January 1 as previously reported ........ Add: Cumulative effect of change in accounting policy, net of $12,000 income tax expense ....... Balance, January 1 as adjusted .......................... Add: Profit............................................................. Less: Cash dividends .......................................... Retained earnings, December 31 ........................

$ 560,000 48,000 608,000 221,600 829,600 40,000 $789,600

Taking It Further: Reporting discontinued operations separate from continuing operations allows the users to assess the performance of the company’s ongoing operations separately from the operations of the business segment being discontinued. The separate presentation is also required for comparative figures so that users can compare the performance of the continuing business.

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PROBLEM 14-5A (a) HYPERCHIP CORPORATION Income Statement Year Ended November 30, 2011

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 Other expenses ........................................ 83,000 35,000 Profit before income taxes ........................................... 334,000 Income tax expense ($334,000 x 25%) ......................... 83,500 Profit............................................................................... $ 250,500

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PROBLEM 14-5A (Continued) (b) HYPERCHIP CORPORATION Statement of Retained Earnings Year Ended November 30, 2011

Balance, December 1, 2010 as previously reported.... $ 755,000 Add: Correction for understatement of 2010 profit due to interest expense error, net of $14,250 income tax expense ................ 42,750 Balance, December 1, 2010 as adjusted ...................... 797,750 Add: Profit ................................................................... 250,500 1,048,250 Less: Cash dividends .................................................. 162,500 Balance, November 30, 2011 ........................................ $ 885,750 Taking It Further: When a previous period error is corrected, the impact of the correction is reflected on amounts presented in the financial statements for comparative purposes. This is important to enhance reliability and comparability. Comparative amounts are presented to enable users to examine trends in company performance over time. By providing corrected comparative information, examining current amounts compared to corrected amounts provides more accurate and useful information.

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PROBLEM 14-6A

(a) Journal entries (not required) GENERAL JOURNAL Date

Account Titles and Explanation

J1 Debit

Credit

Jan. 15 Common Shares ($41 × 20,000)............. 80,000 Contributed Capital—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 (10,000 × $5 × ¼) .................................... 12,500 Cash ...................................................

12,500

Jun. 30 Cash Dividends—Preferred (10,000 × $5 × ¼) .................................... 12,500 Cash ...................................................

12,500

Jul. 1 Investments ........................................... 250,000 Income Tax Payable ($250,000 × 25%) 62,500 Retained Earnings [$250,000 × (1 − 25%)] ....................... 187,500 Oct. 1 Cash (100,000 × $8) ............................... 800,000 Common Shares ............................... 800,000

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PROBLEM 14-6A (Continued) (a) (Continued) Dec. 31 Income Summary [$760,000 × (1 − 25%)] .......................... 570,000 Retained Earnings ......................... 570,000 31 Retained Earnings ................................ 25,000 Cash Dividends—Preferred ..........

25,000

Common Shares Date

Explanation

Jan.

1 Balance (320,000) 15 Reacquisition of shares (20,000) Oct. 1 Issue of shares (100,000)

Ref. ✓ J1

Debit

Credit

Balance 1,280,000

80,000 1,200,000 800,000 2,000,000

Contributed Capital—Reacquisition of Common Shares Date

Explanation

Ref.

Jan.

1 Balance 15 Reacquisition of shares

✓ J1

Debit

Credit

Balance 30,000 0

30,000

Retained Earnings Date Jan.

1 15 July 1 Dec. 31 31

Explanation Balance Reacquisition of shares Prior period error Profit Dividends

Ref. ✓ J1 J1 J1 J1

Debit 30,000

25,000

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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PROBLEM 14-6A (Continued) (b) JAJOO CORPORATION Statement of Retained Earnings Year Ended December 31, 2011

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 Add: Profit .......................................................... 00,570,000 3,201,000 Less: Cash dividends—preferred ...... $ 25,000 Reacquisition of shares ........... 30,000 55,000 Balance, December 31 ......................................... $3,146,000

Note X: $500,000 of retained earnings are restricted by a debt covenant.

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 14-7A (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Credit

Jan. 20 Common 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 Capital— Reacquired Common Shares ......... 16,750 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 (1,125,000* × $0.50) .... 562,500 Dividends Payable ............................ 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 ................................. 562,500 31 Accumulated Other Comprehensive Income (Loss) ........................................ 28,000 Other Comprehensive Loss .............

28,000

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PROBLEM 14-7A (Continued) (b) Common Shares Date

Explanation

Jan.

1 Balance 20 Feb. 12 Nov. 2

Ref.

Debit

Credit

Balance

✓ J1 J1 J1

3,000,000 400,000 3,400,000 250,000 3,650,000 3,570,750 79,250

Common Stock Dividends Distributable Date Jan.

Explanation 1 Balance 20

Ref. ✓ J1

Debit

Credit

Balance

400,000

400,000 0

400,000

Contributed Capital—Reacquired Common Shares Date

Explanation

Jan. 1 Balance Dec. 31

Ref.

Debit

✓ J1

Credit

Balance

5,000 16,750

5,000 21,750

Credit

Balance

562,500

562,500 0

Cash Dividends Date

Explanation

Dec. 31 Dec. 31 Closing entry

Ref.

Debit

J1 J1

562,500

Ref.

Debit

✓ J1 J1 J1

1,200,000 42,000 1,242,000 280,000 1,522,000 959,500 562,500

Retained Earnings Date

Explanation

Jan. 1 Balance Mar. 31 Dec. 31 Closing entry Dec. 31

Credit

Balance

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-7A (Continued) (b) (Continued) Accumulated Other Comprehensive Income (Loss) Date

Explanation

Dec. 31 Closing entry

Ref.

Debit

28,000

Credit

Balance 28,000Dr

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-7A (Continued) (c) CEDENO INC. Statement of Changes in Shareholders’ Equity Year ended December 31, 2011

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 Balance, January 1 ................................................. 400,000 Common stock dividend distributed ................ (400,000) Balance, December 31 ............................................ 0 Contributed capital − 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 2010, 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)................. (28,000) Balance, December 31 ............................................ (28,000) Total shareholders' equity .......................................... $4,524,000

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PROBLEM 14-7A (Continued) (d) CEDENO INC. Partial Balance Sheet December 31, 2011

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 capital—reacquired common shares ......................................... 21,750 Total contributed capital ....................................... 3,592,500 Retained earnings .................................................. 959,500 Accumulated other comprehensive income (loss) (28,000) Total shareholders' equity .................................... $4,524,000 Taking It Further: The statement of changes in shareholders’ equity is not required of companies following Canadian GAAP for Private Enterprises because these companies typically have fewer and less complex shareholder equity transactions. The same information is presented, but using a statement of retained earnings and additional note disclosure. Many private companies use a statement of changes in shareholders’ equity even if it not required since it presents the same information in one statement with less note disclosure.

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PROBLEM 14-8A TMAO INC. Statement of Changes in Shareholders’ Equity Year Ended December 31, 2011

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 depreciation in 2010, 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% = 16,000 × $12 = $192,000 3 4,000 x 2 from split x ($3 ÷ 2) = $12,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-8A (Continued)

Taking It Further: Companies reporting under IFRS are required to prepare a statement of changes in shareholders’ equity instead of a statement of retained earnings. The statement of changes in shareholders’ equity contains all of the information in the statement of retained earning plus information about changes to other equity accounts such as share capital and accumulated other comprehensive income.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-9A SUNCOR ENERGY INC. Statement of Comprehensive Income Year Ended December 31, 2008 (US$ millions)

Profit............................................................................. Other comprehensive income items .......................... Comprehensive income ..............................................

$2,137 350 $2,487

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PROBLEM 14-9A (Continued) SUNCOR ENERGY INC. Statement of Retained Earnings Year Ended December 31, 2008 (US$ millions)

Share capital Balance, January 1, 925,566 thousand shares issued.................................................................. Stock dividend issued, 135 thousand shares .. Shares issued under stock option plan, 9,823 thousand shares .............................................. Balance, December 31, 935,524 thousand shares issued.................................................................. Contributed capital Balance, January 1 ................................................. Share-based compensation expense ............... Reduction for shares issued under stock option plan ....................................................... Balance, December 31 ............................................ Retained earnings Balance, January 1 ................................................. Profit ................................................................... Stock dividends.................................................. Cash dividends................................................... Balance, December 31 ............................................ Accumulated other comprehensive income (loss) Balance, January 1 ................................................. Other comprehensive income ........................... Balance, December 31 ............................................ Total shareholders' equity ..........................................

$881 6 226 1,113 194 130 (36) 288 11,074 2,137 (6) (180) 13,025 (253) 350 97 $14,523

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-9A (Continued) SUNCOR ENERGY INC. Partial Balance Sheet December 31, 2008 (US$ millions)

Shareholders' equity Contributed capital Share capital ............................................................ $ 1,113 Contributed capital................................................... 288 Total contributed capital .............................................. 1,401 Retained earnings ........................................................ 13,025 Accumulated other comprehensive income ............... 97 Total shareholders' equity ................................................ $14,523 Taking It Further: A statement of comprehensive income can be prepared under two possible formats, the all-inclusive format and the separate statement format. The all-inclusive format shows traditional profit and other comprehensive income to arrive at comprehensive income all on one statement. The separate statement format shows a “traditional” income statement arriving at profit and then in a separate statement of comprehensive income, profit and other comprehensive income to arrive at comprehensive income. 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 and the information needs of its users. For example, if a company has several material transactions to disclose in other comprehensive income, it may choose the separate statement format if all of the information of the income statement and other comprehensive income will not fit on one page. A company may also choose a separate statement format if it wants to emphasize the profit amount rather than comprehensive income. Solutions Manual 14-57 Chapter 14 Copyright © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is prohibited.

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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 x $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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Accounting Principles, Fifth Canadian Edition

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 on 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-11A (a)

($ in millions) Ratio

1. Return on equity 2. Earnings per share 3. Price-earnings ratio 4. Payout ratio (b)

2009 $279 − $0 = 15.53% $1,796 $279 − $0 = $1.34 208 $20.94 = 15.63 times $1.34 $112 = 40.14% $279

2008 $288 − $0 = 18.27% $1,576 $288 − $0 = $1.38 208 $27.88 = 20.20 times $1.38 $95 = 32.99% $288

During 2009, the profitability of the Saputo declined. The return on equity declined because profit declined and shareholders’ equity increased. Both factors contributed to the decline in the return on equity. Earnings per share also declined because of the decline in profit. The company’s price-earnings ratio also decreased because investors were not willing to pay as much for shares of the company. The decrease in the market price and the decrease in earnings per share caused the priceearnings ratio to decrease. Investors were not as optimistic about the company’s future prospects. The payout ratio increased due to higher cash dividends and lower profit.

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Accounting Principles, Fifth Canadian Edition

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-12A (a) Before Discontinued Operations Ratio 2011 $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

2010 $810 − $20 = 32.92% $2,400 $810 − $20 = $2.72 290 $33.65 = 12.37 times $2.72

2009 $570 − $15 = 30.83% $1,800 $570 − $15 = $1.98 280 $44.80 = 22.63 times $1.98

After Discontinued Operations Ratio 2011 $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

2010 $730 − $20 = 29.58% $2,400 $730 − $20 = $2.45 290 $33.65 = 13.73 times $2.45

2009 $500 − $15 = 26.94% $1,800 $500 − $15 = $1.73 280 $44.80 = 25.90 times $1.73

Solutions Manual

Chapter 14

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-12A (Continued) (b) Before Discontinued Operations: Highlander’s return on equity increased slightly from 2009 to 2011 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 2011 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 2011. 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 2011 change this trend for all three ratios.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-12A (Continued) Taking It Further: The purpose of reporting separately the discontinued operations of a component of an entity is to allow the performance of 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-1B (a)

(b) Number of Common Shares

(c)

(e) Share Price

(f) Fair Value of Mark’s Portfolio

Date

Common Shares

Jul. 1 Aug. 31 Sep 30 Dec. 1 Dec. 1

$2,000,000 112,000 2,112,000 600,000 $2,712,000

100,000 4,000 104,000 20,000 124,000

$350,000 (112,000) 238,000 000 0000 $238,000

25,000 1,000 26,000 5,000 31,000

$25 28 29 30 30

$625,000

Mar. 31 (before) Mar. 31 Mar. 31 (after)

$2,712,000

124,000

$238,000

31,000

806,000

000000000 $2,712,000

124,000 248,000

000 0000 $238,000

31,000 62,000

806,000

Jun. 30

$2,712,000

248,000

$238,000

62,000

930,000

Solutions Manual

Retained Earnings

(d) Number of Shares Held by Mark Bradbury

754,000 930,000

Chapter 14

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-1B (Continued) Taking It Further Companies issue stock dividends for reasons such as: • A gesture to give something to shareholders if cash is not available to give a cash dividend to shareholders; • To decrease the share price by issuing more shares; • To capitalize a portion of retained earnings and make it permanently retained in the business. In the case of Gull Lake Enterprises, the number of shares issued as a stock dividend is low, so it is unlikely the company is trying to reduce the share price. It is most likely to satisfy dividend expectations of shareholders since cash dividends were not paid out during the year.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-2B (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% = 25,000 × $30 = $750,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-2B (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 the shareholder 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-2B (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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-3B (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. 01 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-3B (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

✓ J1 J1

Credit 300,000

195,000

Balance 600,000 900,000 705,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-3B (Continued) (c) ASAAD CORPORATION Partial Balance Sheet December 31, 2011

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 ............................................. 4 6705,000 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, on account of investor interest.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-4B HYPERCHIP CORPORATION Income Statement Year Ended November 30, 2011

Net sales ......................................................................... $1,500,000 Cost of goods sold ......................................................... 0 ,800,000 Gross profit..................................................................... 700,000 Operating expenses ....................................................... 240,000 Profit from operations .................................................... 460,000 Other revenues ................................................ $40,000 Other expenses ............................................... 030,000 , 010,000 Profit before income tax ................................................ 470,000 Income tax expense ($470,000 × 25%) .......................... 0 ,117,500 Profit from continuing operations ................................. 352,500 Discontinued operations Loss from operations of ceramics division, net of $37,500 income tax saving .............. $112,500 Gain on sale of ceramics division, net of $17,500 income tax expense ........... 0 52,500 ((60,000) Profit................................................................................ $ 292,500

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PROBLEM 14-4B (Continued) (b) HYPERCHIP CORPORATION Statement of Retained Earnings Year Ended November 30, 2011

Balance, December 1 as previously reported ....... Less: Cumulative effect of change in accounting policy, net of $7,500 income tax saving............... Balance, December 1 as adjusted .......................... Add: Profit................................................................ Less: Cash dividends ............................................. Retained earnings, November 30 ...........................

$1,050,000 (22,500) 1,027,500 292,500 1,320,000 45,000 $1,275,000

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PROBLEM 14-5B (a) COQUITLAM CORPORATION Income Statement Year Ended December 31, 2011 Net sales ................................................................ $1,816,0001 Cost of goods sold ................................................ 1,088,000 Gross profit .......................................................... 728,000 Operating expenses .............................................. 551,000 Profit from operations ........................................... 177,000 Other revenues ................................ $47,000 Other expenses ................................ 28,000 19,000 Profit before income taxes ................................... 196,000 Income tax expense ($196,000 x 25%) ................. 49,000 Profit....................................................................... $ 147,000 1

Net sales = $1,750,000 + $66,000 = $1,816,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-5B (Continued)

(b) COQUITLAM CORPORATION Statement of Retained Earnings Year Ended December 31, 2011

Balance, January 1, as previously reported ...... $ 642,000 Less: Correction for overstatement of sales in 2010, net of $16,500 income tax savings .............................................. 49,500 Balance, January 1, as adjusted ........................ 592,500 Add: Profit .......................................................... 147,000 739,500 Less: Cash dividends ....................................... 125,000 Balance, December 31 ........................................ $ 614,500 Taking It Further: When a previous period error is corrected, the impact of the correction is reflected on amounts presented in the financial statements for comparative purposes. This is important to enhance reliability and comparability. Comparative amounts are presented to enable users to examine trends in company performance over time. By providing corrected comparative information, examining current amounts compared to corrected amounts provides more accurate and useful information.

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PROBLEM 14-6B (a) Journal entries (not required) 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

Jul.

1 Common Shares (25,000 × $12.801) ...... 320,000 Contributed Capital—Reacquisition of Shares ........................................... 20,000 Cash (25,000 × $12) ........................... 300,000 ($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

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Accounting Principles, Fifth Canadian Edition

PROBLEM 14-6B (Continued) (a) (Continued) Dec. 31 Income Summary [$750,000 × (1 − 30%)] ........................... 525,000 Retained Earnings ............................ 525,000 31 Retained Earnings ................................. 45,000 Cash Dividends—Preferred ..............

45,000

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

Debit

Credit

Balance

3,210,000 310,000 3,520,000 3,200,000

J1 320,000

Retained Earnings Date Jan. 1 Sept. 1 Dec. 31 31

Explanation

Ref.

Debit

Credit

Balance

Balance Correction of error Profit Dividends

✓ J1 J1 J1

980,000 938,000 42,000 525,000 1,463,000 1,418,000 45,000

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PROBLEM 14-6B (Continued) (b) MICHAUD CORPORATION Statement of Retained Earnings Year Ended December 31, 2011

Balance, January 1, as previously reported ........ $ 980,000 Less: Correction of overstatement of 2010 sales net of $18,000 income tax saving ............ 42,000 Balance, January 1, as adjusted ........................... 938,000 Add: Profit .......................................................... 0 525,000 1,463,000 Less: Cash dividends—preferred ...................... 45,000 Balance, December 31 ........................................... $1,418,000 Note X: $15,000 of preferred dividends are in arrears. Note Y: $250,000 of the retained earnings are restricted by a debt covenant. 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 14-7B (a) Date

GENERAL JOURNAL Account Titles and Explanation

J1 Debit

Aug. 01 Income Tax Payable (Recoverable) ...... 13,500 Retained Earnings ................................. 31,500 Inventory............................................

Credit

45,000

Oct. 015 Stock Dividends—Common .................. 450,000 Common Stock Dividends Distributable .................................... 450,000 (250,000 × 10% × $18) Nov. 10 Common Stock Dividends Distributable ........................................ 450,000 Common Shares ............................... 450,000 Dec. 15 Cash Dividends—Preferred ................. 48,000 Dividends Payable—Preferred ......... (12,000 × $4)

48,000

31 Income Summary................................... 395,000 Retained Earnings ............................ 395,000 31 Retained Earnings ................................. 498,000 Cash Dividends—Preferred .............. 48,000 Stock Dividends—Common ............. 450,000 31 Other Comprehensive Income .............. 12,000 Accumulated Other Comprehensive Income (Loss) .................................

12,000

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PROBLEM 14-7B (Continued) (b) Preferred Shares Date Jan.

Explanation 1 Balance

Ref.

Debit

Credit

✓

Balance 800,000

Common Shares Date

Explanation

Jan. 1 Balance Nov. 10

Ref.

Debit

✓ J1

Credit

Balance

450,000

500,000 950,000

Contributed Capital—Reacquired Common Shares Date Jan.

Explanation 1 Balance

Ref.

Debit

Credit

✓

Balance 100,000

Common Stock Dividends Distributable Date

Explanation

Oct. 15 Nov. 10

Ref.

Debit

J1 J1

450,000

Ref.

Debit

J1 J1

450,000

Ref.

Debit

J1 J1

48,000

Credit

Balance

450,000

450,000 0

Stock Dividends—Common Date

Explanation

Oct. 15 Dec. 31 Closing entry

Credit 450,000

Balance 450,000 0

Cash Dividends—Preferred Date

Explanation

Dec. 15 31 Closing entry

Credit 48,000

Balance 48,000 0

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PROBLEM 14-7B (Continued) (b) (Continued)

Retained Earnings Date

Explanation

Jan. 1 Balance Aug. 1 Dec. 31 Closing entry 31 Closing entry

Ref.

Debit

Credit

Balance

✓ J1 J1 J1

900,000 868,500 31,500 395,000 1,263,500 765,500 498,000

Accumulated Other Comprehensive Income (Loss) Date

Explanation

Jan. 1 Balance Dec. 31 Closing entry

Ref. ✓ J1

Debit

Credit

Balance

50,000Dr 12,000 38,000Dr

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PROBLEM 14-7B (Continued) (c) FRYMAN LTD. Statement of Changes in Shareholders’ Equity Year ended December 31, 2011

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 capital—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) Balance, January 1 ................................................. (50,000) Other comprehensive income ........................... 12,000 Balance, December 31 ............................................ (38,000) Total shareholders' equity .......................................... $2,577,500

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PROBLEM 14-7B (Continued) (d) FRYMAN LTD. Partial Balance Sheet December 31, 2011

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 capital—reacquired common shares ..................................... 100,000 Total contributed capital..................... 1,850,000 Retained earnings (See Note B) ....................... 765,500 Accumulated other comprehensive loss ........ (38,000) Total shareholders' equity .................. $2,577,500 Note B: Retained earnings is restricted for plant expansion, in the amount of $200,000. Taking It Further: The statement of changes in shareholders’ equity is not required of companies following Canadian GAAP for Private Enterprises because these companies typically have fewer and less complex shareholder equity transactions. The same information is presented, but using a statement of retained earnings and additional note disclosure. Many private companies use a statement of changes in shareholders’ equity even if it not required since it presents the same information in one statement with less note disclosure. Solutions Manual 14-84 Chapter 14 Copyright © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is prohibited.

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PROBLEM 14-8B KANADA INC. Statement of Changes in Shareholders’ Equity Year Ended September 30, 2011

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 2010, net of $16,200 income tax expense .................................................... 37,800 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 $XXX income tax expense ......................................... 27,000 Balance, September 30........................................... 122,000 Total shareholders' equity .......................................... $2,285,400 1

25,000 × 4% = 1,000 × $10 = $10,000 $325,000 × (1 − 30%) = $227,500 3 6,000 x $5 = $30,000 2

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PROBLEM 14-8B (Continued) Taking It Further: Companies reporting under IFRS are required to prepare a statement of changes in shareholders’ equity instead of a statement of retained earnings. The statement of changes in shareholders’ equity contains all of the information in the statement of retained earning plus information about changes to other equity accounts such as share capital and accumulated other comprehensive income.

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PROBLEM 14-9B CANADIAN NATIONAL RAILWAY COMPANY Statement of Comprehensive Income Year Ended December 31, 2008 (in millions)

Profit.......................................................................... Less: Other comprehensive losses ........................ Comprehensive income ...........................................

$1,895 124 $1,771

CANADIAN NATIONAL RAILWAY COMPANY Statement of Retained Earnings Year Ended December 31, 2008 (in millions)

Share capital, common shares Balance, January 1, 485.2 million shares issued . Reacquired, 19.4 million shares ........................ Shares issued under stock option plan, 2.4 million shares................................................... Balance, December 31, 468.2 million shares issued ................................................................. Retained earnings Balance, January 1 ................................................. Profit ................................................................... Reacquired common shares ............................. Cash dividends................................................... Balance, December 31 ............................................ Accumulated other comprehensive income (loss) Balance, January 1 ................................................. Other comprehensive loss ................................ Balance, December 31 ............................................ Total shareholders' equity ..........................................

$4,283 (172) 68 4,179 5,925 1,895 (849) (436) 6,535 (31) (124) (155) $10,559

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PROBLEM 14-9B (Continued)

CANADIAN NATIONAL RAILWAY COMPANY Partial Balance Sheet December 31, 2008 (in millions)

Shareholders' equity Common shares ....................................................... Retained earnings .................................................... Accumulated other comprehensive income (loss) Total shareholders' equity .....................................

$4,179 6,535 10,714 (155) $10,559

Taking It Further: A statement of comprehensive income can be prepared under two possible formats, the all-inclusive format and the separate statement format. The all-inclusive format shows traditional profit and other comprehensive income to arrive at comprehensive income all on one statement. The separate statement format shows a “traditional” income statement arriving at profit and then in a separate statement of comprehensive income, profit and other comprehensive income to arrive at comprehensive income. 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 and the information needs of its users. For example, if a company has several material transactions to disclose in other comprehensive income, it may choose the separate statement format if all of the information of the income statement and other comprehensive income will not fit on one page. 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 14-10B (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 x $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)

Ratio 2008 $776 − $32 1. Return on common = 16.18% shareholders' equity $4,598 $776 − $32 2. Earnings per share = $4.68 159 $45.21 = 9.66 3. Price-earnings ratio times $4.68 $394 4. Payout ratio = 50.77% $776

2007 $541 − $21 = 11.71% $4,439 $541 − $21 = $3.25 160 $54.65 = 16.82 times $3.25 $364 = 67.28% $541

(b) During 2008, the profitability of the National Bank of Canada increased substantially. This is apparent from the higher profit, which caused the earnings per share to increase. This increase in profit also led to an increase in the return provided to shareholders as evidenced by the increase in the return on common shareholders’ equity from 11.71% in 2007 to 16.18% in 2008. The increase in profit was partially offset by an increase in common shareholders’ equity. The company’s price-earnings ratio decreased because the market price of the common shares decreased and because earnings per share increased. The decrease in market price of the shares when the company is more profitable may be due to investor expectations about the future prospects of the company or because of general market conditions. The company’s payout ratio decreased even though dividends to common shareholders increased because of the substantial increase in profit.

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PROBLEM 14-11B (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 14-12B (a) Before Discontinued Operations Ratio 2011 $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

2010 $1,130 − $80 = 43.75% $2,400 $1,130 − $80 = $2.23 470 $19.88 = 8.91 times $2.23

2009 $990 − $60 = 48.95% $1,900 $990 − $60 = $2.02 460 $21.60 = 10.69 times $2.02

After Discontinued Operations Ratio 2011 $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

2010 $980 − $80 = 37.50% $2,400 $980 − $80 = $1.91 470 $19.88 = 10.41 times $1.91

2009 $810 − $60 = 39.47% $1,900 $810 − $60 = $1.63 460 $21.60 = 13.25 times $1.63

Solutions Manual

Chapter 14

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PROBLEM 14-12B (Continued)

(b) Before Discontinued Operations: All Care’s return on equity decreased from 2009 to 2011 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 2011 due to losses from discontinued operations. The same loss also causes a large decrease in earnings per share for 2011. 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 2011. 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 2011. The results before discontinued operations do not show the sharp decrease caused by the large losses in 2011 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 the performance of 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 GENERAL JOURNAL Date (a) Dec.

Apr.

June

Account Titles and Explanation 1 Cash ............................................... Preferred Shares ....................... 30 Cash Dividends—Preferred (2,500 × $0.50 × ½) ......................... Dividends Payable ....................

Debit

2,500

625 625 625

30 Common Shares (1,300 × $.996) ... Retained Earnings ......................... Cash ...........................................

1,295 5

Number of Common Shares Issued 23,550 1,300 24,850 (1,300) 23,550

Credit

2,500

1 Dividends Payable ......................... Cash ...........................................

Transaction Issuance to Natalie & Curtis Issuance to lawyer Sub-total Repurchase June 30 Ending Balance Oct.

625

1,300

Common Share Average Value Cost $23,550 1,200 $24,750 $.996 (1,295) $23,455 $.996

31 Income Tax Expense ..................... 18,000 Income Tax Payable .................. ($475,000 – $385,000) × 20%

18,000

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CONTINUING COOKIE CHRONICLE (Continued) Oct.

31 Cash Dividends—Preferred (2,500 × $0.50 × ½) ......................... Dividends Payable ....................

625 625

(b) COOKIE & COFFEE CREATIONS LTD. Statement of Retained Earnings Year Ended October 31, 2012

Balance, November 1, 2011 ...................................... $ Add: Profit ............................................................... 72,000 72,000 Less: Cash dividends—preferred ............. $1,250 Reacquisition of common shares ....... 5 1,255 Balance, October 31, 2012 ........................................ $70,745

Shareholders' equity Contributed capital Share capital $0.50-noncumulative preferred shares, no par value, 10,000 authorized, 2,500 shares issued ................................ $ 12,500 Common shares, no par value, unlimited number of shares authorized, 23,550 shares issued............................... 23,455 Total contributed capital....................... 35,955 Retained earnings .............................................. 70,745 Total shareholders' equity .................... $106,700

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CONTINUING COOKIE CHRONICLE (Continued)

(d) Oct.

31 Revenues ....................................... 475,000 Income Summary ...................... 475,000 31 Income Summary........................... 403,000 Expenses ................................... 385,000 Income Tax Expense................. 18,000 31 Income Summary........................... 72,000 Retained Earnings ....................

31 Retained Earnings ......................... Cash Dividends—Preferred .........................

72,000

1,250 1,250

(e)

If Cookie & Coffee Creations Ltd. were using IFRS, the financial statements would have to include the following: 1. Income statement would need to show earnings per share. 2. Assuming the transactions of the business required it, there would be Other comprehensive income in the Comprehensive income statement and Accumulated other comprehensive income on the balance sheet. 3. Instead of a statement of retained earnings, the business would need to prepare a statement of changes in shareholders’ equity.

(f)

Because of the nature and the size of the Cookie & Coffee Creations Ltd. business and the direct involvement of the shareholders, the additional information that would be provided by following IFRS would not be relevant. Any need for additional information that could possibly be useful to the users of the financial statements would be easily obtained by management.

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BYP 14-1 FINANCIAL REPORTING PROBLEM

(a)

Forzani declared and paid dividends in fiscal 2009 in the amount of $9,327,000.

(b) Forzani reported: (1) Other comprehensive earnings of $871,000 for 2009, (2) A prior period adjustment concerning implementation of new a new accounting policy, (3) No restricted retained earnings. (c) Instead of presenting a Consolidated statement of changes in shareholders’ equity, Forzani presented Consolidated Statements of Retained Earnings, Comprehensive Earnings and Accumulated Other Comprehensive Earnings (Loss). (d) Basic earnings per share for 2008 was $1.40. The earnings per share weakened in 2009 to $0.94. (e) Fully diluted earnings per share were reported in both years. In each case, the fully diluted amounts were one cent lower than the basic amounts ($0.93 and $1.39 in 2009 and 2008, respectively). (f)

The price-earnings ratio decreased from 11.1 times in 2008 to 10 times in 2009. This is a weakening of the ratio, consistent with the declining earnings per share. Investors most likely believe that Forzani is not in as good a position to improve earnings in the future.

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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 3-for-1 stock split would have no impact on assets, liabilities or shareholders’ equity. All that would change is that the number of shares issued would triple.

(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. (c)

Immediately after the 3-for-1 stock split, the share price should drop by around 67%, to $7.33.

(d) The cash dividend would be $0.10 after the split, one third of $0.30.

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BYP 14-2 (Continued) (e) 2008

Ratio Earnings per share

$(4,369) 11,016

2007 = $(0.40)

$20,313 11,460

= $1.77

Return on $(4,369) $20,313 sharehol= (4.5)% = 20.7% $90,677+$104,952 $104,952 + $90,922 ders' equity 2 2

Payout ratio

A payout ratio cannot be calculated when the company has a loss.

$3,327 $20,313

= 16.4%

The loss for the year 2008 led to a negative earnings per share, and a negative return on shareholders’ equity. The payout ratio cannot be calculated in this situation because it is not a logical calculation if the company has a loss. The payout ratio is meant to show how much of the profit has been paid out as dividends. When the company has a loss and still pay dividends it has paid out more than it earned, not a percentage of what it earned. On the other hand, the results for 2007 showed positive profitability, strong return on shareholders’ equity, and good payout ratio.

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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 price. 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 over priced. 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 Canadian GAAP for Private Enterprises, 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)

Option #1 advantages: 1. Has less risk that the share price will not increase in the future. 2. Provides better cash flow to deal with personal living expenses month to month. 3. You will feel more secure knowing that cash will be available in the future to address commitments such as student loan repayments. Option #1 disadvantages: 1. You will pay more income taxes on the income earned. 2. You could potentially miss out on an opportunity for significant increase in personal wealth based on the stock performance.

(b)

Option #2 advantages: 1. You have the potential for significant increase in personal wealth based on the stock performance. 2. You will pay far less income taxes on your take home pay. Option #2 disadvantages: 1. Has more risk that the share price will not increase in the future. 2. Provides far less cash flow from your net pay to deal with personal living expenses month to month. 3. When applying for loans, banks will not consider stock options as income and you will have more difficulty making major purchases such as a car or home. 4. Less security in knowing you will have sufficient funds to live on and less opportunity to make investments. 5. Stock option plans usually require you to remain employed with the company so your job flexibility will be adversely affected.

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BYP 14-6 (Continued) (c)

You need to take into account financial commitments already in place, as well as your life goals including starting a family or furthering your education. Student loan repayments, car lease payments, house rental or mortgage payments will add up quickly and might not allow you to take the risk of Option #2.

(d) The company might be very enthusiastic about its financial prospects and so might be biased in its expectations for the price of stock in the immediate future. To the extent possible, ask for the financial statements of the company, do research on other businesses in the industry, and use your knowledge to reduce the amount of risk you are taking in making your decision. In the case of a publicly traded company, a great deal more information is available concerning past performance and stock information in the company’s financial history. Consequently, the amount of risk involved in Option #2 would be substantially reduced. As well, a history of other employees having been able to obtain remuneration from exercising stock options in the past will reaffirm the opportunity to generate cash and income in the future.

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Legal Notice Copyright

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CHAPTER 15 Long-Term Liabilities ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

Problems Set A

Problems Set B

1. Compare the impact of issuing debt instead of equity.

1, 2, 3

1, 12

2. Account for bonds payable.

4, 5, 6, 7, 8, 9

2, 3, 4, 5, 6, *17, *18

1, 2, 3, *10, *11

3. Account for long-term notes payable.

10, 11, 12, 13, 14

7, 8, 9

2, 3, 4, 5, 6, *14, *15, *16 7, 8, 9

4, 5, 6

4. Account for leases.

15, 16, 17,

10, 11, 12

10, 11

7, 8

5. Explain and illustrate the methods for the presentation and analysis of long-term liabilities.

18, 19, 20, 21

9, 13, 14, 15

9, 11, 12, 13

8, 9

6. Apply the effective-interest method of amortizing bond discounts and premiums (Appendix 15A).

*22, *23, *24

*16, *17, *18

*14, *15, *16

*10, *11

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendix to each chapter.

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record bond transactions.

Simple

15-20

Record bond transactions; show balance sheet presentation.

Moderate

25-35

Record bond transactions; show balance sheet presentation.

Moderate

20-30

Record note transactions.

Moderate

20-30

Record note transactions.

Moderate

20-30

Prepare instalment payment schedule and record note transactions. Show balance sheet presentation.

Moderate

25-30

Analyze lease situations. Discuss financial statement presentation.

Simple

20-25

Calculate and analyze solvency ratios.

Simple

15-20

Analyze leverage.

Simple

10-15

*10A

Record bond transactions and prepare amortization schedule. Show balance sheet presentation.

Moderate

30-40

*11A

Record bond transactions and answer questions.

Moderate

25-35

Record bond transactions.

Simple

15-20

Record bond transactions; show balance sheet presentation.

Moderate

25-35

Record bond transactions; show balance sheet presentation.

Moderate

20-30

Record note transactions.

Moderate

20-30

Record note transactions.

Moderate

20-30

Prepare instalment payment schedule and record note transactions. Show balance sheet presentation.

Moderate

25-30

Analyze lease situations. Discuss financial statement presentation.

Simple

20-25

Calculate and analyze solvency ratios.

Simple

15-20

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze leverage.

Simple

10-15

*10B

Record bond transactions and prepare amortization schedule. Show balance sheet presentation.

Moderate

30-40

*11B

Record bond transactions and answer questions.

Moderate

25-35

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Accounting Principles, Fifth Canadian Edition

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 E15-12

2. Account for bonds payable.

Q15-4 Q15-5 Q15-6 Q15-8 Q15-9

Q15-7 BE15-2 BE15-3 BE15-4 BE15-5 BE15-6 *BE15-17 *BE15-18 E15-2 E15-3 E15-4 E15-5 E15-6

*E15-14 *E15-15 *E15-16 P15-1A P15-2A P15-3A *P15-10A *P15-11A P15-1B P15-2B P15-3B *P15-10B *P15-11B

3. Account for long-term notes payable.

Q15-10 Q15-11 Q15-12 Q15-13

Q15-14 BE15-7 BE15-8 BE15-9 E15-7 E15-8

E15-9 P15-4A P15-5A P15-6A P15-4B P15-5B P15-6B

4. Account for leases.

Q15-15 Q15-16

Q15-17 BE15-11 BE15-12 E15-10

E15-11 P15-7A P15-7B

Q15-21

BE15-9 BE15-13 BE15-14 BE15-15 E15-9 E15-11 E15-12 E15-13

1. Compare the impact of issuing debt instead of equity.

5. Explain and illustrate the methods for the presentation and analysis of long-term liabilities.

Q15-18 Q15-19 Q15-20

Analysis P15-9A P15-9B

Synthesis

BE15-10 P15-8A P15-8B

P15-8A P15-9A P15-8B P15-9B

Evaluation

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Accounting Principles, Fifth Canadian Edition

BLOOM’S TAXONOMY TABLE (Continued) Study Objectives

6. Apply the effectiveinterest method of amortizing bond discounts and premiums (Appendix 15A). Broadening Your Perspective

Knowledge *Q15-22

Comprehension Application *Q15-23 *BE15-16 *P15-10A *Q15-24 *BE15-17 *P15-11A *BE15-18 *P15-10B *E15-14 *P15-11B *E15-15 *E15-16

Analysis

BYP15-5

BYP15-2 BYP15-3 BYP15-6

BYP15-1 BYP15-4 Continuing Cookie Chronicle

Synthesis Evaluation

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Accounting Principles, Fifth Canadian Edition

ANSWERS TO QUESTIONS 01.

Current liabilities are obligations that are due within the next year, and that will require the use of current assets or the creation of other current liabilities. Examples include accounts payable and wages payable. Longterm liabilities are obligations that are expected to be paid after one year or the company’s normal operating cycle, whichever is longer. Examples include long-term notes payable and lease liabilities.

02.

(a) The major advantages of debt over equity are: 1. Shareholder control is not affected—debtholders 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 may be higher because shareholders’ equity is lower since no additional shares are issued. (b) The major disadvantage in 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)

Bonds are similar to notes payable in that they are a formal instrument of credit in which the interest must be paid periodically and the principal repaid at a specified date.

(b)

Bonds are similar to common shares in that they are sold to investors on organized securities exchanges. Both allow the company to raise capital.

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QUESTIONS (Continued) 5. (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 life 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.

Investors will be willing to pay the present value of the future cash flows, discounted at the current market interest rate. The present value of the interest payments is determined by multiplying the periodic (usually semiannual) interest payment by the present value of a $1 annuity factor. The present value of the principal is determined by multiplying the face amount of the bond by the present value of $1 factor. Financial calculators or functions in worksheet software packages can also be used to calculate the amounts.

Investors paid $2,000 ($100,000 – $98,000) less than the face value. The market interest rate must have been greater than the contractual interest rate. These bonds are said to have been sold at a discount.

(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 keeping with the matching concept, 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. According to the matching concept, these savings should reduce bond interest expense over the life of the bonds.

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.

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QUESTIONS (Continued) 10.

Both short and long-term notes are normally interest-bearing. A short-term note typically is repaid in full at maturity whereas most long-term notes are repayable in a series of periodic payments. Interest may be due monthly or at maturity for a short-term note, whereas it tends to be due monthly for a long-term note. As well, long-term notes often have their interest rates tied to changes in the market rate of interest and are more likely to be secured by an asset as collateral.

11.

This type of loan is a floating rate loan as the prime rate changes over time. Since the loan repayment 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.

Instalment notes payable with fixed principal payments are repayable in equal periodic amounts, plus interest. Since the periodic interest will drop as the loan is repaid, the periodic payment will get smaller each time. Instalment notes with blended principal and interest payments are repayable in equal periodic amounts, including interest.

13.

The advantage to the student in paying blended payments is that the payments are the same each month. It is easier for a graduating student to fit in a fixed blended payment into their cash planning.

14.

This is not the case. Each payment by Doug consists of (1) interest on the unpaid balance of the loan and (2) a reduction of loan principal. The interest 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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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 16.

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 GAAP 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.

17.

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 amortized 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.

18.

The nature and the amount of each long-term liability should be presented in the balance sheet or in schedules in the accompanying notes to the financial statements. The notes should also indicate the interest rates, maturity dates, conversion privileges, and any assets pledged as collateral. The amount of long-term debt maturing within 12 months of the balance sheet date should be reported under current liabilities.

19.

Current liabilities include those principal payments on the mortgage note payable that are going to be due for payment in one year. The principal payments appearing under long-term debt are those amounts to be paid beyond that period. 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.

20.

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 long-term 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.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 21.

The debt to total assets and interest coverage ratios help assess solvency by providing insight into the ability of a company to repay its long-term 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.

*22. 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 purchased. The difference between the interest payment and the interest expense is the amount of discount or premium amortized each period. *23. (a) Regardless of whether bonds are issued at a discount or a premium, the interest payment is unchanged each period. With a discount, the interest expense will increase each period as the amortized cost increases. The bond’s amortized cost will also increase until it reaches its maturity value. (b) Regardless of whether bonds are issued at a discount or a premium, the interest payment is unchanged each period. With a premium, the interest expense will decrease each period as the amortized cost decreases. The bond’s amortized cost will also decrease until it reaches its maturity value. *24. (a) If bonds are issued at a premium, then the issue price is greater than the maturity value. In addition, the premium amount reduces the cost of borrowing, resulting in less interest expense than interest paid. Consequently, as the premium is amortized, the bond’s amortized cost will decrease until its amortized cost equals its maturity value. (b) If bonds are issued at a discount, then the issue price is less than the maturity value. In addition, the discount amount increases the cost of borrowing, resulting in more interest expense than interest paid. Consequently, as the discount is amortized, the bond’s amortized cost will increase until its amortized cost equals its maturity value. Solutions Manual 15-10 Chapter 15 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15-1 Profit before interest and income tax Interest expense ($4,000,000 X 6%) Profit before income tax Income tax expense (25%) Profit Number of shares Earnings per share (profit ÷ number of shares) Shareholders’ equity ($10,000,000 + $4,000,000 + $750,000) ($10,000,000 + $570,000) Return on equity (profit ÷ shareholders’ equity)

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

$14,750,000 $10,570,000

5.08%

5.39%

Even though profit is lower, the debt alternative is better as earnings per share and return on equity are higher.

BRIEF EXERCISE 15-2 (a)

($500,000 X 0.82035) + ($500,000 X 2.5% X 8.98259) = $522,457

(b) ($500,000 X 0.78120) + ($500,000 X 2.5% X 8.75206) = $500,000 (rounded) (c)

($500,000 X 0.74409) + ($500,000 X 2.5% X 8.53020) = $478,673

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 15-3 (a)

Apr. 01 Cash .......................................... 1,000,000 Bonds Payable .................... 1,000,000

(b) Oct. 01 Bond Interest Expense ............. Cash ($1,000,000 X 4% X 6/12) ......

20,000

(c)

10,000

Dec. 31 Bond Interest Expense ............. Bond Interest Payable ($1,000,000 X 4% X 3/12) ......

(d) Apr. 1 Bond Interest Expense ($1,000,000 X 4% X 3/12) .......... Bond Interest Payable .............. Cash ...................................... (e) Apr.

20,000

10,000

10,000 10,000 20,000

1 Bonds Payable .......................... 1,000,000 Cash ...................................... 1,000,000

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BRIEF EXERCISE 15-4 (a)

Apr. 1 Cash ($1,000,000 X 0.98) .......... Bonds Payable .....................

980,000 980,000

(b) Apr. 1 Cash ($1,000,000 X 1.02) .......... 1,020,000 Bonds Payable ..................... 1,020,000 (c)

(1) Long-term liabilities Bonds payable, 4%, due 2016.......

$1,000,000

(2) Long-term liabilities Bonds payable, 4%, due 2016.......

$980,000

(3) Long-term liabilities Bonds payable, 4%, due 2016.......

$1,020,000

(d) Regardless of whether the bonds were sold at face value, at a discount, or at a premium, at maturity on April 1, 2016, the amortized cost of the bonds will be $1,000,000.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 15-5 (a)

Jan. 01 Cash ($1,000,000 X 98%) .......... Bonds Payable .....................

980,000 980,000

July 01 Bond Interest Expense ............. 26,766 Bonds Payable ..................... Cash ($1,000,000 X 5% X 6/12)

1,766 25,000

(b) Jan. 01 Cash .......................................... 1,000,000 Bonds Payable ..................... 1,000,000 July 01 Bond Interest Expense ............. 25,000 Cash ($1,000,000 X 5% X 6/12) (c)

25,000

Jan. 01 Cash ($1,000,000 X 102%) ........ 1,020,000 Bonds Payable ..................... 1,020,000 July 01 Bond Interest Expense ............. 23,196 Bonds Payable .......................... 1,804 Cash ($1,000,000 X 5% X 6/12)

25,000

BRIEF EXERCISE 15-6 (a) July 1

(b) July 1

Bonds Payable .............................. Loss on Bond Redemption ($1,010,000 – $980,000) .............. Cash ($1,000,000 X 101%) ........

980,000

Bonds Payable .............................. Gain on Bond Redemption ($980,000 – $970,000) .............. Cash ($1,000,000 X 97%) ..........

980,000

30,000 1,010,000

10,000 970,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 15-7

Monthly Interest Period Issue Date 1 2 3 4

(A) Cash Payment $111.02 111.02 111.02 111.02

(B) Interest (C) (D) Expense Reduction Principal (D) X 6% X of Principal Balance 1/12 (A) – (B) (D) – (C) $10,000.00 $50.00 $61.02 9,938.98 49.69 61.33 9,877.65 49.39 61.63 9,816.02 49.08 61.94 9,754.08

BRIEF EXERCISE 15-8 (a)

Monthly Interest Period Nov. 30, 2010 Dec. 31, 2010 Jan. 31, 2011

(B) Interest (D) Expense (A) Principal (D) X 6% X Reduction Balance 1/12 of Principal (D) – (A) $360,000 $1,800 $3,000 357,000 1,785 3,000 354,000

2010 Nov. 30 Cash .................................................... 360,000 Mortgage Note Payable ................. Dec. 31 Interest Expense................................. Mortgage Note Payable ...................... Cash ................................................ 2011 Jan. 31 Interest Expense................................. Mortgage Note Payable ...................... Cash ................................................

360,000

1,800 3,000 4,800

1,785 3,000 4,785

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 15-8 (Continued) (b)

Monthly (A) Interest Cash Period Payment Nov. 30, 2010 Dec. 31, 2010 $3,997 Jan. 31, 2011 3,997

(B) Interest (C) Expense Reduction (D) X 6% X of Principal 1/12 (A) – (B) $1,800 1,789

2010 Nov. 30 Cash .......................................... Mortgage Note Payable ....... Dec. 31 Interest Expense....................... Mortgage Note Payable ............ Cash ...................................... 2011 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

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 15-9 (a) 2010 Mar. 31 Cash .......................................... Note Payable ........................ 2011 Mar. 31 Note Payable ............................. Interest Expense ($500,000 X 5%) ........................ Cash ......................................

500,000 500,000

125,000 25,000 150,000

(b) BOW RIVER INC. Balance Sheet (Partial) March 31, 2011 Current liabilities Current portion of note payable ................................ $125,000 Long-term liabilities Note payable, net of current portion .........................

250,000

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BRIEF EXERCISE 15-10 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 15-11 (a)

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

2,500

(b) Cash ............................................................ Rent Revenue .........................................

2,500

BRIEF EXERCISE 15-12 (a)

Lessor: Lessee:

Bracer Construction, Inc. Chang Corp.

(b) Leased Asset—Equipment ........................ 300,000 Lease Liability ........................................

300,000

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BRIEF EXERCISE 15-13 COOKE INC. Balance Sheet (Partial) December 31, 2010 Current liabilities Interest payable .......................................................... Current portion of note payable ................................

$ 4,800 16,375

Long-term liabilities Note payable, due 2020, net of current portion ........

223,625

BRIEF EXERCISE 15-14 WAUGH CORPORATION Balance Sheet (Partial) December 31, 2011 Current liabilities Accounts payable ....................................................... $ 55,000 Income tax payable ..................................................... 12,000 Current portion of lease liability ................................ 15,000 Current portion of notes payable .............................. 15,000 Total current liabilities ........................................... 97,000 Long-term liabilities Bonds payable, due 2028 ........................................... 935,000 Notes payable, due 2015, net of current portion ...... 120,000 Lease liability, net of current portion ........................ 0 35,000 Total long-term liabilities ...................................... 1,090,000 Total liabilities .............................................. 1,187,000

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BRIEF EXERCISE 15-15 ($ in U.S. millions) (a)

Debt to total assets = Total debt ÷ Total assets $4,426.9 $10,416.6

42.5%

(b) Interest coverage = EBIT ÷ Interest expense $388.0 + $103.3 + $102.9 $103.3

5.75 times

*BRIEF EXERCISE 15-16 Discount = $100,000 – $95,735 = $4,265 (A)

(B)

(C)

(D)

Interest Discount UnamorPayment Interest Amortized $100,000 Expense tization Discount Date X 2.5% (E) X 3% (B) – (A) (D) – (C) Apr. 1, 2011 $4,265 Oct. 1, 2011 $2,500 $2,872 $372 3,893 Apr. 1, 2012 2,500 2,883 383 3,510

(E) Bond Amortized Cost $100,000 – (D) $95,735 96,107 96,490

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*BRIEF EXERCISE 15-17 (a) 1. 2.

Interest expense = $32,232 ($35,000 – $2,768) Unamortized premium = $71,619 ($74,387 – $2,768) Or Bond amortized cost – face value ($1,071,619 – $1,000,000)

Premium amortization = $2,851 ($35,000 – $32,149)

Bond amortized cost = $1,068,767 ($1,071,619 – $2,851) Or Bond amortized cost = $1,068,767 ($1,000,000 + $68,767)

(b) Face value = $1,000,000 ($1,074,387 – $74,387) (c)

Contractual interest rate: $1,000,000 = 7%

($35,000 X 2) ÷ face value

Market interest rate = 6% ($32,232 ÷ $1,074,387) X 2 (d) Interest expense is less than interest paid because the bonds sold at a premium. The bonds sold at a premium because investors were satisfied with a 6% market (or effective) interest rate, which was lower than the 7% contractual interest rate. (e)

Interest expense decreases each period because the bond’s amortized cost decreases each period. As the market interest rate is applied to this bond’s amortized cost, interest expense will decrease.

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*BRIEF EXERCISE 15-17 (Continued) (f) Apr. 30 Interest Expense ........................ Bond Payable ............................. Cash ........................................

32,232 2,768

Oct. 31 Interest Expense ........................ Bonds Payable ........................... Cash ........................................

32,149 2,851

35,000

*BRIEF EXERCISE 15-18 (a)

Principal $120,000 X 0.61027 = Interest $120,000 X 3% X 15.58916 (2.5%, 20 periods)

(b) 2011 May 1

$ 73,232 56,121 $129,353

Cash ............................................ 129,353 Bonds Payable........................

129,353

3,234 366 3,600

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SOLUTIONS TO EXERCISES EXERCISE 15-1 (a) Profit before interest and income tax Interest expense ($5,400,000 X 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.

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EXERCISE 15-2 (a)

Market interest rate 5% ($1,000,000 X 0.61027) + ($1,000,000 X 3% X 15.58916) = $1,077,945 Cash ............................................ 1,077,945 Bonds Payable........................ 1,077,945

(b)

Market interest rate 6% ($1,000,000 X 0.55368) + ($1,000,000 X 3% X 14.87747) = $1,000,000 (rounded) Cash ............................................ 1,000,000 Bonds Payable........................ 1,000,000

(c)

Market interest rate 7% ($1,000,000 X 0.50257) + ($1,000,000 X 3% X 14.21240) = $928,942 Cash ............................................ 928,942 Bonds Payable........................ 928,942

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EXERCISE 15-3 (a)

Discount – less than their face value.

(b) Premium – more than their face value. (c)

The difference in price is often explained by a major difference in maturity dates. This is not the case here as the maturity dates are only a few months apart. The credit ratings of the companies would more likely provide the reason for the large discrepancy between the bond prices. The lower the credit rating, the higher the return demanded by investors. It may be that George Weston Ltd., parent company of Loblaw has a lower credit rating than Greater Toronto Airport Authority.

(d) George Weston Ltd.: Cash ............................................................ 854.50 Bonds Payable ......................................

854.50

Greater Toronto Airport Authority (GTAA): Cash ............................................................1,207.50 Bonds Payable ...................................... 1,207.50

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EXERCISE 15-4 (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) 2010 July 31 Cash ($400,000 X 102%) .............. 408,000 Bonds Payable ........................ (c)

2011 Jan. 31 Bond Interest Expense ................ Bonds Payable ............................. Cash ($400,000 X 4% X 6/12) ..

408,000

7,667 333 8,000

(d) LARAMIE CORPORATOIN Balance Sheet (Partial) January 31, 2011 Long-term liabilities Bonds payable, due 2020 ........................................... $407,667 ($408,000 – $333) = $407,667

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EXERCISE 15-5 (a)

2010 July 1 Cash ($800,000 X 98%) ................ 784,000 Bonds Payable ........................

(b) Dec. 31 Bond Interest Expense ................ 21,413 Bond Payable .......................... Bond Interest Payable ............ ($800,000 X 5% X 6/12) (c)

2011 Jan. 31 Bond Interest Payable ................. 20,000 Cash .........................................

784,000

1,413 20,000

20,000

(d) BRIGHTLIGHT CORPORATOIN Balance Sheet (Partial) December 31, 2010 Long-term liabilities Bonds payable, due 2015 ........................................... $785,413 ($784,000 + $1,413) = $785,413

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EXERCISE 15-6 1. June 30 Bonds Payable ................................ 136,500 Loss on Bond Redemption ($144,200 – $136,500) ..................... 7,700 Cash ($140,000 X 103%) .............

144,200

2. June 30 Bonds Payable ................................ 152,000 Gain on Bond Redemption ($152,000 – $147,000) ................. Cash ($150,000 X 98%) ...............

5,000 147,000

3. June 30 Bonds Payable ................................ 175,000 Cash ............................................

175,000

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EXERCISE 15-7 (a)

Semi-annual Interest Period Dec. 31, 2011 June 30, 2012 Dec. 31, 2012

(A) Cash Payment $10,000 9,875

(B) Interest (C) (D) Expense Reduction Principal (D) X 5% X of Principal Balance 1/2 (A) – (B) (D) – (C) $200,000 $5,000 $5,000 195,000 4,875 5,000 190,000 Issue of Note

2011 Dec. 31

Cash ................................................... 200,000 Mortgage Note Payable .................

200,000

First Instalment Payment 2012 June 30

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

5,000 5,000 10,000

Second Instalment Payment Dec. 31

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

4,875 5,000 9,875

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EXERCISE 15-7 (Continued) (b)

Semi-annual (A) Interest Cash Period Payment Dec. 31, 2011 June 30, 2012 $7,967 Dec. 31, 2012 7,967

(B) Interest Expense (D) X 5% X 1/2

$5,000 4,926

$2,967 3,041

(D) Principal Balance (D) – (C) $200,000 197,033 193,992

Issue of Note 2011 Dec. 31

Cash ................................................... 200,000 Mortgage Note Payable .................

200,000

First Instalment Payment 2012 June 30

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

5,000 2,967 7,967

Second Instalment Payment Dec. 31

Interest Expense................................ Mortgage Note Payable ..................... Cash ..........................................

4,926 3,041 7,967

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Accounting Principles, Fifth Canadian Edition

EXERCISE 15-8 (a)

This is a fixed principal loan as the principal is being reduced by $10,000 each year.

(b) The interest rate is 5% ($2,500 ÷ $50,000). (c)

Interest Expense.......................................... 2,500 Notes Payable.............................................. 10,000 Cash........................................................

12,500

(d) Current portion = $10,000 Long-term portion = $30,000 – $10,000 = $20,000

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EXERCISE 15-9 (a)

Cash Payment

Period Jan. 1, 2011 Dec. 31, 2011 $5,612 Dec. 31, 2012 5,612 Dec. 31, 2013 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) 2011 Jan. 1 Cash .......................................... Notes Payable ......................

(c)

15,000 15,000

Dec. 31 Interest Expense ....................... Notes Payable ........................... Cash ......................................

900 4,712

Current liability ........................................ Long-term liability ...................................

$4,995 5,293

5,612

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EXERCISE 15-10 (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 that 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 Car Rental Expense ....................... Cash ...........................................

750 750

2. Jan. 01 Leased Asset—Equipment ........... 118,000 Lease Liability ........................... 118,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 15-11 (a)

[dollar figures in millions] 2008 Debt to total assets =

Interest coverage =

$2,841.2 $6,419.3

44.3%

$565.2 + $63.9 + $253.3 = $63.9

2007 Debt to total assets =

Interest coverage =

$2,433.1 $5,621.9

13.81 times

43.3%

$490.4 + $52.8 + $242.9 = $52.8

14.89 times

The portion of debt has increased and the interest coverage has decreased. As a result, the solvency deteriorated. (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, Fifth Canadian Edition

EXERCISE 15-12 (a)

Assets Liabilities Shareholders’ Equity Profit ($2,000,000 + $315,000) ($2,000,000 + $525,000)

Issue Debt $17,000,000 13,000,000 4,000,000

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.

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EXERCISE 15-13 (a) PRIYA CORPORATION Balance Sheet (Partial) July 31, 2011 Long-term liabilities Bonds payable, due 2018 ................................... $176,400 Note payable, net of current portion* ................ 140,000 Lease liability, net of current portion** ............. 42,000 Total long-term liabilities .............................. $358,400 * ($165,000 – $25,000) = $140,000 ** ($56,000 – $14,000) = $42,000 (b) Interest Payable should be classified as a current liability. 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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*EXERCISE 15-14 (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) $200,000 ($215,589 bond amortized cost – $15,589 unamortized premium) (c)

The bond amortized cost will be $200,000 at the maturity date.

(d) Contractual interest rate = 6% $6,000 ÷ $200,000 = 3% semi-annually X 2 = 6% annually Market interest rate = 5% $5,390 ÷ $215,589 = 2.5% semi-annually X 2 = 5% annually (e)

Total interest payment = $120,000 $200,000 X 6% X 10 years = $120,000 or $6,000 X 20 semi-annual periods = $120,000 Total interest expense = $104,411 $120,000 (interest payment) – $15,589 (premium) = $104,411

(f)

The total interest payment of $120,000, 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 $120,000 plus the amount of the discount. For a premium, as shown in (e), the interest expense is calculated as the total of the interest payments less the amount of the premium.

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*EXERCISE 15-15 (a) $650,000 X 0.50257 + $650,000 X 3% X 14.2124 = $603,812 (3.5%, 20 periods) Discount = $650,000 – $603,812 = $46,188 (b) and (d) on the next page (c) Date

(A) Interest Payment $650,000 X 3%

Jan. 1, 2010 July 1, 2010 Jan. 1, 2011 July 1, 2011 Jan. 1, 2012 (c)

19,500 19,500 19,500 19,500

(B) Interest Expense (E) X 3.5%

21,133 21,191 21,250 21,311

1,633 1,691 1,750 1,811

(D) (E) Unamortized Bond Discount Amortized Cost (D) – (C) $650,000 – (D) 46,188 603,812 44,555 605,445 42,864 607,136 41,114 608,886 39,303 610,697

QUÉBEC CORPORATION Balance Sheet (Partial) December 31, 2011 Current liabilities Bond interest payable .......................... Long-term liabilities Bonds payable, due 2020.....................

Solutions Manual

$19,500 $610,697

Chapter 15

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*EXERCISE 15-15 (Continued) (b) 2010 Jan. 1 Cash ............................................ 603,812 Bonds Payable ........................

603,812

2011 (d) Dec. 31 Bond Interest Expense ................ 21,311 Bond Payable .......................... Bond Interest Payable ............

1,811 19,500

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*EXERCISE 15-16 2011 (a) Jan. 1

Cash ............................................. 642,637 Bonds Payable ........................

642,637

Bond Interest Expense ($642,637 X 7% X 6/12) ................ 22,492 Bonds Payable ($24,000 – $22,492) ...................... 1,508 Cash ($600,000 X 8% X 6/12) ..

24,000

Dec. 31 Bond Interest Expense [($642,637 – $1,508) X 7% X 6/12] 22,440 Bonds Payable ($24,000 – $22,440 ....................... 1,560 Interest Payable ($600,000 X 8% X 6/12) ............

24,000

(b) July 1

(c)

2012 (d) Jan. 1

Interest Payable ........................... 24,000 Bonds Payable ............................. 639,569 ($642,637 – $1,508 – $1,560) Gain on Bond Redemption ($639,569 – $624,000) .............. Cash ($600,000 X 104% + $24,000) ..

15,569 648,000

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SOLUTIONS TO PROBLEMS PROBLEM 15-1A (a) Jan. 1 Bond Interest Payable ............... Cash ......................................

45,000

(b) Jan. 1 Bonds Payable ........................... Gain on Bond Redemption ... Cash ($450,000 X 0.99) ..........

450,000

45,000

4,500 445,500

(c) July 1 Bond Interest Expense .............. 33,750 Cash ....................................... [($1,800,000 – $450,000) X 5% X 6/12]

33,750

(d) Dec. 31 Bond Interest Expense .............. 33,750 Bond Interest Payable........... [($1,800,000 – $450,000) X 5% X 6/12]

33,750

Taking It Further: The bonds were initially issued at par. The market rate of interest at the time of the redemption was higher than when the bonds were issued because the bonds were trading at a discount ($450,000 X 0.99) at the time of redemption.

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PROBLEM 15-2A 2010 (a) May 1 Cash ($900,000 X 103%) ............ Bonds Payable ...................... 2011 (b) Apr. 30 Bond Interest Expense .............. Bonds Payable ........................... Bond Interest Payable........... ($900,000 X 7%) (c) MEM Corp. Balance Sheet (Partial) April 30, 2011

927,000 927,000

58,237 4,763 63,000

Current liabilities Bond interest payable .............................

$63,000

Long-term debt Bonds payable ......................................... *($927,000 – $4,763) = $922,237

*922,237

(d) May 1 Bond Interest Payable ............... Cash .......................................

63,000

(e)

922,237

May 1 Bonds Payable ........................... Gain on Bond Redemption ($922,237 – $891,000) ............ Cash ($900,000 X 99%)..........

63,000

31,237 891,000

Taking It Further: The market rate of interest on May 1, 2010 was 6.28%. Using a financial calculator, Solutions Manual 15-42 Chapter 15 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

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PV = 927,000 FV = (900,000) Pymts = (63,000) N= 5 I =? The bonds traded at a premium, so the market rate of interest must be less than the contractual rate of interest. Using the tables and using a trial and error approach you can determine that the interest rate is between 6% and 7%. Calculating the price of the bonds using 6% interest and the tables the present value of the bonds would be $937,912. $900,000 X .74726 = 672,534 63,000 X 4.21236 = 265,379 937,912 The present value of the bonds at 6% interest is more than the price the bonds were issued at so the market rate of interest must be between the contractual rate of 6% and 7%.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-3A 2010 (a) July 1 Cash ($1,200,000 X 98%) ........... 1,176,000 Bonds Payable ...................... 1,176,000

(b) Dec. 30 Bond Interest Expense .............. Bonds Payable ...................... Bond Interest Payable........... ($1,200,000 X 6% X 6/12) (c)

881 36,000

ENERGY POWER CORPORATION Balance Sheet (Partial) December 31, 2010 Current liabilities Bond interest payable ......................... Long-term liabilities Bonds payable, due 2020 .................... * ($1,176,000 + $881) = $1,176,881

2011 (d) Jan. 1 Bond Interest Payable ............... Cash ....................................... (e)

36,881

The total amount of interest payment: Contract rate 6% X $1,200,000 X 10 years Total interest expense: Interest paid ............................................ Add: discount ($1,200,000 – $1,176,000) Total expense ..........................................

$36,000 *1,176,881

36,000 36,000

$720,000 $720,000 24,000 $744,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-3A (Continued) Taking It Further: In order for the total interest expense to be equal to the interest payments, the bond must be issued at par. If the bond is issued at a premium, the total interest expense will be lower than then amount of the total interest paid. On the other hand, if the bond is issued at a discount as is the case in this problem, the total interest expense will be greater than the total amount of interest paid. Bonds are issued at a discount when the market rate of interest is greater than the contractual rate.

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PROBLEM 15-4A (A) Cash Payment (B) + (C)

Period Apr. 1, 2010 Mar. 31, 2011 $270,000 Mar. 31, 2012 256,000 Mar. 31, 2013 242,000 Mar. 31, 2014 228,000 Mar. 31, 2015 214,000 Total $1,210,000

(B) Interest Expense (D) X 7% $70,000 56,000 42,000 28,000 14,000 $210,000

(D) Balance (D) – (C) $1,000,000 800,000 600,000 400,000 200,000 0

(a) 2010 April 1 Cash ........................................ 1,000,000 Note Payable ...................... 1,000,000 (b) 2010 Dec. 31 Interest Expense ..................... Interest Payable ................. ($1,000,000 X 7% X 9/12) 2011 Mar. 31 Note Payable ........................... Interest Expense ..................... Interest Payable ...................... Cash .................................... (c) 2011 Dec. 31 Interest Expense ..................... Interest Payable ................. ($800,000 X 7% X 9/12) 2012 Mar. 31 Note Payable ........................... Interest Expense ..................... Interest Payable ...................... Cash ....................................

52,500 52,500

200,000 17,500 52,500 270,000

42,000 42,000

200,000 14,000 42,000 256,000

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PROBLEM 15-4A (Continued) Taking It Further: (A)

(B) Interest Portion (D) X 7%

Date Payment Apr. 1, 2010 Mar. 31, 2011 $ 243,890 $70,000 Mar. 31, 2012 243,890 57,828 Mar. 31, 2013 243,890 44,803 Mar. 31, 2014 243,890 30,867 Mar. 31, 2015 243,890 * 15,952 $1,219,450 *$219,450

(D) Note Payable Balance (D) – (C) $1,000,000 $ 173,890 826,110 186,062 640,048 199,087 440,961 213,023 227,938 * 227,938 0 $1,000,000

* adjusted for previous cumulative rounding Where the note is repaid in fixed principal payments, the reduction of the principal is the same ($200,000) 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.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-5A

(a)

2011 July 31 Equipment ................................. Note Payable ........................ Cash ......................................

750,000 650,000 100,000

(b) (A) Monthly Interest Period

Cash Payment

Aug. 31 Sep. 30

$15,265 15,265

(B) (C) (D) Interest Expense Reduction Principal (D) X 6% X of Principal Balance 1/12 (A) – (B) (D) – (C) $650,000 $3,250 $12,015 637,985 3,190 12,075 625,910

Aug. 31 Interest Expense ........................ Note Payable .............................. Cash .......................................

3,250 12,015

Sep. 30 Interest Expense ........................ Note Payable .............................. Cash .......................................

3,190 12,075

15,265

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-5A (Continued) (c) (A) Monthly Interest Period

Cash Payment (B) + (C)

Aug. 31 Sep. 30

$16,792 16,724

(B) (C) (D) Interest Expense Principal (D) X 6% X Reduction Balance 1/12 of Principal (D) – (C) $650,000 $3,250 $13,542 636,458 3,182 13,542 622,916

Aug. 31 Interest Expense ........................ Note Payable .............................. Cash .......................................

3,250 13,542

Sep. 30 Interest Expense ........................ Note Payable .............................. Cash .......................................

3,182 13,542

16,792

16,724

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 $13,542.

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PROBLEM 15-6A (a) (A) Semi-annual Interest Period Dec. 31, 2010 June 30, 2011 Dec. 31, 2011 June 30, 2012 Dec. 31, 2012

(b)

Cash Payment

(B) (C) Interest Reduction Expense of Principal (D) X 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

2010 Dec. 31 Cash ............................................. 700,000 Mortgage Note Payable .......

700,000

Current liabilities Current portion of mortgage note payable* ............... $ 50,372 Long-term 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, 2010 balance.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-6A (Continued) (d) 2011 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)

2011 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) X 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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PROBLEM 15-7A (a)

In order for Manitoba Enterprises 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 an option to buy, (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 truck lease and so it should be treated as a finance lease. Both the bulldozer and photocopier 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) For the bulldozer and the photocopier, there would be no transactions on January 1, 2011 as they are treated as operating leases. The truck lease is a finance lease. The entry to record the finance lease on January 1, 2011 is as follows: Leased Asset—Truck ................................. 74,800 Lease Liability .....................................

74,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-7A (Continued) (c)

Since the bulldozer lease and photocopier 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: Photocopier Rent Expense $3,900 and Equipment Rental Expense $14,000. The truck lease is a finance lease. Therefore, the truck would be recorded as an asset 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 2011. 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, 2011 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, 2011 for the accrual of interest on the lease liability would be as follows: Interest Expense on Finance Lease .......... Interest Payable................................... (($74,800 – $14,981) X 8% = $4,786)

4,786 4,786

Since the rental cost of the bulldozer and the photocopier have been paid and expensed during the year, no accruals need be recorded for the two remaining leases.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-8A (a)

($ in millions) Debt to total assets = Total debt ÷ Total assets 2008 2007

$8,155 ÷ $13,985 = 58.3% $8,129 ÷ $13,674 = 59.4%

Interest coverage = EBIT ÷ Interest expense 2008 2007

($545 + $228 + $263) ÷ $263 = 3.9 times ($330 + $150 + $252) ÷ $252 = 2.9 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 slightly in 2008 and the times interest earned ration 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-9A (a) Rona is more solvent than Home Depot. Rona’s debt to total assets is substantially lower and it can pay for its interest costs more easily that Home Depot. (b) Home Depot is making better use of its debt to produce a higher return on equity. Its return on equity is 12.7%, compared to Rona’s 11.4%. Taking It Further: Additional information that would be useful in analysing each company’s solvency would be the amount of commitment each company has for operating leases. The use of operating leases improves a company’s solvency ratios, since operating leases are accounted for as rent expense. The maturity dates of the debt would also be useful.

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*PROBLEM 15-10A (a)

$1,400,000 X 0.50257 = $1,400,000 X 3% X 14.2124 = (3.5%, 20 periods)

$ 703,598 596,921 $1,300,519

(b) 2010 July 1 Cash ........................................... 1,300,519 Bonds Payable .....................

1,300,519

(c) GLOBAL SATELLITES Bond Discount Amortization Table Effective Interest Method—Semi-annual Interest Payments 6% Bonds Issued at market rate of 7% (A) (B) (C) (D) (E) SemiInterest Interest Discount UnamorBond annual Payment Expense Amortized Amortized Interest $1,400,000 (E) X 7% tization Discount Cost Period X 6% X 6/12 X 6/12 (B) – (A) (D) – (C) $1,400,000–(D) July 1, 2010 $99,481 $1,300,519 Jan. 1, 2011 $42,000 $45,518 $3,518 95,963 1,304,037 July 1, 2011 42,000 45,641 3,641 92,322 1,307,678 Jan. 1, 2012 42,000 45,769 3,769 88,553 1,311,447 (d) 2011 Dec. 31 Bond Interest Expense ....................... 45,769 Bonds Payable ............................... 3,769 Bond Interest Payable ................... 42,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-10A (Continued)

(e) GLOBAL SATELLITES Balance Sheet (Partial) December 31, 2011

Current liabilities Bond interest payable ................................... Long-term liabilities Bonds payable, 7%, due 2020 .......................

42,000

1,311,447

Taking It Further: If the bonds are redeemed on December 31, 2011 at par, the amount of cash required will be: Face value of bonds $1,400,000 ......................... Bond amortized cost ........................................... Resulting loss on redemption of bond ..............

$1,400,000 1,311,447 $ 88,553

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-11A (a) 2010 1. July 01 Cash ....................................... Bonds Payable .................. 2.

Dec. 31 Bond Interest Expense ($4,327,029 X 4% X 6/12) ............ Bonds Payable............................ Bond Interest Payable ($4,000,000 X 5% X 6/12) .......

2011 Jan.

July

4,327,029 4,327,029

86,541 13,459 100,000

1 Bond Interest Payable ................ 100,000 Cash ............................................... 100,000 01 Bond Interest Expense [($4,327,029 – $13,459) X 4% X 6/12]. 86,271 Bonds Payable................................ 13,729 Cash ............................................... 100,000

(b) 1.

Interest expense for 2010 is $86,541.

Bond interest expense for bonds issued at a premium as in this problem, is less than bond 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, Fifth Canadian Edition

*PROBLEM 15-11A (Continued) (b) (Continued) 3.

The total cost of borrowing will be the total interest payments less the premium. Total interest payments = $4,000,000 X 2.5% X 20 = Premium Total cost of borrowing

$2,000,000 327,029 $1,672,971

Bond interest expense for bonds issued at a premium is less than bond 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.

$4,000,000 X 0.55368 = $ 2,214,720 $4,000,000 X 2.5% X 14.87747 = 1,487,747 (3%, 20 periods) $3,702,467 The total cost of borrowing will be the total interest payments plus the discount. Total interest payments = $4,000,000 X 2.5% X 20 = Discount ($4,000,000 – $3,702,467) Total cost of borrowing

$2,000,000 297,533 $2,297,533

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-11A (Continued) Taking It Further: Had the market rate of interest gone to 4.5% in December 2010, there would be no change in how the debt would be accounted on the records of Webhancer Corp. The company would likely be happy that it managed to sell the bond at a large premium, when it did, as it would have to take a smaller premium if it had issued the bond in December 2010.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 15-1B (a) Jan. 1 Bond Interest Payable .................... 12,000 Cash ...........................................

12,000

(b) Jan. 1 Bonds Payable ................................ 150,000 Loss on Bond Redemption ............ 1,500 Cash ($150,000 X 101%)............. 151,500 (c) July 1 Bond Interest Expense ................... Cash ............................................ [$400,000 – $150,000) X 6% X 6/12]

7,500

(d) Dec. 31 Bond Interest Expense ................... Bond Interest Payable................ [($400,000 – $150,000) X 6% X 6/12]

7,500

Taking It Further: The bonds were initially issued at par. The market rate of interest at the time of the redemption was lower than the rate the bonds were issued at because the bonds were trading at a premium ($150,000 X 101%) when they were redeemed.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-2B (a)

2010 Oct. 1 Cash ($800,000 X 98%) ............. Bonds Payable .....................

(b) 2011 Sep. 30 Bond Interest Expense ............. Bonds Payable ..................... Bond Interest Payable ($800,000 X 5%) ....................

784,000 784,000

41,257 1,257 40,000

(c) PFQ Corp. Balance Sheet (Partial) September 30, 2011 Current liabilities Bond interest payable .............................

$40,000

Long-term debt Bond payable ........................................... *($784,000 + 1,257) = $785,257 (d) 2011 Oct. 1 Bond Interest Payable .............. Cash ...................................... (e)

2011 Oct. 1 Bonds Payable .......................... Loss on Bond Redemption ($808,000 – $785,257) ............... Cash ($800,000 X 101%) ......

*785,257

40,000 40,000

785,257 22,743 808,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-2B (Continued) Taking It Further: The market rate of interest on Oct 1, 2010 was 5.26%. Using a financial calculator, PV = 784,000 FV = (800,000) Pymts = (40,000) N= 10 I =? The bonds traded at a discount, so the market rate of interest must be more than the contractual rate of interest. Using the tables and using a trial and error approach you can determine that the interest rate is between 5% and 6%. Calculating the price of the bonds using 6% interest and the tables the present value of the bonds would be $937,912. $800,000 X .55839 = $446,712 $40,000 X 7.36009 = 294,404 $741,116 The present value of the bonds at 6% interest is less than the price the bonds were issued at so the market rate of interest must be between the contractual rate of 5% and 6%.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 15-3B 2010 (a) July 1 Cash ($1,500,000 X 101%) ......... 1,515,000 Bonds Payable ...................... 1,515,000

(b) Dec. 30 Bond Interest Expense .............. Bonds Payable ........................... Bond Interest Payable........... ($1,500,000 X 7% X 6/12) (c)

52,500

ALTERNATE CORPORATION Balance Sheet (Partial) December 31, 2010 Current liabilities Bond interest payable ......................... Long-term liabilities Bonds payable, due 2020 .................... * ($1,515,000 – $534) = $1,514,466

2011 (d) Jan. 1 Bond Interest Payable ............... Cash ....................................... (e)

51,966 534

The total amount of interest payment: Contract rate 7% X $1,500,000 X 10 years Total interest expense: Interest paid ............................................ Less premium ($1,515,000 – $1,500,000) Total expense ..........................................

$52,500 *1,514,466

52,500 52,500

$1,050,000 $1,050,000 15,000 $1,035,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-3B (Continued) Taking It Further: In order for the total interest expense to be equal to the interest payments, the bond must be issued at par. If the bond is issued at a premium, as is the case in this problem, the total interest expense will be lower than the total interest paid. The market rate of interest at date of issue was less than the contractual rate so the bonds were issued at a premium. On the other hand, if the bond is issued at a discount, the total interest expense will be greater than the total interest paid.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-4B

(A)

Period May 1 June 30 Aug. 31

(a)

2011 May

Cash Payment $6,381 6,381

(B) (C) Interest Principal Expense Reduction (D) X 9% X 2/12 (A) – (B) $1,500 1,427

$4,881 4,954

1 Cash ......................................... 100,000 Note Payable .......................

(D) Balance (D) – (C) $100,000 95,119 90,165

100,000

(b) June 30 Note Payable............................ Interest Expense ..................... Cash.....................................

4,881 1,500

Aug. 31 Note Payable............................ Interest Expense ..................... Cash.....................................

4,954 1,427

6,381

(c) Principal portion = $100,000 ÷ (3 X 6) = $5,556 June 30: $5,556 + [$100,000 X 9% X 2/12] = $7,056 Aug. 31: $5,556 + [($100,000 – $5,556) X 9% X 2/12] = $6,973 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. The final blended payment will have a larger principal component.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-5B (A) Quarterly Interest Period Sep. 30, 2010 Dec. 31, 2010 Mar. 31, 2011

Cash Payment

(B) Interest Expense (D) X 6% X 3/12

$38,921 38,921

$8,250 7,790

(C)

(D)

Reduction Principal of Principal Balance (A) – (B) (D) – (C) $550,000 $30,671 519,329 31,131 488,198

(a) 2010 Sep. 30 Equipment ................................. Cash ...................................... Mortgage Note Payable ....... (b) Dec. 31 Interest Expense ....................... Mortgage Note Payable ............ Cash ...................................... 2011 Mar. 31 Interest Expense ....................... Mortgage Note Payable ............ Cash ...................................... (c) 2010 Dec. 31 Interest Expense ....................... Mortgage Note Payable ($550,000 ÷ (4 X 4)) ................... Cash ......................................

600,000 50,000 550,000 8,250 30,671 38,921

7,790 31,131 38,921

8,250 34,375

2011 Mar. 31 Interest Expense ($550,000 – $34,375) X 6% X 3/12 7,734 Mortgage Note Payable ............ 34,375 Cash ......................................

42,625

42,109

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-5B (Continued) Taking It Further: Total payments $38,921 X 4 X 4 = Less: Principal repayment Total interest expense of note

$622,736 550,000 $72,736

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-6B (a) (A) Semi-annual Interest Period Dec. 31, 2010 June 30, 2011 Dec. 31, 2011 June 30, 2012 Dec. 31, 2012 (b)

Cash Payment (B) + (C) $39,375 38,531 37,688 36,844

(B) (C) (D) Interest Expense Principal (D) X 7.5% Reduction Balance X 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

2010 Dec. 31 Cash ............................................. 450,000 Mortgage Note Payable ..........

450,000

Current liabilities Current portion of mortgage note payable ................ $ 45,000 Long-term liabilities Mortgage notes payable, 7.5% .................................... *405,000 * $450,000 – $45,000 = $405,000 or see Dec. 31, 2011 balance (d) 2011 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-6B (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 terms 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-7B (a)

In order for Klippert Inc. 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 an option to buy, (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 delivery equipment and automobile 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) For the delivery equipment and automobile, there would be no transaction on January 1, 2011 as both leases are operating leases. The manufacturing equipment lease is a finance lease. The entry to record the finance lease on January 1, 2011 is as follows: Leased Asset—Manufacturing Equipment Lease Liability .....................................

45,000 45,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-7B (Continued) (c)

Since the delivery equipment and automobile 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: Delivery Equipment Rent Expense $4,800 and Auto Rental Expense $7,000. 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 2011. 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, 2011. This amount would be reduced by the first lease payment which was made on January 1, 2011. Interest expense accrued for 2011 would also appear on the income statement.

2,532 2,532

Since the rental cost of the delivery equipment and automobile have been paid and expensed during the year, no accruals need be recorded for the two remaining leases.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-8B a)

($ in thousands) Debt to total assets = Total debt ÷ Total assets 2008 2007

$2,234,684 ÷ $3,452,101 = 64.7% $1,769,043 ÷ $2,997,844 = 59.0%

Interest coverage = EBIT ÷ Interest expense 2008 2007

[(-$36,857 + -$8,538) + $88,651] ÷ $88,651 = .49 times ($194,964 + $801 + $94,122) ÷ $94,122 = 3.1 times

(b) In 2008, Maple Leaf Foods’ long-term solvency has deteriorated. The company’s debt to total assets ratio has climbed from 59% in 2007 to 64.7% in 2008. What is worse, due to the loss in 2008 the company is struggling to cover its interest charges as evidenced by the decrease in the interest coverage ratio from 3.1 in 2007 to .49 times in 2008. 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 if the leases had been accounted for as finance leases. The company’s liquidity problem in 2008, as revealed by the ratios, could be even worse.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 15-9B

(a)

Petro-Canada is far more solvent than Suncor Energy. It has a lower debt to total assets ratio than Suncor, and covers its interest charges far more times.

(b)

Petro-Canada is making better use of its debt, since it has a higher return on equity than Suncor Energy. If a company can issue debt at a lower cost than the return earned with the borrowed money, the shareholders will benefit by an increase in their return.

Taking It Further: As a result of the merger of Petro-Canada and Suncor, the debt to total asset should be lower than the current Suncor debt to total asset ratio of 55.4%. The main cause for the decrease is that the Petro-Canada ratio is lower prior to the acquisition. The second reason is the effect of the increased value of the PetroCanada assets. Since the denominator, total assets will increase from the increased value to fair values of the PetroCanada assets at acquisition, the ratio should be further improved from the merger.

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-10B (a)

$2,500,000 X 0.61027 = $2,500,000 X 2% X 15.58916 = (2.5%, 20 periods)

$ 1,525,675 779,458 $2,305,133

(b) 2010 July 01 Cash .......................................... 2,305,133 Bonds Payable ..................... 2,305,133 (c) PONASIS CORPORATION Bond Discount Amortization Table Effective Interest Method—Semi-annual Interest Payments 4% Bonds Issued at 5%

(A) (B) (C) (D) (E) SemiInterest Interest Discount UnamorBond annual Payment Expense Amortized Amortized Interest $2,500,000 (E) X 5% tization Discount Cost Period X 4% X 6/12 X 6/12 (A) – (B) (D) – (C) $2,500,000–(D) July 1, 2010 $194,867 $2,305,133 Jan. 1, 2011 $50,000 $57,628 $7,628 187,239 2,312,761 July 1, 2011 50,000 57,819 7,819 179,420 2,320,580 Jan. 1, 2012 50,000 58,015 8,015 171,405 2,328,595

(d) 2011 Dec. 31 Bond Interest Expense ...................... 58,015 Bonds Payable .............................. 8,015 Bond Interest Payable .................. 50,000

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-10B (Continued) (e) PONASIS CORPORATION Balance Sheet (Partial) December 31, 2011

Current liabilities Bond interest payable ..............................

Long-term liabilities Bonds payable, 4%, due 2020 ...............

2,328,595

50,000

Taking It Further: The bonds would be redeemed at par because the market rate of interest is equal to the contractual rate. Face value of bonds .......................................... Bond amortized cost ........................................... Resulting loss on redemption of bond ..............

$2,500,000 2,328,595 $ 171,405

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-11B (a)

2010

July 1 Cash .......................................... Bonds Payable .....................

Dec. 31 Bond Interest Expense ($3,449,423 X 5% X 6/12) ................... 86,236 Bonds Payable ................................... 9,764 Bond Interest Payable ($3,200,000 X 6% X 6/12) ............... 96,000

3,449,423 3,449,423

2011 Jan 1 Bond Interest Payable ....................... 96,000 Cash ............................................... 96,000

Jul.

1 Bond Interest Expense [($3,449,423 – $9,764) X 5% X 6/12] .. 85,991 Bonds Payable ................................... 10,009 Cash ............................................... 96,000

(b) 1.

Interest expense for 2010 is $86,236.

Bond interest expense for bonds issued at a discount is greater than bond 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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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-11B (Continued) (b) (Continued) 3.

The total cost of borrowing will be the total interest payments less the premium. Total interest payments $3,200,000 X 3% X 20 Premium ($3,449,423 – $3,200,000) Total cost of borrowing

$1,920,000 249,423 $1,670,577

Bond interest expense for bonds issued at a discount is greater than bond 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.

$3,200,000 X 0.50257 = $3,200,000 X 3% X 14.2124 = (3.5%, 20 periods)

$1,608,224 1,364,390 $2,972,614

The total cost of borrowing will be the total interest payments plus the discount. Total interest payments = $3,200,000 X 3% X 20 = Discount ($3,200,000 – $2,972,614) Total cost of borrowing

$1,920,000 227,386 $2,147,386

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Accounting Principles, Fifth Canadian Edition

*PROBLEM 15-11B (Continued) Taking It Further: Had the market rate of interest gone to 5.5% in December 2010, there would be no change in how the debt would be accounted on the records of Waubonsee Ltd. The company would likely be happy that it managed to sell the bond at a large premium, when it did, as it would have to take a smaller premium if it had issued the bond in December 2010.

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a)

Alternative 1

Interest Period

May 1, 2012 Nov. 1, 2012 May 1, 2013 Nov. 1, 2013 May 1, 2014 Nov. 1, 2014 May 1, 2015 Totals

(A) Cash Payment (B) + (C)

(B) Interest Expense (D) × 4% × 6/12

(C)

$ 1,960 1,925 1,890 1,855 1,820 1,785 $11,235

$210 175 140 105 70 35 $735

$ 1,750 1,750 1,750 1,750 1,750 1,750 $10,500

(B) Interest Expense (D) × 4% × 6/12

(D) Principal Balance

(A) − (B)

(D) − (C) $10,500 8,835 7,137 5,405 3,638 1,836 0

Reduction of Principal

(D) Principal Balance (D) − (C) $10,500 8,750 7,000 5,250 3,500 1,750 0

Alternative 2

Interest Period

(A) Cash Payment

May 1, 2012 Nov. 1, 2012 $ 1,875 May 1, 2013 1,875 Nov. 1, 2013 1,875 May 1, 2014 1,875 Nov. 1, 2014 1,875 May 1, 2015 1,875 Totals $11,250 *$2 rounding difference

$210 177 143 108 73 39* $750

$ 1,665 1,698 1,732 1,767 1,802 1,836 $10,500

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) May. 1 Equipment ................................. Cash ...................................... Note Payable ........................ (c)

15,000 4,500 10,500

Alternative 1 2012 Nov. 1 Note Payable ............................. Interest Expense ....................... Cash ...................................... May

1 Note Payable ............................. Interest Expense ....................... Cash ......................................

1,750 210 1,960 1,750 175 1,925

Alternative 2 2012 Nov. 1 Note Payable ............................. Interest Expense ....................... Cash ...................................... May

1 Note Payable ............................. Interest Expense ....................... Cash ......................................

1,665 210 1,875 1,698 177 1,875

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (d) 1

Current Portion Long-term Portion 1

(e)

Alternative 1 $3,500 7,000 $10,500

Alternative 2 $3,363 7,137 $10,500

$1,750 + $1,750 = $3,500 $1,665 + 1,698 = 3,363

The alternatives are almost identical when it comes to cost. In Alternative 1 the total cash paid is $11,235 and in Alternative 2 total cash paid is $11,250, a difference of only $15. 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. In my opinion, Alternative 1 is slightly better because the overall cost is not as great.

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Accounting Principles, Fifth Canadian Edition

BYP 15-1 FINANCIAL REPORTING PROBLEM * dollar amounts are in thousands (a) Forzani’s total debt reported in the note at February 1, 2009 was $$7,627. This is a substantial decrease of $50,822 from February 3, 2008 long-term debt of $58,449. (b) Yes, Forzani reports a current portion of long-term debt in the current liability section of its balance sheet. At February 1, 2009, Forzani has $7,501 of its long-term debt currently due. (c)

In note 8 to the financial statements, we see that Forzani’s long-term debt consists of vendor take-backs, mortgages, and asset retirement obligations.

(d) A revolving loan is an arrangement which allows for the loan amount to be withdrawn, repaid, and redrawn again in any manner and any number of times, until the arrangement expires. The interest rate payable on the revolving loan is based on Forzani’s financial performance as determined by its interest coverage ratio. The interest rate is therefore floating. The amount reported as a current liability on the balance sheet for indebtedness under the revolving credit facility at February 1, 2009 was $17,130. Only the amount actually borrowed is reported in the balance sheet. Forzani’s has the opportunity to borrow up to $250 million, however at February 1, 2009, only $17,130 had been borrowed. The amount is classified as a current liability, because it is management’s intention to repay the loan as funds become available to do so. Repayment would be given a priority to avoid interest costs. (e)

In note 13 to the financial statements, it is disclosed that Forzani has significant long-term leases that are being treated as operating for accounting purposes. The use of operating leases is a form of off-balance sheet financing.

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Accounting Principles, Fifth Canadian Edition

BYP15-1 (Continued) (f)

2008 Debt to total assets = Total debt ÷ Total assets Debt to total assets

$399,481 $754,964

53%

Interest coverage = EBIT ÷ Interest expense =

$47,451 + $5,797 + $24,390 $5,797

13.4

times

Forzani’s solvency worsened in 2009. Debt to total assets was virtually unchanged. However, the profit available for the payment of interest decreased in 2009 while interest expense increased. This is apparent from the decrease in the interest coverage ratio from 13.4 in 2008 to 9.6 in 2009.

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Accounting Principles, Fifth Canadian Edition

BYP 15-2 INTERPRETING FINANCIAL STATEMENTS (a) Reitmans

($ in thousands) Debt to total assets

$110,700 $633,239

Times interest earned

$85,806 + $921 + $41,371 $921

($ in thousands)

Le Château

= 17.5%

= 139 times

Debt to total assets

$74,017 $216,431

Times interest earned

$38,621 + $1,798 + $19,095 = 33.1 times $1,798

= 34.2%

(b) Le Château relied more heavily on debt financing; 34.2% of every dollar of assets was financed with debt versus only 17.5% by Reitmans. In addition Reitmans has a much higher times interest earned indicating it is more than able to meet its interest obligations. (c)

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. Le Château commitments under operating leases are lower than that of Reitmans.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 15-87 Chapter 15 © 2010 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP15-4 (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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP 15-5 ETHICS CASE (a)

The stakeholders in the Enron case are: Senior Management (e.g., CEO) Board of Directors Shareholders Existing creditors (debt holders) Employees, suppliers, and customers General stock market investors

(b) Shifting debt off the balance sheet gives investors an incorrect representation of the true liquidity and solvency position of a company. When liabilities are not reported on the balance sheet, investors are prevented from making an accurate analysis of the financial position of the company and may therefore make inappropriate investment decisions. (c)

Management’s ultimate role is to fulfill a stewardship responsibility on behalf of shareholders. 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. GAAP provides a set of guidelines for financial reporting but any other disclosures and accounting information presented by management which increase the relevance and faithful representation of financial information (keeping in mind the constraints of materiality and cost vs. benefits) should be employed when preparing financial statements.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 4.5%, fixed rate on the Loan Repayment Calculator will be 9.5% (4.5% + 5% = 9.5%).

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP15-6 (Continued) (c)

Answers will vary by student, depending on the interest rate assumed. The following answers assume that the student takes advantage of the grace period and pays off the grace period interest in a lump-sum. The following answers assume a prime interest rate of 4.5%: 1. 2.

Monthly payment = $267.00 Interest payable = $10,438 (114 X $267 - $20,000)

The following answers assume a prime interest rate of 2.25%: 1. 2.

(d)

Monthly payment = $243.25 Interest payable = $7,730.50 (114 X $243.25 - $20,000)

Answers will vary by student depending on the interest rate assumed. The following answers assume that the student takes advantage of the grace period and pays off the grace period interest in a lump-sum. The following answers assume a prime interest rate of 4.5%: 1. 2.

Monthly payment = $400.5 Interest payable = $15,657.54

The following answers assume a prime interest rate of 2.25%: 1. 2.

Monthly payment = $364.87 Interest payable = $11594.97

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP15-6 (Continued) (e)

Monthly payment = 318.19 Interest payable = $25,364.27

The following answers assume a prime interest rate of 2.25%: 1. 2.

Monthly payment = $279.11 Interest payable = $18,564.64

(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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

Legal Notice Copyright

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CHAPTER 16 Investments ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Problems Exercises Exercises Set A

Problems Set B

1. Identify reasons to invest, and classify investments.

1, 2, 3

1, 2

2. Account for debt investments that are reported at amortized cost.

4, 5, 6, 13

3, 4, 5

3, 4, 13

1, 2, 3, 6

3. Account for trading investments.

4, 5, 6, 7, 13

6, 7, 8, 9

5, 6, 7, 8, 9, 13

1, 3, 4, 5, 6

4. Account for strategic investments.

7, 8, 9, 10, 10, 11 11, 12, 13

10, 11, 12. 13

6, 7, 8

5. Indicate how investments are reported in the financial statements.

14, 15, 16, 12, 13, 17 14

13, 14, 15

1, 2, 3, 4, 5, 6, 8, 9, 10

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Accounting Principles, Fifth 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 fair value and liability; show statement presentation.

Moderate

40-50

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; compare balances.

Moderate

25-35

Record strategic equity investments, using fair value and equity methods. Show statement presentation.

Moderate

35-45

Prepare income statement and statement of comprehensive income.

Simple

20-30

10A

Prepare statement of comprehensive income and balance sheet.

Moderate

35-45

Record debt investments; show statement presentation.

Moderate

30-40

Record debt investments; show statement presentation.

Moderate

20-25

Record debt investment at fair value and 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; compare balances.

Moderate

25-35

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record strategic equity investments, using fair value and equity methods. Show statement presentation.

Moderate

35-45

Prepare income statement and statement of comprehensive income.

Simple

20-30

10B

Prepare statement of comprehensive income and balance sheet.

Moderate

35-45

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 Q16-3 Q16-1 invest, and classify BE16-1 Q16-2 investments. BE16-2 E16-1 E16-2 2. Account for debt Q16-4 BE16-3 P16-2A investments that Q16-5 BE16-4 P16-3A are reported at Q16-6 BE16-5 P16-6A amortized cost. P16-1B Q16-13 E16-3 P16-2B E16-4 E16-13 P16-3B P16-1A P16-6B 3. Account for trading 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 P16-6A Q16-13 E16-5 P16-1B E16-6 P16-3B E16-7 P16-4B E16-8 P16-5B E16-9 E16-13 P16-6B 4. Account for strategic investments.

Q16-8 Q16-9

5. Indicate how investments are reported in the financial statements.

Q16-14 Q16-15 Q16-16

Broadening Your Perspective

Q16-7 Q16-10 Q16-11 Q16-12 Q16-13

BYP 16-1

Analysis Synthesis Evaluation

BE16-10 P16-6A BE16-11 P16-7A E16-10 P16-8A E16-11 P16-6B E16-12 P16-7B E16-13 P16-8B Q16-17 P16-8A BE16-12 P16-9A BE16-13 P16-10A BE16-14 P16-1B E16-13 P16-2B E16-14 P16-3B E16-15 P16-4B P16-1A P16-5B P16-2A P16-6B P16-3A P16-8B P16-4A P16-9B P16-5A P16-10B P16-6A BYP 16-4 BYP 16-2 BYP 16-6 BYP 16-3 Continuing Cookie BYP 16-5 Chronicle

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ANSWERS TO QUESTIONS 1.

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.

The purchase of Canadian Hydro Developers Inc. by Transalta was a strategic, long-term investment. This acquisition helped Transalta diversify its renewable generation facilities and expand its own power generation capabilities.

Trading securities are debt or equity securities that are purchased and held for resale in the short term. Trading securities are classified as current assets and are adjusted to their fair value at the balance sheet date. Investments held to earn interest income are debt securities that are held to generate interest income. They may be current or long-term depending on management’s intention and are shown on the company’s balance sheet at amortized cost.

Bonds purchased for trading are reported at fair value. Bonds held to earn interest revenue are reported at amortized cost.

If the Bank of Canada bonds are purchased at face value, the classification of the bonds as either trading or held to earn interest income will have no impact on the amount of interest recognized on the investment. However, if the investment is purchased at a premium or discount, the amortization of the premium or discount will affect the interest revenue differently, depending on the classification of the bonds. If a bond is classified as held to earn interest income, amortization of premium or discounts decreases or increases the interest revenue accordingly. If the bonds are classified as trading, any premium or discount is not amortized and therefore there is no impact on interest revenue. This is because the bonds are held for such as short period of time any misstatement of revenue is not considered significant.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 6.

When a company purchases money-market instruments, such as a treasury bill, it must first record the acquisition. Subsequently, interest revenue is accrued with the passage of time. When the money-market instrument is redeemed, the company records the proceeds received and removes the money market instrument as well as any interest receivable from its books. No gain or loss is recognized. When bonds are acquired, they are recorded at the cost incurred to acquire them. Interest is accrued over time just as it would with a moneymarket instrument. However, since these are a short-term investment, the bonds will most likely be sold before their maturity date, at a gain or loss. A gain or loss would be realized when the bonds are sold for an amount higher or lower than their carrying value. This realized gain or loss would appear as other revenue or other expense on the company’s income statement.

For public companies, gains and losses for fair value adjustments on trading investments are reported in other revenues or other expenses in the income statement. Gains and losses for fair value adjustments on long-term equity investments can be reported as other comprehensive income in the statement of comprehensive income.

Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. An investment (direct or indirect) of 20% or more of the voting shares of an investee constitutes significant influence, unless there exists evidence to the contrary. However, companies are required to use judgement 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.

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Accounting Principles, Fifth Canadian Edition

\QUESTIONS (Continued) 9.

(a)

Whenever the investor's influence on the operating and financial affairs of 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 investee. 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.

10. The equity method is used when an investor has significant influence over the affairs of an 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. 11. 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. 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 company’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 declares and pays dividends. 12.

(a) (b)

Onex Corporation is the parent; Celestica Inc. is the subsidiary. Consolidated statements should be prepared.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 13.

Short and long-term debt instruments held to earn interest income are reported at amortized cost. Strategic equity investments with significant influence are reported using the equity method. As such, the balance in the equity investment account is adjusted up or down for the portion of profit or loss of the investee, and down for cash dividends received from the investee. Since debt instruments held to earn interest income and equity investments are not held for resale in the short-term, current market values are not relevant. If however, there is a permanent decline in the market value below the carrying value, the investments are written down to reflect this impairment.

14.

Trading investments are reported as current assets, because management purchased the investment for the purpose of selling it in the near future at a gain.

15. (a) (b) (c)

(d) (e)

Trading securities are classified as a current assets and reported at fair value. 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 long-term investments and reported at amortized cost. Strategic investments reported at fair value are classified as longterm investments. Strategic investments accounted for using the equity method are classified as long-term investments.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 16. Account

Financial Statement

Classification

(a)

Gains (Losses) on Fair Value Adjustments on Trading Securities

Income Statement

Other revenues/ Other expenses

(b)

Gains (Losses) on Sale of Trading Securities

Income Statement

Other revenue/ Other expenses

(c)

Gains (Losses) on Fair Value Adjustment on Long-term Equity Investments

Statement of Comprehensive Income Or Income Statement

Other comprehensive income (losses) Or Other revenue/ Other Expenses

(d)

Dividend Revenue

Income Statement

Other revenue

(e)

Interest Revenue

Income Statement

Other revenue

17. (a) (b)

All debt instruments are reported at amortized cost. There is no “trading” classification or use of fair value for debt instruments. Non-strategic equity investments are reported at fair value with gains and losses in other income (other expenses) on the income statement. There is no statement of comprehensive income, or other comprehensive income.

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Accounting Principles, Fifth 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 securities 2. Non-strategic investments

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-2

1. 2.

(a) (b) NonCurrent Asset strategic or or Long-term Strategic Investment 120-day treasury bill NonCurrent Asset strategic Common shares NonCurrent Asset purchased by a strategic bank for resale at a gain in the near future 15% of the common Strategic Long-term shares purchased to Investment hold with the intent of acquiring control 10-year bonds NonLong-term purchased to hold strategic Investment and earn interest revenue. 10-year bonds NonCurrent Asset purchased to sell in strategic the near future at a gain

Fair value*

Amortized cost

Fair value

* It is assumed that 15% ownership does not constitute significant influence.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-3 (a) Dec. 2 Short-term Investment – Treasury Bill .................................................... 100,000 Cash .................................................. (b) Dec. 31 Short-term Investment – Treasury Bill ........................................................ 500 Interest Revenue .............................. (c) Mar. 1 Cash ...................................................... 101,500 Interest Revenue .............................. Short-term Investment – Treasury Bill ...............................................

100,000

500

1,000 100,500

BRIEF EXERCISE 16-4 (a) Jan. 1 Long-Term Investment – Cullen Bonds 400,000 Cash .................................................. 400,000 (b) July 1 Cash ($400,000 x 5% x 6/12) ................. 10,000 Interest Revenue .............................. 10,000 (c) Dec. 31 Interest Receivable ............................... 10,000 Interest Revenue .............................. 10,000 Since the bonds are held to earn interest income, there is no fair value adjustment at December 31.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-5 (a) June 30 Long-Term Investment—Plaza Bonds 151,500 Cash ($150,000 x 1.01) ................... 151,500 (b) Dec. 31 Cash ($150,000 X 5% X 6/12).............. 3,750 Long-Term Investment—Plaza Bonds Interest Revenue ............................

135 3,615

BRIEF EXERCISE 16-6 Investor’s books – Coast Corp.: (a) June 30 Trading Securities—Plaza Bonds ..... 151,500 Cash ($150,000 x 1.01) ................... 151,500 (b) Dec. 31 Cash ($150,000 X 5% X 6/12).............. Interest Revenue ............................ (c) Dec. 31 Trading Securities—Plaza Bonds ..... Gain on Fair Value Adjustment of Trading Securities ..................... ($150,000 x [1.02 – 1.01])

3,750 3, 750

1,500 1,500

Investee’s books – Plaza: (d) June 30 Cash ($150,000 x 1.01) ....................... 151,500 Bonds Payable ............................... 151,500 Dec. 31 Interest Expense................................. Bonds Payable.................................... Cash ($150,000 X 5% X 6/12) .........

3,615 135 3, 750

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-7 Aug. 01 Trading Securities— Datawave Common Shares ............... 72,000 Cash ................................................

72,000

Oct. 15 Cash (2,000 X $2) ................................ Dividend Revenue ..........................

4,000

Dec. 01 Cash .................................................... 70,000 Loss on Sale of Trading Securities ... 2,000 Trading Securities— Datawave Common Shares ...........

72,000

BRIEF EXERCISE 16-8 Nov. 30 Trading Securities – Deal Inc. Common Shares............................... 4,000 Gain on Fair Value Adjustment of Trading Securities ($68,000 – $64,000) ...... 4,000 Dec. 31 Loss on Fair Value Adjustment of Trading Securities ($68,000 – $66,000) .......... 2,000 Trading Securities – Deal Inc. Common Shares .......................... 2,000

BRIEF EXERCISE 16-9 Jan. 15 Cash............................................................... 67,000 Gain on Sale of Trading Securities* ........ 1,000 Trading Securities – Deal Inc. Common Shares ....................... 66,000 *($67,000 – $66,000)

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-10 (a) Jan. 1 Long-Term Investment— Hook Common Shares ........................ 150,000 Cash .................................................

150,000

Dec. 31 Cash (20% X $5,000) ............................... 1,000 Dividend Revenue ..............................

1,000

Dec. 31 Long-Term Investment— Hook Common Shares ........................... 10,000 Other Comprehensive Income – Gain On Fair Value Adjustment .................

10,000

(b) Jan. 1 Equity Method Investment— Hook Common Shares ........................ 150,000 Cash .................................................

150,000

Dec. 31 Equity Method Investment— Hook Common Shares ........................ 36,000 Revenue from Equity Investment in Hook (20% X $180,000) ...............

36,000

31 Cash (20% X $5,000) ............................ Equity Method Investment— Hook Common Shares....................

1,000 1,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-11 (a) Fair Value Balance Sheet: Long-term investment in Dong Ltd. common shares Income Statement: Dividend revenue Revenue from equity investment Other Comprehensive Income: Gain on fair value adjustment

(b) Equity Method

$315,000

$347,000 *

$3,000

0 $50,000

$15,000

* Long-term investment in Dong Ltd. Common shares Less dividend (20% x $15,000) Add: investee income (20% x $250,000) Carrying value of investment

$300,000 (3,000) 50,000 $347,000

BRIEF EXERCISE 16-12 ATWATER CORPORATION Statement of Comprehensive Income Year Ended April 30, 2010

Profit............................................................................ Other comprehensive income Gain on fair value adjustment on strategic investments............................................................ Comprehensive income .............................................

$650,000

46,000 $696,000

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 16-13 Financial Statement

Classification

Trading securities

Balance Sheet

Current assets

Dividend revenue

Income Statement

Other revenue

Equity method investment

Balance Sheet

Long-term investments

Long-term investment – bonds

Balance Sheet

Long-term investments

Gain on sale of trading securities

Income Statement

Other revenue

Gain on fair value adjustment for trading securities

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, Fifth Canadian Edition

BRIEF EXERCISE 16-14 SABRE CORPORATION Balance Sheet (Partial) November 30, 2010 Assets Current assets Treasury bills, at amortized cost ............................. Trading securities, at fair value............................... Long-term investments Equity investment – fair value ................................. Bond investment, at amortized cost ....................... Equity investment – equity method ........................

$25,125 26,000 51,125 105,000 150,000 250,000 505,000

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 16-1 1.

15% of the common Strategic investment shares of Lewis • Management’s intention is to Telecommunications influence the operations of Inc. Lewis Telecommunications. 100% of 15-year Non-Strategic investment bonds of Li Internet • The purpose is to generate Ltd. 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 gives Gleason Inc. 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 investment income. 10% of the common Non-Strategic investment shares of Talk to Us • The investment was made with Ltd. the intention to generate gains from trading the investment.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-2

1. 2. 3. 4.

5. 6. 7.

(a) 10-year BCE bonds Nonstrategic 10-year GE bonds Nonstrategic 1-year Government Nonof Canada bonds strategic 180-day treasury Nonbill strategic

(b) Long-term

Bank of Montreal preferred shares Tim Hortons common shares Kriska Holdings common shares

Current

Fair value

Current

Fair value

Long-term

N/A

Nonstrategic Nonstrategic Strategic

Long-term Current Current

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-3 (a) Jan. 02 Short-Term Investment—T-Bills .......... 9,900 Cash .................................................

9,900

May 01 Cash ..................................................... 10,000 Short-Term Investment —T-Bills .... Interest Revenue ..............................

9,900 100

June 01 Short-Term Investment — Money Market Fund .............................. 50,000 Cash .................................................

50,000

30 Short-Term Investment — Money Market Fund .............................. Interest Revenue ..............................

125 125

July 31 Short-Term Investment — Money Market Fund .............................. Interest Revenue ..............................

125

Aug. 15 Cash ...................................................... 50,350 Interest Revenue .............................. Short-Term Investment — Money Market Fund ......................... Oct. 31 Short-Term Investment — Term Deposit ........................................ 30,000 Cash ................................................. (b) Nov. 30 Interest Receivable ($30,000 X 2.5% X 1/12) ........................ 62.50 Interest Revenue ..............................

125

100 50,250

30,000

62.50

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EXERCISE 16-4 (a) (1) Imperial (investor) July 1 Long-Term Investment—Acme Bonds 490,000 Cash ($500,000 x 0.98) ................... 490,000 (2) Acme (investee) July 1 Cash .................................................... Bonds Payable ...............................

490,000

(b) (1) Imperial (investor) Dec. 31 Interest Receivable ............................. Long-Term Investment —Acme bonds Interest Revenue ............................ ($500,000 X 4% X 6/12)

10,000 406

(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 ................................................

490,000

10,406

10,406 406 10,000

10,000 10,000

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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 in the issue price by the investee and the purchase price of the investor.

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EXERCISE 16-5 (a) 2010: July 1 Trading Securities—Acme Bonds ..... Cash ($500,000 x 0.98) ................... (b) Dec. 31 Interest Receivable ............................. Interest Revenue ............................ ($500,000 X 4% X 6/12) Dec. 31 Trading Securities—Acme Bonds ..... Gain on Fair Value Adjustment of Trading Securities ......................... ([$500,000 X 0.99] – $490,000)

490,000 490,000

10,000 10,000

5,000 5,000

(c) The investment will be shown in the current asset section. (d) 2011: Jan. 1 Cash .................................................... Interest Receivable ........................ (e) July

1 Cash ($500,000 X 0.995) ..................... Gain on Sale of Trading Securities Trading Securities—Acme Bonds

10,000 10,000

497,500 2,500 495,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-6 Jan. 01 Trading Securities—Harris Bonds.... 121,200 Cash ($120,000 X 1.01) .......................

121,200

July 01 Cash ($120,000 X 6% X 6/12) .................. 3,600 Interest Revenue ................................

3,600

1 Cash......................................................... 64,000 Gain on Sale of Trading Securities ($64,000 – $60,600) ............................. Trading Securities— Harris Bonds ($121,200 X 1/2) ..........

60,600

Dec.31 Interest Receivable ................................. 1,800 Interest Revenue ($60,000 X 6% X 6/12) .........................

1,800

Dec.31 Loss on Fair Value Adjustment of Trading Securities .................................. Trading Securities—Harris Bonds ($60,600 – $60,000) .............................

3,400

600 600

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-7 2010 Nov.

1 Trading Securities—Lyman Shares (4,000 X $35) ....................................... 140,000 Trading Securities —Kaur Bonds ..... 200,000 Cash ................................................. 340,000

Dec. 15 Cash (1,600 X $50) ............................... 80,000 Trading Securities —Lyman Shares (1,600 X $35) .................................... Gain on Sale of Trading Securities 31 Trading Securities—Lyman Shares ... Gain on Fair Value Adjustment of Trading Securities .......................... [2,400 X ($45 – $35)] 31 Loss on Fair Value Adjustment of Trading Securities ............................... Trading Securities —Kaur Bonds .. [$200,000 X (1.00 – 0.98)] 31 Interest Receivable .............................. Interest Revenue ($200,000 X 6% X 2/12)....................

56,000 24,000

24,000 24,000

4,000 4,000

2,000 2,000

2011 Mar. 31 Cash (2,400 X $40) ............................... 96,000 Loss on Sale of Trading Securities .... 12,000 Trading Securities—Lyman Shares (2,400 X $45) .................................... 108,000 May

1 Cash ($200,000 X 6% X 6/12).................. 6,000 Interest Receivable ............................ Interest Revenue ................................

2,000 4,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-7 (Continued) Nov.

1 Cash ($200,000 X 6% X 6/12).................. 6,000 Interest Revenue ................................

6,000

Dec. 31 Interest Receivable ................................. 2,000 Interest Revenue ($200,000 X 6% X 2/12).......................

2,000

31 Trading Securities —Kaur Bonds ...... Gain on Fair Value Adjustment of Trading Securities .......................... [$200,000 X (1.00 – 0.98)]

4,000 4,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-8 (a) Dec. 31 Loss on Fair Value Adjustment—Trading Securities ...................................................... 5,000 Trading Securities – Co. B Preferred Shares 1,500 Trading Securities – Co. A Common Shares ....................................... 2,500 Trading Securities – Co. C bonds ............ 4,000 (b) YANIK, INC. Balance Sheet (Partial) December 31, 2010

Current assets Trading securities, at fair value ............................. $49,000

YANIK, INC. Income Statement (Partial) Year Ended December 31, 2010

Other expenses Loss on fair value adjustment on trading securities ................................................................. $5,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-9 Jan. 01 Trading Securities— Starr Preferred Shares ............................ 110,000 Cash ..................................................... 110,000 Apr. 1 Cash (1,000 X $5 ÷ 4) ............................... Dividend Revenue ...............................

1,250

July 1 Cash (1,000 X $5 ÷ 4) ............................... Dividend Revenue ...............................

1,250

02 Cash.......................................................... 58,000 Gain on the Sale of Trading Securities 3,000 Trading Securities— Starr Preferred Shares ($110,000 X 1/2) 55,000 Oct. 1 Cash (500 X $5 ÷ 4) .................................. Dividend Revenue ............................... Dec. 31 Loss on Fair Value Adjustment of Trading Securities ............................... Trading Securities — Starr Preferred Shares ............................. [500 X ($110 – $60)]

625 625

25,000 25,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-10 1. Jan.

2 Equity Method Investment— Diner Common Shares (12,000 X $18) . 216,000 Cash (30,000 X 40% X $18).............. 216,000

June 15 Cash ($30,000 X 40%) ............................. 12,000 Equity Method Investment— Diner Common Shares .................... 12,000 Dec. 31 Equity Method Investment— Diner Common Shares .......................... 152,000 Revenue from Equity Investment ($380,000 X 40%) .......... 152,000 2. Mar. 18 Long-Term Investment— Image Fashion Common Shares ........... 480,000 Cash (400,000 X 10% X $12) ............. 480,000 June 30 Cash ($44,000 X 10%) ............................ Dividend Revenue.............................

4,400 4,400

Dec. 31 Other Comprehensive Income— Loss on Fair Value Adjustment ............. 40,000 Long-Term Investment— Image Fashion Common Shares . 40,000 (400,000 X 10% X [$12 – $11])

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-11 (a) Jan. 01 Equity Method Investment— Bellingham Common Shares .............. 360,000 Cash .............................................. 360,000) Dec. 31 Cash ($30,000 X 20%) .......................... Equity Method Investment— Bellingham Common Shares ....... Dec. 31 Equity Method Investment— Bellingham Common Shares .............. Revenue from Equity Investment ($200,000 X 20%)........................... (b)

6,000 6,000)

40,000 40,000)

Balance Sheet Long-Term investments Equity investment—equity method ($360,000 – $6,000 + $40,000) ...............

$394,000

Income Statement Other revenue Revenue from equity method investment

$40,000

(c) Jan. 01 Long-Term Investment— Bellingham Common Shares .............. 360,000 Cash .............................................. 360,000) Dec. 31 Cash ($30,000 X 20%) .......................... Dividend Revenue ........................

6,000 6,000)

Dec. 31 Long-Term Investment— Bellingham Common Shares .............. 400,000 Other Comprehensive Income – Gain on Fair Value Adjustment.... 400,000) (200,000 x 20%) x $19 – $360,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-11 (Continued) (c)

(Continued) Balance Sheet Long-term investments Equity investment—fair value ($360,000 + $400,000) ............................

$760,000

Income Statement Other revenue Dividend revenue ...................................

$6,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-12 (a)

Bank of America Corporation is the parent and Merrill Lynch & Co. is the subsidiary.

(b)

Merrill Lynch shares no longer trade on the exchange because they are no longer being bought or sold. Consolidated statements are prepared to provide to the shareholders of Bank of America with a comprehensive view of the entire company’s performance.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-13

Balance Sheet

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

Assets NE (+/-) + NE (+/-) NE (+/-) + NE (+/-) NE (+/-) + NE (+/-) NE (+/-) + + +

Solutions Manual

Liabilities NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE

Shareholders’ Equity NE + NE NE + NE NE + NE NE + + +

Income Statement

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

Profit 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

Chapter 16

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-14 NEW BAY INC. Balance Sheet December 31, 2011

Assets Current assets Cash........................................................................... $ 22,000 Trading securities, 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, 2014 .................. 60,000 Bond investment – amortized cost .......................... 180,000 Equity investments – equity method ....................... 55,000 Total investments................................................. 320,000 Property, plant and equipment Computers and equipment ........................ $66,000 Less: Accumulated depreciation ............... 40,000 26,000 Total assets .......................................................... $468,000

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Accounting Principles, Fifth Canadian Edition

EXERCISE 16-14 (Continued) NEW BAY INC. Balance Sheet (Continued) December 31, 2011

Liabilities and Shareholders' Equity Current liabilities Accounts payable ..................................................... Interest payable ($10,000 + $8,000) ......................... Total current liabilities ......................................... Long-term liabilities Bond payable, 8%, due 2015 .................................... 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 ...........

$ 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, Fifth Canadian Edition

EXERCISE 16-15 OAKRIDGE LTD. Statement of Comprehensive Income Year Ended December 31, 2011

Profit from operations ....................................................... $125,000 Other revenue Interest revenue ............................................... $5,000 Gain on fair value adjustment – trading securities ......................................... 7,500 12,500 Other expenses Interest expense .............................................. 8,000 Loss on sale – trading securities ................... 1,500 9,500 Profit before income tax ................................................... 128,000 Income tax ($128,000 X 30%) ........................................ 38,400 Profit................................................................................... 89,600 Other comprehensive income Loss on fair value adjustment (net of $900 income tax)* 2,100 Comprehensive income .................................................... $87,500 * [$3,000 - ($3,000 X 30%)]

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 16-1A 2010: (a) Jan. 1 Long-Term Investment – Pearl Bonds .................................. 385,460 Cash ......................................... (b) Jul. 1 Cash .............................................. Long-Term Investment – Pearl Bonds .................................. Interest Revenue ..................... ($400,000 X 6% X 6/12)

12,000

(c) Dec. 31 Interest Receivable ...................... Long-Term Investment – Pearl Bonds .................................. Interest Revenue .....................

12,000

385,460

527 12,527

544 12,544

(d) MORRISON INC. Partial Balance Sheet December 31, 2010

Long-term investments Bonds investment – amortized cost ........................ ($385,460 + $527 + $544)

$386,531

2011: (e) Jan. 1 Cash .............................................. Interest Receivable ..................

12,000 12,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-1A (Continued) 2020: (f) Jan. 1 Cash .............................................. 400,000 Long-Term Investment – Pearl Bonds .............................

400,000

(g) Trading 2010: Jul.

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

12,000

Dec. 31 Interest Receivable ........................... Interest Revenue .....................

12,000

Dec. 31 Trading Securities – Pearl Bonds.... Gain on Fair Value Adjustment on Trading Securities .............. ($395,000 – $385,460) 2011:

9,540

Jan. 1 Cash .................................................. Interest Receivable ..................

12,000

9,540

12,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-1A (Continued) Taking It Further: The market rate of interest was 6.50% per year. Present value of $400,000 received in 20 periods $400,000 × 0.52747 (n = 20, i = 3.25 1) $ 210,988 Present value of $12,000 received for each of 20 periods $12,000 × 14.53935 (n = 20, i = 3.25) 174,472 Present value (market price) of bonds $385,460 1

The interest is divided by two for the semi-annual interest payments.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-2A (a) Jan. 01 Short-Term Investment – Treasury Bill........................................... 98,039 Cash ...................................................

98,039

June 30 Cash ....................................................... 100,000 Interest Revenue ............................... Short-Term Investment – Treasury Bill

1,961 98,039

July 5 Short-Term Investment — Money-Market Fund............................... 25,000 Cash ...................................................

25,000

Oct.

1 Cash ....................................................... 25,185 Short-Term Investment — Money-Market Fund .......................... Interest Revenue ...............................

25,000 185

1 Short-Term Investment — Term Deposit ......................................... 75,000 Cash ...................................................

75,000

Dec. 31 Interest Receivable ($75,000 X 3% X 3/12) 563 Interest Revenue .................................

563

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-2A (Continued) (b) LIU CORPORATION Partial Balance Sheet December 31, 2010

Current assets Interest receivable...................................................... Short-term investment – term deposit ......................

$ 563 75,000

LIU CORPORATION Income Statement Year Ended December 31, 2010

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) x 12/6

$1,961 98,039 4.0%

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PROBLEM 16-3A (a) CASB Jan. 1 Cash ($1,000,000 X 0.98) ........... Bonds Payable ......................

980,000

June 30 Interest Expense ........................ Bonds Payable ...................... Cash ($1,000,000 X 7% X 6/12)

35,672

Dec. 31 Interest Expense ........................ Bonds Payable ...................... Cash ($1,000,000 X 7% X 6/12)

35,696

980,000

672 35,000

696 35,000

(b) CASB INCORPORATED Partial Balance Sheet December 31, 2010

Long-term liabilities Bonds payable, 7%, due 2020 .................................. ($980,000 + $672 + $696)

$981,368

CASB INCORPORATED Income Statement Year Ended December 31, 2010

Other expenses Interest expense ($35,672 + $35,696) ......................

$71,368

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-3A (Continued) (c) Densmore Jan. 1 Long-Term Investment– CASB Bonds (200,000 X .98).................. 196,000 Cash ........................................................ 196,000 June 30 Cash ($200,000 X 7% X 6/12).................. 7,000 Long-Term Investment– CASB Bonds(672 x (200,000/1,000,000)) 134 Interest Revenue ................................

7,134

Dec. 31 Cash ($200,000 X 7% X 6/12).................. Long-Term Investment– CASB Bonds(696 x(200,000/1,000,000)) Interest Revenue ................................

7,139

7,000 139

(d) DENSMORE CONSULTING LTD. Balance Sheet (Partial) December 31, 2010

Long-term investments Long-term bond investment, at amortized cost ($196,000+134+139)

$196,273

DENSMORE CONSULTING LTD. Income Statement Year Ended December 31, 2010

Other revenues Interest revenue ($7,134+7,139) ...............................

$14,273

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PROBLEM 16-3A (Continued) (e) Densmore - Trading Jan. 1 Trading Securities– CASB Bonds ........................................... 196,000 Cash .................................................... 196.000 June 30 Cash ($200,000 X 7% X 6/12).................. Interest Revenue ................................

7,000

Dec. 31 Cash ($200,000 X 7% X 6/12).................. Interest Revenue ................................

7,000

Dec. 31 Trading Securities– CASB Bonds ........................................... Gain on Fair Value Adjustment on Trading Securities.............................. ([$200,000 x 99%] – $196,000)

7,000

2,000 2,000

(f) DENSMORE CONSULTING LTD. Balance Sheet (Partial) December 31, 2010

Current assets Trading securities, at fair value ...................

$198,000

DENSMORE CONSULTING LTD. Income Statement Year Ended December 31, 2010

Other revenues Interest revenue ($7,000 + 7,000) ............................. Gain on fair value adjustment on trading securities

$14,000 2,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-3A (Continued) Taking It Further: (1) To hold and earn interest: 2011: Jan. 1 Cash ..................................................... 199,000 Gain on Sale of CASB Bonds ............ 2727 Long-Term Investment– CASB Bonds ...................................... 196,273 (2) For purposes of trading: 2011: Jan. 1 Cash ..................................................... 199,000 Gain on Sale of CASB Bonds ............ 1,000 Trading Securities– CASB Bonds ...................................... 198,000 CASB does not record an entry to record the sale of its bonds by Densmore because the bonds are still outstanding; they have not been purchased by CASB. The bonds have been purchased from Densmore by a third party. This individual or company will now receive the interest payments and if the bonds are held to maturity, the face value of the bond.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-4A (a) Feb. 1 Trading Securities— IBF Common Shares ............................. 20,400 Cash ...................................................

20,400

Mar. 1 Trading Securities — RST Common Shares ............................ 36,000 Cash ...................................................

36,000

Apr. 1 Trading Securities — CRT Bonds ............................................. 138,000 Cash ................................................... 138,000 July 1 Cash ($1 X 425) ...................................... Dividend Revenue .............................

425

Aug. 01 Cash (125 X $45) .................................... Loss on Sale of Trading Securities ($6,000 – $5,625) .................................... Trading Securities — IBF Common Shares [($20,400  425) X 125] ......................

5,625

Oct. 01 Cash ($140,000 X 5% X 6/12)................. Interest Revenue ...............................

3,500

425

375

6,000

3,500

01 Cash ....................................................... 140,000 Gain on Sale of Trading Securities ($140,000 – $138,000) ........................ 2,000 Trading Securities — CRT Bonds ........................................ 138,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-4A (Continued) Dec. 31 Trading Securities — RST Common Shares ............................ 3,000 Gain on Fair Value Adjustment of Trading Securities ($51,900 – $50,400) Trading Securities — IBF Common Shares ($14,400 – $12,900) Common Shares IBF RST

Cost $14,400* 36,000 $50,400 * $20,400 – $6,000 (b)

Market Value $12,900 39,000 $51,900

1,500 1,500

(300 X $43) (1,000 X $39)

RAKAI CORPORATION Balance Sheet (Partial) December 31, 2010

Current assets Trading securities, at fair value ........................... $51,900

RAKAI CORPORATION Income Statement (Partial) Year Ended December 31, 2010

Other revenue Interest revenue .................................. Dividend revenue ................................ Gain on sale of investment ................ Gain on fair value adjustment of trading securities ............................ Other expenses Loss on sale of trading securities .....

$3,500 425 2,000 1,500

$7,425 375

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Accounting Principles, Fifth Canadian Edition

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. 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-5A (a) Jan. 7 Cash (500 x $55) ..................................... 27,500 Trading Securities— Aglar Corporation Common Shares . Gain on Sale of Trading Securities ...

26,000 1,500

10 Trading Securities — Miley Corporation Common Shares ...... 15,600 Cash (200 X $78) ................................

15,600

Feb. 2 Cash ........................................................ Dividend Revenue ($1 X 600) ............

600

10 Cash ($27 X 600) ..................................... 16,200 Loss on Sale of Trading Securities ....... 600 Trading Securities —Hicks Corporation Preferred Shares ...........

600

16,800

Apr. 30 No entry is necessary for the stock split. The new cost basis of the shares is $30 ($42,000  1,400). Aug. 03 No entry is necessary for the stock dividend. The number of shares held is now 220, at a cost of $70.91 per share ($15,600 ÷ 220). Sep. 1 Trading Securities — Miley Corporation Common Shares ...... 56,000 Cash ($70 X 800) ..................................

56,000

Dec. 31 Trading Securities – BAL Corporation Common Shares ($44,800 – $42,000) ...... 2,800 Trading Securities – Miley Corporation Common Shares ($73,440 – $71,600) ...... 1,840 Gain on Fair Value Adjustment on Trading Securities................................

4,640

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-5A (Continued) (a) (Continued)

BAL

Number of Shares 1,400

Miley

1,020

Total * $15,600 + $56,000

Cost $ 42,000

Market $ 44,800

71,600*

73,440

$113,600

$118,240

1,400 X $32 1,020 X $72

(b) HI-TECH INC. Balance Sheet (Partial) December 31, 2011

Current assets Trading securities, at fair value .............................

$118,240

HI-TECH INC. Income Statement (Partial) Year Ended December 31, 2011 Other revenue Dividend revenue .................................................... Gain on sale of trading securities ......................... Gain on fair value adjustment on trading securities ................................................................. Other expenses Loss on sale of trading securities .........................

$ 600 1,500 4,640 6,740 600

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PROBLEM 16-5A (Continued) (c) Jan. 31 Cash (510 x $74) ..................................... 37,740 Gain on Sale of Trading Securities ... Trading Securities —Miley Corporation Common Shares (510 x $72) .............

1,020 36,720

Taking It Further: Number of Shares BAL 1,400 Miley 510 Total

Carrying Value $ 44,800 1 36,720 2 $ 81,520

Market $ 40,600 35,190 $ 75,790

Loss on Fair Value Adjustment of Trading Securities = $81,520 – $75,790 = $5,730 1 2

Fair Value at December 31, 2011. $73,440 – $36,720 = $36,720

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-6A

Balance Sheet

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

Assets NE (+/-) + NE (+/-) + NE (+/-) NE (+/-) + NE (+/-) + NE NE

Solutions Manual

Liabilities NE NE NE NE NE NE NE NE NE NE NE NE

Shareholders’ Equity NE + NE + NE NE + NE + NE NE

Income Statement

Revenues Expenses 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

Statement of Comprehensive Income Other Comprehensive Income NE NE NE NE NE NE NE NE NE NE NE

Chapter 16

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-6A (Continued) Taking It Further: If Olsztyn Inc. reports under Canadian GAAP for Private Enterprises, there is no Other Comprehensive Income. Only transaction #11 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.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-7A (a) (1) No significant influence Jan. 01 Long-Term Investment — Edra Common Shares ...................... 2,400,000 Cash .............................................. 2,400,000 June 30 Cash .................................................. 60,000 Dividend Revenue (100,000 X $0.60)

60,000

Dec. 31 Cash .................................................. 60,000 Dividend Revenue (100,000 X $0.60)

60,000

Dec. 31 Long-Term Investment — Edra Common Shares ...................... 100,000 Other Comprehensive Income – Gain on Fair Value Adjustment ... ([$25 x 100,000] – $2,400,000)

100,000

(2) Significant influence Jan. 01 Equity Method Investment— Edra Common Shares ...................... 2,400,000 Cash .............................................. 2,400,000 June 30 Cash (100,000 X $0.60) ..................... Equity Method Investment — Edra Common Shares..................

60,000

Dec. 31 Cash (100,000 X $0.60) ..................... Equity Method Investment — Edra Common Shares..................

60,000

31 Equity Method Investment— Edra Common Shares ...................... 300,000 Revenue from Equity Investment ($1,500,000 X 20%) .......................

60,000

300,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-7A (Continued) (b) No Significant Influence Long-Term Investment - Edra Common Shares Equity Method Investment ($2,400,000 – $60,000 – $60,000 + $300,000) Dividend Revenue Gain on Fair Value Adjustment Revenue from Equity Investment

Significant Influence

$2,500,000

$2,580,000 120,000 100,000 300,000

Taking It Further: There are many potential advantages. For example: • securing a supply of raw material • building a relationship with a customer • gaining a foothold in a new industry • obtaining the benefits of vertical or horizontal integration • influencing policies of another company

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-8A

(a) Situation 1: Situation 2: Situation 3: 100%

Fair Value 100,000 ÷ 1,000,000 = 10% Equity Method 300,000 ÷ 1,000,000 = 30% Equity Method* 1,000,000 ÷ 1,000,000 =

* Consolidated financial statements are also prepared for reporting purposes. (b) Situation 1 Jan. 10 Long-Term Investment– Sub Common ................................. Cash (100,000 X $10) ................ Dec. 31 Cash (100,000 X $0.35) .................. Dividend Revenue ..................... Dec. 31 Long-Term Investment– Sub Common ................................. Other Comprehensive Income – Gain on Fair Value Adjustment (100,000 x [$12 – $10]) Situation 2 Jan. 10 Equity Method Investment– Sub Common ................................. Cash (300,000 X $10) ................ Dec. 31 Cash (300,000 X $0.35) .................. Equity Method Investment– Sub Common ............................ 31 Equity Method Investment– Sub Common ................................. Revenue from Equity Investment –Sub Common ($260,000 x 30%) PROBLEM 16-8A (Continued)

1,000,000 1,000,000 35,000 35,000

200,000 200,000

3,000,000 3,000,000 105,000 105,000

78,000 78,000

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Accounting Principles, Fifth Canadian Edition

Situation 2

$1,200,000

Income Statement Revenue from investment in Sub Dividend revenue

$2,973,000

78,000 35,000

* $3,000,000 – $105,000 + $78,000 = $2,973,000 Taking It Further: Fair value, Dec. 31, 2012: 100,000 x $13 = Cost: 100,000 x $10 Cumulative other comprehensive income Less income taxes (30% x $300,000) Accumulated other comprehensive income, Dec. 31, 2012

$1,300,000 1,000,000 300,000 90,000 $210,000

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PROBLEM 16-9A (a) SILVER LINING CORPORATION Income Statement Year ended December 31, 2011 (in millions)

Silver sales Cost of sales Gross profit Operating expenses Profit from operations Other revenue Other revenues Interest income Other expenses Other expenses Equity loss in investee earnings Interest expense Income before income tax Income tax expense Profit

$3,350 2,214 1,136 639 497 $ 6 38

$67 6 7

44 541

80 461 60 $ 401

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PROBLEM 16-9A (Continued) SILVER LINING CORPORATION Statement of Comprehensive Income Year ended December 31, 2011 (in millions)

Profit Other comprehensive income Gains on fair value adjustment, net of tax Comprehensive income

(b)

Accumulated other comprehensive income ($49 + $12)

$401 12 $413

$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 Balance Sheet April 30, 2011

Assets Current assets Cash............................................................................. $ 100,000 Trading securities, at fair value ................................ 15,000 Accounts receivable .................................................. 48,000 Supplies....................................................................... ,0 5,000 Total current assets ............................................... 168,000 Investments Long-term equity investment— common shares, at fair value................... $220,000 Equity investment – equity method ............ 170,000 Long-term bond investment, at amortized cost ....................................... 0 24,000 Total investments ...................................................

414,000

Property, plant and equipment Equipment .................................................... $275,000 Less: Accumulated depreciation ................ 72,000

203,000

Intangible assets Goodwill ................................................................... Total assets ...............................................................

50,000 $835,000

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PROBLEM 16-10A (Continued) STINSON CORPORATION Balance Sheet (Continued) April 30, 2011

Liabilities and Shareholders' Equity Current liabilities Accounts payable ...................................................... $0,65,000 Income tax payable .................................................... 00,25,000 Total current liabilities .......................................... 90,000 Long-term liabilities Bonds payable ........................................................... Total liabilities .......................................................

150,000 240,000

Shareholders' equity Share capital Common shares, no par value, unlimited authorized, 200,000 shares issued ..................................................... 300,000 Retained earnings* ................................................... , 289,000 Accumulated other comprehensive income** ........ 6,000 Total shareholders' equity .................................... 595,000 Total liabilities and shareholders' equity ............ $835,000 * $161,660 + $127,340 Profit = $289,000 ** $18,000 – $12,000 = $6,000

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PROBLEM 16-10A (Continued) STINSON CORPORATION Statement of Comprehensive Income Year Ended April 30, 2011

Service revenue................................................................. $550,000 Operating expenses Salary expense .......................................... $235,000 Rent expense ............................................. 79,000 Depreciation expense ................................ 27,500 Supplies expense ...................................... 7,500 349,000 Profit from operations ....................................................... 201,000 Other revenues Dividend revenue ....................................... $ 11,000 Gain on sale of trading securities ............ 3,000 Gain on fair value adjustment on trading securities .................................... 1,500 Interest revenue ......................................... 1,200 16,700 217,700 Other expenses Interest expense ........................................................... 7,500 Profit before tax ................................................................. 210,200 Income tax expense .......................................................... 82,860 Profit................................................................................... 127,340 Other comprehensive income Loss on fair value adjustment, net of $3,600 tax ........ 12,000 Comprehensive income .................................................... $115,340

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PROBLEM 16-10A (Continued) Taking It Further: If Stinson Corporation applied Canadian GAAP for Private Enterprises, 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 2010: (a) Jan. 1 Long-Term Investment – Schuett Bonds.............................. 104,000 Cash ($100,000 x 1.04) ............ (b) Jul. 1 Cash .............................................. Long-Term Investment – Schuett Bonds ......................... Interest Revenue ..................... ($100,000 X 9% X 6/12)

4,500

(c) Dec. 31 Interest Receivable ...................... Long-Term Investment – Schuett Bonds ......................... Interest Revenue .....................

4,500

104,000

340 4,160

354 4,146

(d) GIVARZ CORPORATION Partial Balance Sheet December 31, 2010

Long-term investments Bonds investment – amortized cost ........................ ($104,000 – $340 – $354)

$103,306

2011: (e) Jan. 1 Cash .............................................. Interest Receivable ..................

4,500 4,500

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PROBLEM 16-1B (Continued) 2015: (f) Jan. 1 Cash .............................................. 100,000 Long-Term Investment – Schuett Bonds .........................

100,000

(g) Trading 2010: Jul.

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

4,500

Dec. 31 Interest Receivable ........................... Interest Revenue .....................

4,500

Dec. 31 Loss on Fair Value Adjustment – on Trading Securities ....................... Long-Term Investment – Schuett Bonds ......................... ($104,000 – $101,000) 2011: Jan. 1 Cash .................................................. Interest Receivable ..................

4,500

3,000 3,000

4,500 4,500

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PROBLEM 16-1B (Continued) Taking It Further: The market rate of interest was 8.0% per year. Present value of $100,000 received in 10 periods $100,000 × 0.67556 (n = 10, i = 4.00 1) $ 67,556 Present value of $12,000 received for each of 20 periods $4,500 × 8.11090 (n = 10, i = 4.00) 36,499 Present value (market price) of bonds $104,055 1

The interest is divided by two for the semi-annual interest payments.

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PROBLEM 16-2B (a) Feb. 01 Short-Term Investment— Term Deposit ....................................... 50,000 Cash .................................................

50,000

Aug. 01 Cash ..................................................... 51,250 Short-Term Investment— Term Deposit ................................... Interest Revenue .............................

50,000 1,250

Aug. 1 Short-Term Investment— Money Market Fund ............................. 55,000 Cash .................................................

55,000

Dec. 1 Cash ..................................................... 55,735 Short-Term Investment— Money Market Fund ........................ Interest Revenue .............................

55,000 735

1 Short-Term Investment— Treasury Bill......................................... 99,260 Cash .................................................

99,260

31 Short-Term Investment— Treasury Bill ($99,508 – $99,260) ........ Interest Revenue .............................

248 248

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PROBLEM 16-2B (Continued) (b) LANNAN CORP. Partial Balance Sheet December 31, 2010

Current assets Short-term investment – treasury bill .......................

99,508

LANNAN CORPORATION Income Statement Year Ended December 31, 2010

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) X 2 ..............

$1,250 50,000 5.0%

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PROBLEM 16-3B (a) CHL Feb. 1 Cash ($10,000,000 X 1.01) ......... 10,100,000 Bonds Payable ...................... 10,100,000 Jul. 31 Interest Expense ....................... Bonds Payable ........................... Interest Payable ($10,000,000 X 6% X 6/12) .....

291,890 8,110

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

300,000

(b) COLLEGE OF HIGHER LEARNING Balance Sheet (Partial) July 31, 2010

Long-term liabilities Bonds payable, 6%, due 2015 ................ ($10,100,000 – $8,110)

$10,091,890

COLLEGE OF HIGHER LEARNING Income Statement Year Ended July 31, 2010

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

$291,890

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PROBLEM 16-3B (Continued) (c) Otutye Feb. 1 Long-Term Investment— CHL Bonds (2,000,000 X 1.01) .. Cash .......................................

2,020,000 2,020,000

July 31 Interest Receivable ($2,000,000 X 6% X 6/12) ........... 60,000 Long-Term Investment— CHL Bonds(8,110 X (2,000,000/10,000,000)) ............................................... Interest Revenue ...................

1,622 58,378

Aug. 1 Cash .................................................. Interest Receivable ......................

60,000

(d) OTUTYE LTD. Balance Sheet (Partial) July 31, 2010

Long-term Investments Long-term bond investment, at amortized cost ... ($2,020,000-1,622)

$2,018,378

OTUTYE LTD. Income Statement Year Ended July 31, 2010

Other revenues Interest revenue ........................................................

$58,378

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PROBLEM 16-3B (Continued) (e) Otutye - Trading Feb. 1 Trading Securities— CHL Bonds ................................. Cash .......................................

2,020,000

July 31 Interest Receivable ($10,000,000 X 6% X 6/12) ......... Interest Revenue ...................

60,000

31 Loss on Fair Value Adjustment on Trading Securities ........................... Trading Securities— CHL Bonds ................................... $2,020,000 - $2,000,000 = 20,000 Aug. 1 Cash .................................................. Interest Receivable ......................

2,020,000

60,000

20,000 20,000

60,000 60,000

(f) OTUTYE LTD. Balance Sheet (Partial) July 31, 2010

Current assets Trading securities, at fair value .............................

$2,000,000

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PROBLEM 16-3B (Continued) (f) (Continued) OTUTYE LTD. Income Statement Year Ended July 31, 2010

Other revenues Interest revenue ........................................................

$60,000

Other expenses Loss on fair value adjustment on trading securities

20,000

Taking It Further: The market rate of interest increased. When Otutye purchased the bonds, the market rate of interest was lower than the stated rate of 6%. This made the bonds more attractive and buyers such as Otutye were willing to pay a premium for a higher rate of interest. At July 31, the bonds are trading at par. This means that the market rate of interest is the same as the bonds stated rate of 6%. The interest rate has increased since February 1. Otutye wants the market interest rate to decrease. This will make the bond’s stated rate of 6% attractive to buyers and give Otutye the opportunity to sell the bonds at a gain.

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PROBLEM 16-4B (a) Feb. 1 Trading Securities—CBF Common Shares ............................................... Cash ..............................................

63,600

Mar. 1 Trading Securities — RSD Common Shares ...................... Cash ..............................................

10,000

Apr. 1 Trading Securities — MRT Bonds ....................................... Cash ..............................................

100,000

63,600

10,000

100,000

July 1 Cash (1,200 X $1) .............................. Dividend Revenue ........................

1,200

Aug. 1 Cash (400 x $50) ............................... Loss on Sale of Trading Securities . Trading Securities— CBF Common Shares [($63,600 ÷ 1,200) X 400] .............

20,000 1,200

Oct.

3,000

1 Cash ($100,000 X 6% X 6/12)............ Interest Revenue ..........................

1,200

21,200 3,000

2 Cash ($100,000 X 1.02) ..................... 102,000 Gain on Sale of Trading Securities............. 2,000 Trading Securities — MRT Bonds............... 100,000

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PROBLEM 16-4B (Continued) (a) (Continued) Dec. 31 Trading Securities — RSD Common Shares ...................... Loss on Fair Value Adjustment on Trading Securities ($52,400 – $46,800) Trading Securities— CBF Common Shares .................. Number of Shares 1,200 – 400 = 800 400

CBF RSD Total * $63,600 – $21,200 (b)

Cost $42,400* 10,000 $52,400

800 5,600 6,400

Market $36,000 10,800 $46,800

(800 X $45) (400 X $27)

MEAD INVESTMENT CORPORATION Balance Sheet (Partial) December 31, 2010

Current assets Trading securities, at fair value ..................................... $46,800 MEAD INVESTMENT CORPORATION Income Statement (Partial) Year ended December 31, 2010

Other revenues Dividend revenue ................................... Interest revenue ..................................... Gain on sale of trading securities ........ Other expenses Loss on sale of trading securities ........ Loss on fair value adjustment on trading securities ...............................

$1,200 3,000 2,000

$6,200

1,200 5,600

6,800

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PROBLEM 16-4B (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. 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 16-5B (a) Jan. 7 Cash (500 x $41) .................................... 20,500 Trading Securities— Alta Common Shares ........................ Gain on Sale of Trading Securities ..

18,500 2,000

10 Trading Securities — Econo Common Shares ........................ 10,600 Cash (200 X $53) ..............................

10,600

Feb. 2 Cash ....................................................... 1,800 Dividend Revenue ($6 X 300) ...........

1,800

10 Cash ($85 X 300) .................................... 25,500 Loss on Sale of Trading Securities ...... 1,500 Trading Securities — Flon Preferred Shares.......................

27,000

Mar.015 No entry is necessary for the stock dividend. The number of shares held is now 770, at a cost of $45.45 per share ($35,000 ÷ 770). June 23 No entry is necessary for the stock split. The number of shares held is now 600, at a cost of $17.67 per share ($10,600 ÷ 600). Dec. 31 Loss on Fair Value Adjustment on Trading Securities* ................................ 2,460 Trading Securities – Econo Corporation Common Shares ($10,800 – $10,600) ... 200 Trading Securities – Brunswick Corporation Commons Shares ........ ($35,000 – $32,340 = $2,660)

2,660

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PROBLEM 16-5B (Continued) (a) (Continued) Number of Market Price Shares $42 770 18 600

Brunswick Econo Total * $45,600 – $43,140 = $2,460

Market Value $32,340 10,800 $43,140

Carrying Value $35,000 10,600 $45,600

(b) HEAD FINANCIAL CORPORATION Balance Sheet (Partial) December 31, 2011

Current assets Trading securities, at fair value ..................................... $43,140 HEAD FINANCIAL CORPORATION Income Statement (Partial) Year ended December 31, 2011

Other Revenue Dividend revenue ............................................................ $1,800 Gain on sale of trading securities ($2,000 – $1,500)..... 500 Other Expenses Loss on fair value adjustment on trading securities.... (c) Feb. 15 Cash (385 x $45) .................................... 17,325 Trading Securities— Brunswick Corporation Common Shares* ......... Gain on Sale of Trading Securities .. ($32,340 / 2 = $16,170)

2,460

16,170 1,155

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PROBLEM 16-5B (Continued) Taking It Further:

Brunswick Econo Total 1 2

Market Price $46 19

Number of Shares 385 600

Carrying Value $16,170 1 10,800 2 $26,970

Market Value $17,710 11,400 $29,110

Gain / (Loss) $1,540 600 $2,140

$32,340 – $16,170 = $16,170 Fair Value at December 31, 2011.

There would be a gain of $2,140 reported in Other Revenues on Head Financial’s income statement.

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PROBLEM 16-6B

Balance Sheet

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

Assets NE (+/-) NE NE (+/-) + NE (+/-) - (+/-) NE (+/-) + NE (+/-) NE (+/-) + + NE

Solutions Manual

Liabilities NE NE NE NE NE NE NE NE NE NE NE NE NE NE NE

Shareholders’ Equity NE NE NE + NE NE + NE NE + + NE

Income Statement

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

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 NE + NE

Chapter 16

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PROBLEM 16-6B (Continued) Taking It Further: If Abioye Inc. reports under Canadian GAAP for Private Enterprises, there is no Other Comprehensive Income. Only transaction #14 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.

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PROBLEM 16-7B (a) (1) No significant influence Jan. 01 Long-Term Investment— BNA Shares...................................... 1,600,000 Cash ............................................. 1,600,000 June 15 Cash ................................................. 40,000 Dividend Revenue (100,000 X $0.40)

40,000

Dec. 15 Cash ................................................. 40,000 Dividend Revenue (100,000 X $0.40)

40,000

Dec. 31 Long-Term Investment— BNA Shares...................................... Other Comprehensive Income Gain on Fair Value Adjustment ..

50,000

(2) Significant influence Jan. 01 Equity Method Investment— BNA Shares...................................... 1,600,000 Cash ............................................. 1,600,000 June 15 Cash (100,000 X $0.40) .................... Equity Method Investment— BNA Shares .................................

40,000

Dec. 15 Cash (100,000 X $0.40) .................... Equity Method Investment— BNA Shares .................................

40,000

Dec. 31 Equity Method Investment— BNA Shares...................................... Revenue from Equity Investment ($800,000 X 20%) .....

40,000

160,000 160,000

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PROBLEM 16-7B (Continued) (b) No Significant Influence Long-Term Investment - BNA Common Shares Equity Method Investment ($1,600,000 – $40,000 – $40,000 + $160,000) Dividend Revenue Gain on Fair Value Adjustment Revenue from Equity Investment

Significant Influence

$1,650,000

$1,680,000 80,000 50,000 160,000

Taking It Further: Significant influence over an investee may result from representation on the board of directors, participation in policymaking processes, or material intercompany transactions. An investment (direct or indirect) of 20% or more of the voting shares of an investee signifies significant influence, unless evidence exists to the contrary. However, companies are required to use judgement 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. Conversely, 19% ownership could constitute significant influence if the remaining shares are widely held.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 16-8B (a)

Situation 1: Fair Value Situation 2: Equity Method Situation 3: Equity Method*

30,000 ÷ 300,000 = 10% 90,000 ÷ 300,000 = 30% 300,000 ÷ 300,000 = 100%

* Consolidated financial statements are also prepared for reporting purposes. (b) Situation 1 Oct. 1 Long-Term Investment– Hat Common............................... Cash (30,000 X $40) ............... 2011 Sept. 30 Sept. 30

1,200,000

Cash ($0.40 X 30,000) ................. Dividend Revenue .................

12,000 12,000

Long-Term Investment– Hat Common (30,000 x [$43 – $40]) Other Comprehensive Income – Gain on Fair Value Adjustment

Situation 2 Oct. 1 Equity Method Investment– Hat Common............................... Cash (90,000 X $40) ............... 2011 Sept. 30

1,200,000

Cash ($0.40 X 90,000) ................. Equity Method Investment– Hat Common ..........................

90,000 90,000

3,600,000 3,600,000 36,000

Equity Method Investment– Hat Common............................... 202,500 Revenue from Equity Investment ($675,000 X 30%)....................

36,000

202,500

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PROBLEM 16-8B (Continued) (c) Situation 1 Balance Sheet Long-Term Investment – Hat Equity Method Investment – Hat*

Situation 2

$1,290,000

Income Statement Revenue from equity investment Dividend revenue

$3,766,500

202,500 12,000

* $3,600,000 – $36,000 + $202,500 = $3,766,500 Taking It Further: Fair value, Sep. 30, 2012: 30,000 x $45 = Cost: 30,000 x $40 Cumulative other comprehensive income Less income taxes (30% x $150,000) Accumulated other comprehensive income, Sep. 30, 2012

$1,350,000 1,200,000 150,000 45,000 $ 105,000

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PROBLEM 16-9B (a)

INVESTMENTS R US COMPANY Income Statement Year ended December 31, 2011 (in millions)

Revenues Operating expenses Profit from operations Other revenue Gain on disposal of land Interest revenue Equity in earnings – Speed Railway Dividend revenue Gain on fair value adjustment – trading securities Other expenses Interest expense Loss on sale of trading securities Other expenses Profit before income tax Income tax expense Profit

$7,240 4,616 2,624 $ 26 6 4 3 2

$ 299 194 21

41 2,665

514 2,151 781 $1,370

INVESTMENTS R US COMPANY Statement of Comprehensive Income Year ended December 31, 2011 (in millions)

Profit Other comprehensive income: Loss on fair value adjustment, net of tax Comprehensive income

$1,370 68 $1,302

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PROBLEM 16-9B (Continued)

(b)

Accumulated other comprehensive loss: ($150 + $68)

$218

Taking It Further: Fair value adjustments on trading securities 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 is also 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 is reflected in other comprehensive income on the statement of comprehensive income.

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PROBLEM 16-10B VLADIMIR CORPORATION Balance Sheet December 31, 2010

Assets Current assets Cash........................................................................... $150,000 Trading securities, at fair value ................................. 37,000 Accounts receivable ................................... $68,000 Less: Allowance for doubtful accounts .... 4,000 64,000 Supplies..................................................................... , 2,500 Total current assets ............................................. 253,500 Investments Notes receivable, due 2013 ......................... $75,000 Long-term investment in bonds, at amortized cost ....................................... 36,000 Long-term equity investment, at fair value 185,000 Equity investment— RIBI common, at equity ............................. 215,000 Total investments................................................. 511,000 Property, plant and equipment Equipment ............................................... $288,000 Less: Accumulated depreciation ........... 92,000 196,000 Intangible assets Goodwill .................................................................... 75,000 Total assets .......................................................... $1,035,500

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PROBLEM 16-10B (Continued) VLADIMIR CORPORATION Balance Sheet (Continued) December 31, 2010

Liabilities and Shareholders' Equity Current liabilities Accounts payable ..................................................... $ 85,000 Income tax payable ................................................... 16,000 Total current liabilities ......................................... 101,000 Long-term liabilities Bonds payable .......................................................... 250,000 Total liabilities ...................................................... 351,000 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 ........... $1,035,500 * Total liabilities and shareholders’ equity (equal Total assets) Less: Total Liabilities Total shareholders’ equity Less: Accumulated other comprehensive income Less: Common shares Retained earnings

$1,035,500 351,000 684,500 40,000 250,000 $394,500

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PROBLEM 16-10B (Continued) VLADIMIR CORPORATION Statement of Comprehensive Income Year Ended December 31, 2010

Service revenues............................................................... $651,000 Operating expenses Salary expense .......................................... $335,000 Rent expense ............................................. 45,000 Depreciation expense ................................ 28,000 Supplies expense ...................................... 6,500 414,500 Profit from operations ....................................................... 236,500 Other revenues Revenue from equity investment .............. $ 31,000 Dividend revenue ....................................... 9,000 Gain on sale of trading securities ............ 2,500 Interest revenue ......................................... 1,800 44,300 280,800 Other expenses Interest expense ........................................ $ 12,500 Loss on fair value adjustment on trading securities ................................................. 1,500 14,000 Profit before tax ................................................................. 266,800 Income tax expense .......................................................... 79,290 Profit................................................................................... 187,510 Other comprehensive income Gain on fair value adjustment, net of $3,600 tax ........ 12,000 Comprehensive income .................................................... $199,510

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PROBLEM 16-10B (Continued)

Taking It Further: If Vladimir Corporation applied Canadian GAAP for Private Enterprises, 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 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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CONTINUING COOKIE CHRONICLE (a)

1. The amount of influence you would have in The Beanery Coffee would determine how you would account for the investment. Given that you would own 20% of the common shares of the Beanery, it would be assumed (unless there was evidence to the contrary) that you could exert significant influence over the dayto-day operations of the business. This is especially so given the small number of shareholders. Significant influence over an investee may also result from representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. 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 roasting beans while taking advantage of the expertise the Thornton sisters have developed with respect to the operation of their coffee shop. 3. There would be disadvantages associated with this investment as well. For example, there may be a significant time investment required by you both, 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 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) Because the investment in the Beanery is a strategic investment, it would be classified as a long-term investment in the noncurrent 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 Beanery’s income, less a proportionate share of any dividends paid by the Beanery.

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CONTINUING COOKIE CHRONICLE (Continued)

(c)

Since the equity method is applied when an investor can exercise significant influence, details of the relationship between Cookie & Coffee Creations and The Beanery are required to support or refute significant influence. For example, how will decisions regarding company policy be made, how will pricing and volume discounts for purchases of coffee bean inventory be determined, etc., what will Natalie and Curtis’ responsibilities be in the running of The Beanery? Because of the voting control exercised by the two sisters, Natalie and Curtis should have a contract setting out their responsibilities and amount of influence they would be able to exercise.

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CUMULATIVE COVERAGE: CHAPTERS 13 TO 16 (a) Jan.

7 Cash ..................................................... 25,000 Preferred Shares ............................ 25,000

Mar. 16 Trading Securities— Osborne Common Shares .................. 19,200 Cash (800 X $24) ............................. 19,200 Aug.

2 Cash (800 X $25) ................................. 20,000 Trading Securities— Osborne Common Shares ............. 19,200 Gain on Sale of Trading Securities 800 5 Short-term Investment— Money Market Fund ............................ 20,000 Cash ................................................ 20,000

Sep. 25 Preferred Shares ($25,000 ÷ 1,000 X 500) ....................... 12,500 Common Shares ............................. 12,500 Oct. 24 Cash ..................................................... 20,200 Short-term Investment — Money Market Fund........................ 20,000 Interest Revenue ............................ 200 Nov. 30 Cash ..................................................... 50,000 Note Payable................................... 50,000 Dec.

1 Cash Dividends—Preferred Shares (500 X $2) ............................................. 1,000 Dividends Payable..........................

1,000

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CUMULATIVE COVERAGE (Continued) (a) (Continued) Dec. 31 Interest Expense ($50,000 X 6% X 1/12).......................... 250 Note Payable ($1,521 – $250) ............ 1,271 Cash ................................................

1,521

31 Equity Method Investment in RES Common Shares ($20,000 X 40%) ....... 8,000 Revenue from Equity Investment in RES ..............................................

8,000

31 Cash .................................................. Equity Method Investment in RES Common Shares ($1,200 X 40%) ....

480

31 Interest Receivable .............................. Interest Revenue .............................

300

480

300

31 Interest Expense .................................. 8,000 Bonds Payable ................................ Interest Payable ($130,000 X 6% ) ..............................

7,800

31 Other Comprehensive Income – Loss on Fair Value Adjustment* ........ 2,000 Long-term Investment – BCB Shares

2,000

200

* $28,000 (fair value) – $30,000 (carrying amount) = $2,000

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CUMULATIVE COVERAGE (Continued) (b) PLANKTON CORPORATION Trial Balance December 31, 2011

Debit

Credit

Cash ($18,000 + $25,000 – $19,200 + $20,000 - $20,000 + $20,200 + $50,000 - $1,521 + $480) $ 92,959 Accounts receivable ........................................ 51,000 Allowance for doubtful accounts .................... $ 2,550 Interest receivable ............................................ 300 Merchandise inventory ................................... 22,700 Equity method investment – RES common shares ($85,000 + $8,000 – $480) ................ 92,520 Long-term debt investment – Sontag bonds .. 10,000 Long-term equity investment – BCB common shares ($30,000 – $2,000) ............ 28,000 Land .................................................................. 120,000 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) ($126,250 + $200) 126,450 $2-noncumulative preferred shares, convertible no par value, 500 issued ($25,000 – $12,500) ........................................ 12,500 Common shares, no par value, 102,500 issued ($100,000 + $12,500) ...................................... 112,500

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CUMULATIVE COVERAGE (Continued) (b) (Continued) PLANKTON CORPORATION Trial Balance (Continued) December 31, 2011

Debit

Credit 120,500

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 + $300) ........ 875 Interest expense ($6,250 + $250 + $8,000) .. 14,500 Revenue from long-term equity investment 8,000 Income tax expense ..................................... 50,000 Gain on sale of trading securities ............... 800 Other Comprehensive Income: Loss on fair value adjustment ............................... 2,000 000000000 Totals $1,274,979 $1,274,979 (c)

Revenues Sales....................................................... Interest revenue..................................... Revenue from long-term equity invest. Gain on sale of trading securities ........ Expenses Cost of goods sold ................................ Operating expenses .............................. Interest expense .................................... Income before income tax ...................

$750,000 875 8,000 800 $759,675 $370,000 180,000 14,500

Dec. 31 Income Tax Expense [($195,175 X 27%) – $50,000] ......... 2,697 Income Tax Payable...................

564,500 195,175

2,697

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CUMULATIVE COVERAGE (Continued) (c) (Continued) PLANKTON CORPORATION Trial Balance December 31, 2011

Debit

Credit

Cash ($18,000 + $25,000 – $19,200 + $20,000 - $20,000 + $20,200 + $50,000 - $1,521 + $480) $ 92,959 Accounts receivable ........................................ 51,000 Allowance for doubtful accounts .................... $ 2,550 Interest receivable ............................................ 300 Merchandise inventory ................................... 22,700 Equity method investment – RES common shares ($85,000 + $8,000 – $480) ................ 92,520 Long-term debt investment – Sontag bonds . 10,000 Long-term equity investment – BCB common shares ($30,000 – $2,000) ............ 28,000 Land .................................................................. 120,000 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 + $2,697) ............. 7,197 Interest payable ................................................ 7,800 Note payable ($50,000 – $1,271) ...................... 48,729 Bonds payable (6%, due 2019) ($126,250 + $200) 126,450 $2-noncumulative preferred shares, convertible no par value, 500 issued ($25,000 – $12,500) ........................................ 12,500 Common shares, no par value, 102,500 issued ($100,000 + $12,500) ...................................... 112,500

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CUMULATIVE COVERAGE (Continued) (c) (Continued) PLANKTON CORPORATION Trial Balance (Continued) December 31, 2011

Debit

Credit 120,500

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 + $300) ........ 875 Interest expense ($6,250 + $250 + $8,000) .. 14,500 Revenue from long-term equity investment 8,000 Income tax expense ($50,000 + $2,697) ...... 52,697 Gain on sale of trading securities ............... 800 Other Comprehensive Income: Loss on fair value adjustment ............................... 2,000 000000000 Totals $1,277,676 $1,277,676

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CUMULATIVE COVERAGE (Continued) (d) PLANKTON CORPORATION Income Statement Year Ended December 31, 2011

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 ................................................. $ 875 Revenue from long-term equity investment .... 8,000 Gain on sale of trading securities .................... 800 9,675 Other expenses Interest expense ........................................................... 14,500 Profit before income tax ................................................... 195,175 Income tax expense .......................................................... 52,697 Profit................................................................................... $142,478

PLANKTON CORPORATION Statement of Comprehensive Income Year Ended December 31, 2011

Profit............................................................................ Other comprehensive income Loss on fair value adjustment on strategic Investment.............................................................. Comprehensive income .............................................

$142,478

2,000 $140,478

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Statement of Changes in Shareholders’ Equity Year Ended December 31, 2011

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 (loss) Balance, January 1 ................................................. Other comprehensive income (loss)................. Balance, December 31 ............................................ Total shareholders' equity ..........................................

0 25,000 (12,500) 12,500

$100,000 12,500 112,500 120,500 142,478 (1,000) 261,978 5,000 (2,000) 3,000 $389,978

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Balance Sheet December 31, 2011

Assets Current assets Cash............................................................................... $ 92,959 Accounts receivable ........................................ $51,000 Less: Allowance for doubtful accounts ........ 0 2,550 48,450 Interest receivable ........................................................ 300 Merchandise inventory ................................................. 22,700 Total current assets ................................................. 164,409 Investments Long-term equity investment, at fair value .... $28,000 Long-term bond investment, at amortized cost......................................... 10,000 Equity method investment in RES common shares .......................................................... 92,520 Total investments ..................................................... 130,520 Property, plant and equipment Land ............................................................... $120,000 Building ........................................... $200,000 Less: Accumulated depreciation ... 0 40,000 160,000 Equipment ....................................... $40,000 Less: Accumulated depreciation .. 15,000 25,000 Total property, plant and equipment ..................... 305,000 Total assets ............................................................ $599,929

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CUMULATIVE COVERAGE (Continued) (d) (Continued) PLANKTON CORPORATION Balance Sheet (Continued) December 31, 2011

Liabilities and Shareholders' Equity Current liabilities Accounts payable ....................................................... $ 18,775 Dividends payable ...................................................... 1,000 Income tax payable ..................................................... 7,197 Interest payable .......................................................... 7,800 Current portion of note payable ................................ 15,757 Total current liabilities ........................................... 50,529 Long-term liabilities Notes payable, 6%, due 2014 ..................... $ 32,972 Bonds payable, 6%, due 2019 .................... 126,450 Total long-term liabilities ....................................... , 159,422 Total liabilities ........................................................ 209,951 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 Total share capital ............................................. 125,000 Retained earnings ...................................................... 261,978 Accumulated other comprehensive income ($5,000 – $2,000) ..................................................... 3,000 Total shareholders' equity ................................ 389,978 Total liabilities and shareholders' equity ......... $599,929

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BYP 16-1 FINANCIAL REPORTING PROBLEM (a)

The financial statements of The Forzani Group Ltd. do not present any non-strategic investments.

(b) Forzani’s strategic investments are disclosed in Note 1: Nature of Operations and in Note 17: Acquisitions. Consolidated statements are presented for the parent and subsidiary companies. Consolidated statements are presented because Forzani’s owns 100% of the investees. This means that intercompany balances, such as an investment account, are eliminated on consolidation.

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BYP 16-2 INTREPRETING FINANCIAL STATEMENTS (a) Royal Bank most likely keeps two different investment classifications as a hedge against future earnings. If the company’s entire investment portfolio is subject to a significant decline in fair value, the company’s income statement would be much more severely impacted if the company’s securities were all trading securities. However, by holding investments under the available-for-sale category, the company can limit the impact of any declines in fair value on the income statement. (b) For equity investments that will be held and not sold, reporting gains and losses in other comprehensive income removes 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 in profit. Only gains and losses from trading securities are included. The Royal Bank will likely not choose this option because its assets consist mainly of debt to customers (such as business and customer loans) and investments. These assets are subject to a significant amount of volatility such as interest rate fluctuations. Its debt consists of loans on deposit which are also subject to interest rate fluctuations. Volatility is inherent to this type of business and the Royal Bank would not benefit from the advantage of reporting gains and losses on equity investments not held for trading in other comprehensive income. (c) The Royal Bank holds a majority of its investments in trading securities to counteract the fluctuations inherent in its assets and liabilities. For example, interest rate increases will increase its interest rate expense but will increase the fair value of debt-based trading securities.

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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 receiving interest are reported at amortized cost. This treatment is required because the primary purpose of the investment is to hold the investment and receive 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 receipt of interest 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) Yes. By classifying the securities that have increased in fair value as trading securities, 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 GAAP. 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) Yes. GAAP requires that investments be classified at the time of purchase based on management’s intention. (e) 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) (f)

- Trading securities are classified as a current assets and reported at fair value. - 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. - Strategic investments 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) “Generally, the types of investments that will be permitted in a TFSA are the same as in a registered retirement savings plan (RRSP). This would include mutual funds, securities listed on a designated stock exchange, Guaranteed Investment Certificates (GICs), bonds, and certain shares of small business corporations.” 1 “You can also make "in kind" contributions to your TFSA, as long as the property is a qualified investment.” 1 (c) Assuming monthly contributions of $200 per month for 20 years at a return of 6%, the TFSA account would yield a balance of $92,870 vs. $85,894 for a taxable account for a net savings 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, the TFSA account would yield a balance of $92,870 vs. $80,024 for a taxable account for a net savings 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. 1

Reproduced from the CRA website at http://www.craarc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/nvstmnts-eng.html

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Legal Notice Copyright

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CHAPTER 17 The Cash Flow Statement ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Brief Questions Exercises

Problems Problems Exercises Set A Set B

1. Describe the purpose 1, 2, 3, 4, and content of the cash 5, 6, 7 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, 22

3, 4, 5, 6, 7, 3, 4, 5, 6, 7, 2A, 3A, 2B, 3B, 4B, 8, 9, 10, 11, 8, 9, 10, 11, 4A, 5A, 5B, 6B, 7B, 12, 13, 14, 12, 13, 6A, 7A, 8B, 9B, 15, 16 8A, 9A, 10B, 11B 10A, 11A

3. Analyze the cash flow statement.

23, 24, 25, 17, 18 26

14, 15

12A

12B

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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.

Moderate

30-40

Calculate cash flows for financing activities.

Moderate

25-35

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

25-30

Prepare cash flow statement–direct method.

Moderate

25-30

10A

Prepare cash flow statement–indirect method.

Complex

30-40

11A

Prepare cash flow statement–direct method.

Complex

30-40

12A

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.

Moderate

30-40

Calculate cash flows for financing activities.

Moderate

25-35

Prepare cash flow statement–indirect method.

Moderate

20-25

Prepare cash flow statement–direct method.

Moderate

20-25

Prepare cash flow statement–indirect method.

Complex

30-40

Prepare cash flow statement–direct method.

Complex

30-40

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

10B

Prepare cash flow statement–indirect method.

Moderate

25-30

11B

Prepare cash flow statement–direct method.

Moderate

25-30

12B

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.

Knowledge Q17-5 Q17-6

Prepare a cash flow statement using either: the indirect method or the direct method.

Q17-11

Analyze the cash flow statement.

Broadening Your Perspective

Comprehension Q17-1 Q17-2 Q17-3 Q17-4 Q17-7 BE17-2 Q17-8 Q17-9 Q17-10 Q17-12 Q17-13 Q17-14 Q17-15 Q17-16 Q17-17 Q17-18 Q17-19 Q17-20 Q17-21

Application BE17-1 E17-1 E17-2 P17-1A P17-1B

Q17-23 Q17-24 Q17-25 Q17-26

BE17-18

BE17-17 E17-14 E17-15 P17-12A P17-12B

Continuing Cookie Chronicle

BYP17-1 BYP17-2 BYP17-3 BYP17-4

Q17-22 BE17-3 BE17-4 BE17-5 BE17-6 BE17-7 BE17-8 BE17-9 BE17-10 BE17-11 BE17-12 BE17-13 BE17-14 BE17-15 BE17-16 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9 E17-10 E17-11 E17-12 E17-13

Analysis

Synthesis

Evaluation

P17-2A P17-3A P17-4A P17-5A P17-6A P17-7A P17-8A P17-9A P17-10A P17-11A P17-2B P17-3B P17-4B P17-5B P17-6B P17-7B P17-8B P17-9B P17-10B P17-11B

BYP17-5 BYP17-6

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ANSWERS TO QUESTIONS 0 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.

Disagree. The cash flow statement is not an optional financial statement— it is required. It is the fourth basic financial statement and it provides information not readily available elsewhere.

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.

0 4.

The three activities are: Operating activities include the cash effects of transactions that create revenues and expenses, and enter into the determination of profit. Investing activities include: (a) acquiring and disposing of investments and productive long-lived assets and (b) lending money and collecting loans. 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.

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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.

Examples of noncash transactions are (1) issue of shares in payment for assets, (2) issue of shares to repay debt, and (3) issue of bonds or notes for assets. If noncash transactions affect financial conditions significantly, GAAP requires that they be disclosed in a separate note to the financial statements.

The cash flow statement covers a period of time—the same period as the income statement—because it reports the operating, investing, and financing activities for the entire period. It ends with the cash balance reported on the balance sheet because it reconciles the changes in cash for the period with the beginning and ending cash balances. In contrast, the balance sheet reports the financial position of the company at the end of a specific period of time.

The income statement and balance sheet are prepared directly from accounts in the company’s general ledger. The income statement reports transaction information for a given time period and the balance sheet reports the permanent account balances at a point in time. The cash flow statement is prepared from the balance sheet, 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.

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 cashbased expenses; (2) sales of property, plant, and equipment; (3) sales of investments; and (4) issue of debt or share capital.

10.

The indirect approach involves converting accrual profit to net cash provided by operating activities. This is done by starting with accrual profit and adding or subtracting noncash items included in profit. Examples of adjustments include depreciation expense and other noncash expenses, and changes in the balances of noncash current asset and current liability accounts from one period to the next.

11.

1. 2. 3.

Depreciation expense Gain or loss on sale of property, plant, or equipment Increase (decrease) in accounts receivable

A number of other items could also be included in this list. 12.

Under the indirect method, depreciation expense is added back to profit to reconcile profit to net cash provided by operating activities. This is necessary because although depreciation is an expense, it does not use cash. Since depreciation expense is a deduction in calculating profit, adding it back to profit effectively cancels this expense.

13.

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.

14.

Net cash provided by operating activities under the direct method is the difference between cash-based revenues and cash-based expenses. The direct method adjusts the revenues and expenses directly to reflect their cash basis. This results in "net cash provided by operating activities." Items include: cash received from customers, cash received from dividends and interest, cash paid to suppliers, cash paid for operating expenses, cash paid to employees, cash paid for interest, and cash paid for income taxes.

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QUESTIONS (Continued) 15.

No. 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.

16.

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.

17. (a) 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. (b) Both methods are acceptable. (c) The CICA has expressed a preference for the direct method. (d) 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 and (3) it also discloses less competitive information about the company. 18.

Although the approaches are different, both the direct and indirect methods will produce the same net cash provided by operating activities.

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QUESTIONS (Continued) 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 included in profit, 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.

The cash paid to redeem the bond is reported as an outflow in the financing activities section. For the indirect method, a loss is added back under the operating activities section; a gain is deducted under the operating activities section. Neither the gain nor the loss itself provided or used cash from operating activities. Rather the cash paid to redeem the bond is the use of cash from financing activities.

21.

When short-term notes relate to trade (i.e., purchase and sale) transactions, or have been issued in exchange for an account payable or an account receivable, then they should be reported in the operating activities section of the cash flow statement along with the expense and revenue accounts to which they relate. When short-term notes relate to lending or borrowing, they should be reported in the financing activities section of the cash flow statement.

22.

Barbara is correct. The actual cash outflow of $10,000 is reported in the investing activities section of the cash flow statement. The noncash portion of the transaction (the purchase of equipment financed by the issue of a note payable) should be disclosed in the notes.

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QUESTIONS (Continued) 23.

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.

24.

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. Established companies typically have positive flows from operating activities and lower flows from investing and financing activities.

25.

Free cash flow indicates the amount of discretionary cash flow a company has. Free cash flow is calculated as cash provided (used) by operating activities less net capital expenditures.

26.

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) (j)

− + − − NE + NE + NE NE

BRIEF EXERCISE 17-2 (a) Financing activity (b) 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.) (c) Financing activity (d) Investing activity (e) Significant noncash activity (f) Financing activity (g) Significant noncash activity (h) Operating activity (i) None of the above. 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. (j) None of the above. 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 CRYSTAL INC. Cash Flow Statement (Partial) Year Ended November 30, 2011

Operating activities Profit ............................................................................ $ 775,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $250,000 Gain on the sale of equipment ............... (25,000) Increase in accounts receivable ............ (150,000) Decrease in prepaid expenses ............... 95,000 Increase in accounts payable ................ 280,000 450,000 Net cash provided by operating activities .......... $1,225,000

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BRIEF EXERCISE 17-5 DUPIGNE CORPORATION Cash Flow Statement (Partial)—Indirect Method Year Ended March 31, 2011

Operating activities Profit .................................................................. $250,000 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................. $60,000 Loss on sale of equipment ..................... 24,500 Decrease in accounts receivable ........... 20,000 Increase in inventory............................... (7,000) Increase in prepaid expenses ................. (2,000) Increase in accounts payable ................. 5,000 Decrease in income tax payable............. (6,000) 94,500 Net cash provided by operating activities.......... $344,500

BRIEF EXERCISE 17-6 Sales............................................................ $275,000 Add: Decrease in accounts receivable ..... 9,000 Cash receipts from customers .................. $284,000

BRIEF EXERCISE 17-7 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

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BRIEF EXERCISE 17-8 Operating expenses ......................................... $100,000 Less: Depreciation expense ............................ (15,000) Plus: Increase in prepaid expenses ................ 10,900 Less: Increase in accrued expenses payable (6,400) Cash payments for operating expenses ......... $89,500

BRIEF EXERCISE 17-9 Salaries expense .............................................. $198,000 Less: Increase in salaries payable .................. (500) Cash payments to employees ......................... $197,500

BRIEF EXERCISE 17-10 Income tax expense ......................................... Add: Decrease in income tax payable ............ Cash payments for income tax........................

$90,000 9,000 $99,000

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BRIEF EXERCISE 17-11 ANGUS MEAT CORPORATION Cash Flow Statement (Partial) Year Ended December 31, 2011

Operating activities Cash receipts from customers1 ................................ $350,000 Cash payments: To suppliers2 ......................................... $164,000 For operating expenses3 ...................... 71,000 For income taxes4................................. 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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BRIEF EXERCISE 17-12 (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 depreciation expense or the loss. The investing activities section would be the same as the indirect method.

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BRIEF EXERCISE 17-13 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, 2011 $237,000 Less: balance in account before equipment purchase: Balance, Jan. 1, 2011 ............. $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

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BRIEF EXERCISE 17-14 Dividends paid $68.4 million Proof: Retained earnings December 31, 2007 .............. $2,455.1 Add: Profit............................................................ 374.2 2,829.3 Less: Share repurchase ...................................... 5.4 2,823.9 Less: Dividends declared and paid ................... 68.4 Retained earnings, December 31, 2008 ............ $2,755.5

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BRIEF EXERCISE 17-15 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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BRIEF EXERCISE 17-16 BAKER CORPORATION Cash Flow Statement—Direct Method Year Ended April 30, 2011

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 and equivalents ....................... Cash, May 1 ................................................................. Cash, April 30 ..............................................................

6,000 8,500 $14,500

Note X: Land was purchased by paying $25,000 cash and issuing a mortgage note payable for $75,000.

BRIEF EXERCISE 17-17 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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BRIEF EXERCISE 17-18 Free cash flow = Cash provided (used) by operating activities − Cash used (provided) by investing activities = $300,000 − $250,000 = $50,000

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SOLUTIONS TO EXERCISES EXERCISE 17-1 1. 2.

3. 4. 5. 6.

8. 9. 10. 11.

12.

Transaction Purchased land. Paid dividends.

(a) − Cash − Cash

Sold a building. Retired bonds at maturity. Sold a long-term equity investment. Paid employee salaries.

+ Cash − Cash + Cash − Cash

Paid interest on a − Cash mortgage note payable. Sold inventory on N/A* account. Collected an + Cash account receivable. Paid an account − Cash payable. Provided services to N/A* a customer. Paid income taxes owing.

− Cash

(b) (c) Land Investing Retained earnings Financing / dividends payable Building Investing Bonds payable Financing Long-term Investing investment Salaries expense Operating / Salaries payable Interest expense Operating / Interest payable Accounts receivable / Sales Accounts receivable Accounts payable Accounts receivable / Service revenue Income tax expense / Income tax payable

Operating Operating Operating Operating

Operating

*The sale of inventory or providing services to customers does not generate cash if the sale or service is on credit, rather the collection of accounts receivable increases cash (see item #9).

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EXERCISE 17-2 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.

Classification O

Cash Inflow or Outflow +$1,000

I NC

−$5,000 NE

+$50,000

+$16,000

−$25,000

+$10,000

−$175,000

−$18,000

−$100,000

+$13,000

−$12,000

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EXERCISE 17-3

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

11. 12.

Transaction

Profit

Sold inventory for cash at a price higher than cost. Sold inventory on account at a price less than cost. Purchased inventory on account. Accrued income tax payable. Paid income taxes.

Net Cash Provided (Used) by Operating Activities +

−

Purchased supplies for cash. Recorded depreciation expense. Paid an amount owing on account. Collected an amount owing from a customer. Paid a one-year insurance policy in advance. Sold land for cash at a price higher than cost. Paid a cash dividend.

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EXERCISE 17-4 PESCI LTD. Cash Flow Statement (Partial) Year Ended November 30, 2011

Operating activities Profit .............................................................................. $58,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................... $50,000 Loss on sale of equipment ....................... 10,000 Increase in accounts receivable .............. (36,000) Decrease in inventory ............................... 19,000 Decrease in prepaid expenses ................. 2,000 Increase in accounts payable................... 12,000 Decrease in income taxes payable .......... (4,000) 53,000 Net cash provided by operating activities ................. $111,000

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EXERCISE 17-5 BARTH INC. Cash Flow Statement (Partial) Year Ended December 31, 2011

Operating activities Profit ............................................................................. $97,500 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................... $42,000 Gain on sale of land .................................. (12,000) Decrease in accounts receivable ............. 31,000 Increase in inventory ................................ (31,000) Decrease in prepaid expenses ................. 5,000 Decrease in accounts payable ................. (8,000) Increase in accrued expenses payable ... 10,000 Increase in income taxes payable ............ 3,500 0 40,500 Net cash provided by operating activities ................. $138,000

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EXERCISE 17-6 (b) (a) Add to (+) or (c) Related Deduct from (-) Related Income Income Cash Statement Statement Receipt or Transaction Account(s) Account Payment 1. Increase in accounts Sales − Cash receipts receivable revenue from customers 2. Decrease in accounts Sales receivable revenue

Cash receipts from customers

3. Increase in accounts Cost of payable goods sold

−

Cash payments to suppliers

4. Decrease in interest payable

Interest expense

Cash payments for interest

5. Increase in prepaid expenses

Operating expenses

6. Increase in inventory Cost of goods sold

Cash payments for operating expenses Cash payments to suppliers

7. Decrease in inventory Cost of goods sold

−

Cash payments to suppliers

8. Increase in income Income tax taxes payable expense

−

Cash payment for income taxes

9. Increase in salaries payable

Salaries expense

−

Cash payments to employees

10. Decrease in accrued Operating expenses payable expenses

Cash payments for operating expenses

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EXERCISE 17-7 (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 ................... Less: Increase in accounts payable ...... Cash payments to suppliers ...................

$110,000 (3,300) (1,350) $105,350

(c) Operating expenses ................................. Less: Depreciation expense ................... Decrease in prepaid expenses ..... Increase in accrued expenses payable ........................................ Cash payments for operating expenses ..

$50,000 (15,000) (2,500)

(d) Interest expense ....................................... Less: Increase in bonds payable from amortization of discount............. Cash payments for interest expense ......

$18,000

(2,000) $30,500

(2,000) $16,000

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EXERCISE 17-8 McGILLIS LTD. Cash Flow Statement (partial)—Direct Method Year Ended October 31, 2011

Operating activities Cash receipts Cash receipts from customers 1............................. $140,000 Cash payments For operating expenses 2..................... $(59,400) For interest 3 ......................................... (8,900) 4 For income taxes ............................... (13,500) (81,800) Net cash provided by operating activities ......... $ 58,200 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 accounts 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 ...........

$182,000 (42,000) $140,000

$88,000 4,400 (33,000) $59,400

$10,000 (1,100) $ 8,900

$15,000 (1,500) $13,500

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EXERCISE 17-9 BARTH INC. Cash Flow Statement (partial)—Direct Method Year Ended December 31, 2011

Operating activities Cash receipts Cash receipts from customers 1............................. $596,000 Cash payments To suppliers 2 ....................................... $(349,000) For operating expenses 3..................... (80,000) 4 For income taxes ............................... (29,000) (458,000) Net cash provided by operating activities ......... $138,000 1. Cash receipts from customers Sales .................................................................... Plus: Decrease in accounts receivable ............

2. Cash payments to suppliers Cost of goods sold ............................................. Add: Increase in inventory ................................. Add: Decrease in accounts payable ..................

3. Cash payments for operating expenses Operating expenses ........................................... Less: Decrease in prepaid expenses ................ Less: Increase in accrued expenses payable ...

4. Cash payments for income taxes Income tax expense ............................................ Less: Increase in income taxes payable ...........

$565,000 31,000 $596,000

$310,000 31,000 8,000 $349,000

$95,000 (5,000) (10,000) $80,000

$32,500 (3,500) $29,000

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EXERCISE 17-10 DUPRÉ CORP. Cash Flow Statement (Partial) Year Ended December 31, 2011

Investing activities Sale of equipment* ..................................... $ 6,000 Purchase of equipment .............................. (70,000) Purchase of equipment (Note X)................ (8,000) Net cash used by investing activities .................... $(72,000) Financing activities Payment of cash dividends ........................ $(4,000) Repayment of note payable ....................... (5,000) Net cash used by financing activities .................... $(9,000) Note X: Equipment costing $53,000 was acquired by paying $8,000 cash and issuing a note payable for $45,000.

*Cost of equipment sold .................................. $39,000 Accumulated depreciation............................... 30,000 Net carrying amount ........................................ 9,000 Loss on sale of equipment .............................. 0 3,000 Cash proceeds from sale ................................. $ 6,000 Cash .................................................................. 6,000 Accumulated Depreciation .............................. 30,000 Loss on Sale of Equipment ............................. 3,000 Equipment .....................................................................

39,000

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EXERCISE 17-11 SAVARY LIMITED Cash Flow Statement Year Ended December 31, 2011

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 17-12 FLYPAPER AIRLINES INC. Cash Flow Statement Year Ended March 31, 2011

Operating activities Cash receipts Cash receipts from customers ............................... $240,000* Dividends on investments ...................................... 14,000 254,000 Cash payments To suppliers .......................................... $(110,000) For salaries and wages ....................... (53,000) For interest ........................................... (10,000) For income tax...................................... (7,500) For operating expenses ....................... (28,000) (208,500) Net cash provided by operating activities ......... 45,500 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 used by financing activities .....................

(14,000)

Net increase in cash.......................................................... 47,500 Cash, April 1, 2010 ............................................................ 0 35,000 Cash, March 31, 2011 ........................................................ $ 82,500 *$48,000 + $192,000 = $240,000

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EXERCISE 17-13 (a) PUFFY LTD. Cash Flow Statement—Indirect method Year Ended December 31, 2011

Operating activities Profit .............................................................................. $115,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $34,000 Gain on sale of land ................................ (5,000) Increase in accounts receivable ............ (9,000) Decrease in inventory ............................. 9,000 Decrease in accounts payable ............... (9,000) Increase in income taxes payable .......... 3,500 0023,500 Net cash provided by operating activities ......... 138,500 Investing activities Sale of land ($25,000 + $5,000 gain) ........... $30,000 Purchase of equipment ............................... (60,000) Net cash used by investing activities .....................

(30,000)

Financing activities Payment of cash dividends* ...................... $(19,000) Redemption of bonds .................................. (80,000) Issue of common shares ............................. 035,000 Net cash used by financing activities .....................

(64,000)

Net increase in cash.......................................................... 44,500 Cash, January 1 ................................................................. 0 24,500 Cash, December 31 ........................................................... $ 69,000 *Profit was $115,000; retained earnings only increased by $96,000, so $19,000 in dividends were declared and paid.

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EXERCISE 17-13 (Continued) (b) PUFFY LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2011

Operating activities Cash receipts Cash receipts from customers* ............................. $969,000 Cash payments To suppliers** ....................................... $(751,000) For operating supplies......................... (43,000) For income taxes*** ............................. (36,500) (830,500) Net cash provided by operating activities ......... 138,500 Investing activities Sale of land ($25,000 + $5,000 gain) ........... $30,000 Purchase of equipment ............................... (60,000) Net cash used by investing activities .....................

(30,000)

Financing activities Payment of cash dividends ........................ $(19,000) Redemption of bonds .................................. (80,000) Issue of common shares ............................. 035,000 Net cash used by financing activities .....................

(64,000)

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EXERCISE 17-13 (Continued) (b) (Continued) *Cash receipts from customers Sales .................................................................... Less: Increase in accounts receivable .............

**Cash payments to suppliers Cost of goods sold ............................................. Less: Decrease in inventory .............................. Cost of goods purchased ................................... Add: Decrease in accounts payable ..................

***Cash payments for income taxes Income tax expense ............................................ Less: Increase in Income taxes payable ...........

$978,000 (9,000) $969,000

$751,000 (9,000) 742,000 9,000 $751,000

$40,000 (3,500) $36,500

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Accounting Principles, Fifth Canadian Edition

EXERCISE 17-14 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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Accounting Principles, Fifth Canadian Edition

EXERCISE 17-15 (a) ($ in millions)

− =

Cash provided (used) by operating activities Cash used (provided) by investing activities Free cash flow

Bank of Montreal

Scotiabank

$ 4,246

$ 20,112

(11,047) $15,293

51,740 $(31,628)

(b) At first glance, Bank of Montreal appears to be in better shape. It has a higher free cash flow since it generated cash from its operations and from its investing activities. However, cash flow generated from investing activities is a positive sign if the company is disposing of surplus assets and the disposals do not hamper its ability to continue operations. It would not be a positive sign if the cash is generated from selling productive assets that are needed to continue operations. Scotiabank generated more cash from operations, but spent more cash in investing 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. (c)

A manufacturing company’s free cash flow would come primarily from its operating activities, not its investing activities. In addition, you would expect net uses of cash for investing activities in a manufacturing company as they invest in new and upgraded productive facilities.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 17-1A (a) Classification Paid telephone bill for the month. O Sold equipment for cash, at a loss.* I Sold a short-term equity I investment, at a gain.* Acquired a building by paying 10% I in cash and signing a mortgage NC payable for the balance. Made principal repayments on the F mortgage. Paid interest on the mortgage. O Sold inventory on account, at a O price greater than cost. Paid wages owing (previously O accrued) to employees. Declared and distributed a stock NC dividend to common shareholders. Paid rent in advance. O Sold inventory for cash, at a price O greater than cost. Wrote down the value of inventory O to net realizable value, which was lower than cost. Received semi-annual bond O interest. Received dividends on an equity O method investment. Issued common shares. F Transaction

1. 2. 3. 4.

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

13. 14. 15.

(b) Cash − + +

− NE

NE NE

−

− NE

− +

−

− +

NE +

−

* Using the indirect method, the loss/gain would be added/deducted under operating activities.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-1A (Continued)

Transaction 16. Paid a cash dividend to common shareholders. 17. Collected cash from customers on account. 18. Collected service revenue in advance.

(a) Classification F

(b) Cash −

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, Fifth Canadian Edition

PROBLEM 17-2A (a)

Indirect method BRECKENRIDGE LTD. Cash Flow Statement (Partial) Year Ended November 30, 2011

Operating activities Profit ............................................................................. $48,000 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................ $025,000 Loss on sale of land ............................... 35,000 Increase in accounts receivable ........... (20,000) Increase in prepaid expenses ............... (15,000) Decrease in accounts payable .............. (30,000) Decrease in accrued expenses payable (10,000) Increase in income tax payable............. 2,000 (13,000) Net cash provided by operating activities ........ $35,000 (b) Direct method BRECKENRIDGE LTD. Cash Flow Statement (Partial) Ended November 30, 2011

Operating activities Cash receipts from customers ........................... Cash payments To suppliers ........................ $(520,000) (2) For operating expenses ..... (231,000) (3) For income taxes................ (14,000) (4) Net cash provided by operating activities .........

$800,000 (1)

(765,000) $ 35,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-2A (Continued) Calculations: (1)

Cash receipts from customers Sales ...................................................................... Less: Increase in accounts receivable ...............

(2)

Cash payments to suppliers Cost of goods sold ................................................ Add: Decrease in accounts payable ...................

(3)

$490,000 30,000 $520,000

Cash payments for operating expenses Operating expenses .............................................. Add: Increase in prepaid expenses .................... Decrease in accrued expenses payable ....

(4)

$820,000 20,000 $800,000

$206,000 15,000 10,000 $231,000

Cash payments for income tax expense Income tax expense .............................................. Less: Increase in income tax payable ................

$16,000 ((2,000) $14,000

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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-3A (a) HANALEI INTERNATIONAL INC. Cash Flow Statement (Partial)—Indirect Method Year Ended December 31, 2011

Operating activities Profit ............................................................................ $161,250 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................... $35,000 Gain on sale of equipment ....................... (25,000) Decrease in accounts receivable ............. 12,000 Increase in prepaid insurance .................. (3,000) Decrease in accounts payable ................. (11,000) Increase in interest payable ..................... 750 Increase in income taxes payable ............ 1,500 Increase in unearned revenue .................. 4,000 14,250 Net cash provided by operating activities ....... $175,500 (b) HANALEI INTERNATIONAL INC. Cash Flow Statement (Partial)—Direct Method Year Ended December 31, 2011

Operating activities Cash receipts from customers .............................. $496,000 (1) Cash payments For operating expenses .............. $(259,000) (2) For interest .................................. (9,250) (3) For income tax............................. (52,250) (4) (320,500) Net cash provided by operating activities ... $175,500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-3A (Continued) (b) (Continued) Calculations: (1) Cash receipts from customers Revenue ............................................................... Add: Decrease in accounts receivable ........... Increase in unearned revenue ................ Cash receipts from customers ...........................

$480,000 12,000 4,000 $496,000

(2) Cash payments for operating expenses Operating expenses ............................................ Add: Increase in prepaid insurance ................. Decrease in accounts payable ............... Cash payments for operating expenses ............

$245,000 3,000 11,000 $259,000

(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 ............................................ Less: Increase in income tax payable ................ Cash payments for income tax ...........................

$53,750 (1,500) $52,250

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.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-4A Cash inflows (outflows) related to property, plant, and equipment 2011: Equipment purchase 1.......................................... Land purchase 2 ................................................... Proceeds from equipment sale 3 ......................... Building purchase 4 .............................................. Proceeds from sale of building 5 ......................... Net cash used by investing activities ..............

$(10,000) (40,000) 3,875 (150,000) 22,500 $(173,625)

Equipment..................................................... 75,000 Cash .......................................................... 10,000 Note Payable ............................................ 65,000 Details of the equipment purchase in exchange for the issuance of the note would be described in a note to the financial statements as a non-cash transaction.

Land .............................................................. 40,000 Cash ..........................................................

40,000

Cash .............................................................. 3,875 Accumulated Depreciation .......................... 19,125 Gain on Sale of Equipment ..................... Equipment *..............................................

1,000 22,000

* Cost of equipment sold $340,000 + $75,000 − $393,000 = $22,000 Accumulated depreciation removed from accounts = Beginning Accumulated depreciation + Depreciation expense − Ending Accumulated deprecation = $94,000 + $49,125 − $124,000 = $19,125 Carrying amount = Cost − Accumulated depreciation = $22,000 − $19,125 = $2,875

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-4A (Continued) 3. (Continued) Cash proceeds = Carrying amount $2,875 + Gain on sale $1,000 = $3,875 4.

Building ** ..................................................... 150,000 Cash .......................................................... 150,000 ** Cost of building purchased = $850,000 − ($750,000 – $50,000) = $150,000

Cash .............................................................. 22,500 Accumulated Depreciation (see below) ...... 17,500 Loss on Sale of Building.............................. 10,000 Building (provided) ..................................

50,000

Accumulated depreciation removed from accounts = $300,000 + $25,000 − $307,500 = $17,500 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. On the other hand, a net cash inflow from investing activities can be either favourable or unfavourable. It is 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. When combined with low or negative cash from operating activities and cash inflows from financing activities, the company may be sacrificing long-term profitability for shortterm survival.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-5A (a)

Profit: Retained earnings, beginning of year ..................... $100,000 Add: Profit (calculated) ............................................ 125,000 225,000 Less: Cash dividends declared ............................... (25,000) Retained earnings, end of year ............................... $200,000

(b) Cash inflows and outflows related to financing activites: 1.

Cash inflow:

Issue of common shares

$90,000

Common shares, beginning of year ........................ $410,000 Add: Conversion of preferred shares ..................... 50,000 Issued for cash (calculated) ........................... 90,000 Less: Cost of common shares reacquired ............. (10,000) Common shares, end of year .................................. $540,000 Preferred shares, beginning of year ....................... $275,000 Less: Converted to common shares ....................... (50,000) Preferred shares, end of year .................................. $225,000

Cash outflow: Repurchase of common shares

$8,000

Cost of common shares reacquired (1,000 × $10) $10,000 Less: Gain on reacquisition [increase in Contributed Capital account ($2,000 – $0)] ............................... (2,000) Cash paid for common shares reacquired ............. $ 8,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-5A (Continued) (b) Continued 3.

Cash outflow: Repayment of mortgage note,

$35,000

Mortgage note payable, beginning of year .............. $310,000 Add: Note issued for equipment .............................. 100,000 Less: Repayment (calculated) .................................. (35,000) Mortgage notes payable, end of year....................... $375,000

Cash outflow: Payment of cash dividends,

$21,250

Dividends payable, beginning of year ..................... $ 2,500 Add: Dividends declared during the year ................ 25,000 Less: Dividends paid during the year (calculated) . (21,250) Dividends payable, end of year ................................ $ 6,250 5.

Note: Cash outflow for interest is an operating activity not a financing activity. Interest Expense ...................................................... $48,250 Less: Amortization of Bonds discount ................... (5,000) Cash paid for interest .............................................. $43,250 Bonds payable, beginning of year .......................... $585,000 Add: Amortization of Bonds discount .................... 5,000 Bonds payable, end of year .................................... $590,000

Note: the amortization of the bond payable does not use cash.

(c)

The issue of the mortgage note of $100,000 to purchase equipment and the conversion of $50,000 preferred shares to common shares would be reported as a noncash financing activities.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-5A (Continued) 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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-6A E-PERFORM LTD. Cash Flow Statement—Indirect Method Year Ended December 31, 2011

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 ................................................................. 0 48,400 Cash, December 31 ........................................................... $ 97,800

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-6A (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, 2010 .............................................. Note issued for equipment .................................. Note payable retired ............................................ Note payable, 2011 .............................................. *** Retained earnings, 2010 ...................................... Profit ..................................................................... Dividends declared and paid .............................. Retained earnings, 2011 ......................................

$150,000 60,000 210,000 (100,000) $110,000 $105,450 141,180 246,630 (12,630) $234,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-6A (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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-7A E-PERFORM LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2011

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 ............................................................ 0 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 P17-6A.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-7A (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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-8A WETASKIWIN LTD. Cash Flow Statement—Indirect Method Year Ended December 31, 2011

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 Net cash provided by investing activities ..............

17,000

Financing activities Repayment of note payable ......................... $ (5,000) (2) Payment of cash dividends ........................... (9,000) (3) Net cash used by financing activities ..................... (14,000) Net decrease in cash......................................................... (1,000) Cash, January 1 ................................................................. 010,000 Cash, December 31 ........................................................... $ 9,000 Note Equipment costing $10,000 was purchased by issuing a note payable.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-8A (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) 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 (3) 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 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 startup 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 2011 are lower at $14,000).

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-9A WETASKIWIN LTD. Cash Flow Statement—Direct Method Year Ended December 31, 2011

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 Net cash provided by investing activities ..............

17,000

Financing activities Repayment of note payable ........................ $ (5,000) Payment of cash dividends ......................... (9,000) (5) Net cash used by financing activities ..................... (14,000) Net decrease in cash......................................................... (1,000) Cash, January 1 ................................................................. 010,000 Cash, December 31 ........................................................... $ 9,000 Note Equipment costing $10,000 was purchased by issuing a note payable.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-9A (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 dividends Retained earnings, beginning of year ................. Add: Profit .......................................................... Less: Dividends (calculated) .............................. Retained earnings, end of year............................

$286,000 (14,000) $272,000 $194,000 4,000 198,000 0018,000 $216,000 $38,000 (11,000) $27,000 $15,000 017,000 $32,000 $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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-10A DIATESSARON INC. Cash Flow Statement Year Ended December 31, 2011

Operating activities Profit .............................................................................. $42,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................. $38,500 (1) Loss on sale of equipment ..................... 2,000 Amortization of discount on long-term debt investment ................... (500) (2) Increase in accounts receivable ............ (26,000) Increase in inventory .............................. (62,000) Increase in accounts payable................. 22,500 Decrease in income tax payable ............ (2,000) (27,500) Net cash provided by operating activities ......... 14,500 Investing activities Acquisition of long-term debt investment . $(97,500) Sale of equipment ........................................ 7,000 (3) Net cash used by investing activities ..................... (90,500) Financing activities Issue of note payable .................................. $ 50,000 Repayment of note payable ........................ (5,000) Net cash provided by financing activities ..............

45,000

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 $125,000.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-10A (Continued) Calculations: (1) Depreciation expense Accumulated depreciation, end of year .................... $162,500 Plus: Accumulated depreciation of equipment sold ($25,000 − $9,000) ................................. 16,000 Accumulated depreciation, beg. of year........ (140,000) Depreciation expense ................................................ $ 38,500 (2) Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year................... $98,000 Less: Purchase price ................................................ (97,500) Discount amortization (non-cash interest revenue) $ 500 (3) Cash from sale of equipment Carrying amount of equipment.................................. Less: Loss on sale .................................................... Cash received .............................................................

$9,000 (2,000) $7,000

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 in the amounts to note disclosure about the various debt instruments.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11A DIATESSARON INC. Cash Flow Statement Year Ended December 31, 2011

Operating activities Cash receipts From customers ...................................................... $606,000 (1) From interest ........................................................... 5,000 (2) Cash payments To suppliers ..................................... $(468,500) (3) For operating expenses .................. (109,000) (4) For interest ...................................... (3,000) For income tax................................. (16,000) (5) (596,500) Net cash provided by operating activities ......... 14,500 Investing activities Acquisition of long-term debt investment . $(97,500) Purchase of equipment ............................... (125,000) Sale of equipment ........................................ 7,000 Net cash used in investing activities ...................... (215,500) Financing activities Issue of note payable .................................. $ 50,000 Issue of common shares ............................. 125,000 Repayment of note payable ........................ (5,000) Net cash used by financing activities .....................

170,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11A (Continued) Calculations: (1) Cash receipts from customers Sales ..................................................................... Less: Increase in accounts receivable ............. (2) Cash receipts from interest Interest revenue ................................................... Less: amortization of discount 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 .............

$632,000 (26,000) $606,000 $5,500 (500) $5,000 $429,000 62,000 491,000 (22,500) $468,500 $147,500 (38,500) $109,000 $14,000 0 2,000 $16,000

Depreciation expense Accumulated depreciation, end of year .................... $162,500 Plus: Accumulated depreciation of equipment sold ($25,000 − $9,000) ................................. 16,000 Accumulated depreciation, beg. of year ........ (140,000) Depreciation expense ................................................ $38,500

Non-cash interest revenue on long-term debt investment Long-term debt investment, end of year................... $98,000 Less: Purchase price ................................................ (97,500) Discount amortization (non-cash interest revenue) $ 500

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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11A (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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Accounting Principles, Fifth Canadian Edition

PROBLEM 17-12A (a)

Net cash provided (used) by operating activities − net cash (provided) used by investing activities = free cash flow ($ in U.S. millions)

(b)

Potash:

$3,013 − $1,647 = $1,366

Agrium:

$1,044 − $3,375 = $(2,331)

Potash appears to be in the stronger financial position. It generates more cash from operating activities, has a higher profit, and a higher free cash flow.

Taking It Further: Agrium is likely in a growth stage. It is borrowing from creditors and/or investors to finance its purchases of property, plant, and equipment, or other businesses. In addition, its profit and cash from operating activities are lower than those of Potash Corporation. In contrast, Potash Corporation does not seem to be in a growth stage since it is investing in property, plant, and equipment, and is also paying down its debt. Its profit is higher, as is its cash provided by operating activities. In addition, since the amounts given are in absolute dollars, it is difficult to tell how much of the difference is due to the relative size of the two companies.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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. Sold preferred shares for cash.

(a) Classification O

(b) Cash −

−

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-1B (Continued)

Transaction 16. Collected cash from customers on account. 17. Issued a non−trade note payable. 18. Paid insurance for the month.

(a) Classification

(b) Cash

−

* The gain on sale of land would appear in the operating section of the cash flow statement if the indirect method was used. ** 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;

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-2B (a) GUM SAN LTD. Cash Flow Statement (Partial)—Indirect Method Year Ended April 30, 2011

Operating activities Profit ......................................................... $84,700 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ......................... $14,500 Gain on sale of equipment ................. (9,500) Increase in accounts receivable ........ (31,000) Decrease in inventory ......................... 22,000 Increase in prepaid expenses ............ (17,000) Increase in accounts payable............. 25,000 Decrease in accrued expenses payable (16,500) Increase in income taxes payable ...... 3,300 (9,200) Net cash provided by operating activities $75,500 (b) GUM SAN LTD. Cash Flow Statement (Partial)—Direct Method Year Ended April 30, 2011

Operating activities Cash receipts From customers ........................... $509,000 (1) For interest .................................... 7,500 $516,500 Cash payments To suppliers ............................ $(282,000) (2) For operating expenses ......... (126,000) (3) For income taxes.................... (33,000) (4) (441,000) Net cash provided by operating activities $ 75,500

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-2B (Continued) (b) (Continued) Calculations (1)

(2)

(3)

(4)

Cash receipts from customers Sales ............................................................ Deduct: increase in accounts receivable . Cash receipts from customers ..................

$540,000 (31,000) $509,000

Cash payments to suppliers Cost of goods sold ..................................... Deduct: Decrease in inventory ................. Cost of purchases ...................................... Deduct: Increase in accounts payable ..... Cash payments to suppliers ......................

$329,000 (22,000) 307,000 (25,000) $282,000

Cash payments for operating expenses Operating expenses .................................. Add: Decrease in accrued expenses payable Increase in prepaid expenses ........... Cash payments for operating expenses ...

$92,500 16,500 17,000 $126,000

Cash payments for income taxes Income tax expense .................................... Less: Increase in income tax payable ...... Cash payments for income taxes ..............

$36,300 (3,300) $33,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-3B (a) SABLE ISLAND LTD. Cash Flow Statement (Partial)—Indirect Method Year Ended December 31, 2011

Operating activities Profit ............................................................................. $135,000 Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ................................ $50,000 Loss on sale of equipment ........................ 23,000 Increase in accounts receivable ............... (8,000) Increase in prepaid expenses ................... (2,500) Increase in accounts payable.................... 5,000 Decrease in income taxes payable ........... (5,250) Increase in interest payable ...................... 450 Decrease in unearned revenue ................. (3,750) 58,950 Net cash provided by operating activities ........ $193,950 (b) SABLE ISLAND LTD. Cash Flow Statement (Partial)—Direct Method Year Ended December 31, 2011

Operating activities Cash receipts from customers ............................... $888,250 (1) Cash payments For operating expenses .............. $(639,500) (2) For interest .................................. (4,550) (3) For income tax............................. (50,250) (4) (694,300) Net cash provided by operating activities .... $193,950

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-3B (Continued) (b) (Continued) Calculations: (1)

Cash receipts from customers Revenues from fees ................................. $900,000 Less: Increase in accounts receivable ... $(8,000) Less: Decrease in unearned revenue ..... (3,750) (11,750) Cash receipts from customers ................................ $888,250

(2)

Cash payments for operating expenses Operating expenses per income statement ..... Add: Increase in prepaid expenses ................. Less: Increase in accounts payable ................. Cash payments for operating expenses ...........

(3)

Cash payments for interest expense Interest expense per income statement ................. Less: Increase in interest payable .......................... Cash payments for income tax................................

(4)

$642,000 2,500 (5,000) $639,500

$5,000 0 0 (450) $4,550

Cash payments for income tax Income tax expense per income statement ............ Add: Decrease in income tax payable .................. Cash payments for income tax................................

$45,000 005,250 $50,250

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-3B (Continued) 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-4B Cash inflows (outflows) related to investing activities in 2011:

(1)

(2)

Purchase of land and building ............... Sale of building ........................................ Sale of equipment .................................... Purchase of equipment ............................

($25,000) (1) 35,500 (2) 1,000 (3) (40,000) (4)

Land .......................................................... Building ..................................................... Cash ...................................................... Mortgage Note Payable .......................

50,000 130,000 25,000 155,000

Cost of building sold $1,250,000 + $130,000 − $1,310,000 = $70,000 Accumulated depreciation for building sold removed from accounts = $600,000 − ($578,750 − $31,250 depreciation expense) = $52,500 Carrying amount of equipment sold = Cost $70,000 − Accumulated depreciation $52,500 = $17,500 Cash proceeds = Carrying amount $17,500 + Gain on Sale $18,000 = $35,500 Cash .......................................................... Accumulated Depreciation—Building..... Gain on Sale of Building ..................... Building ................................................

35,500 52,500 18,000 70,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-4B (Continued) (3)

Accumulated depreciation for equipment sold removed from accounts = $192,000 − ($218,000 − $48,000 depreciation expense) = $22,000 Carrying amount of equipment sold = $28,000 Cost − Accumulated depreciation $22,000 = $6,000 Cash proceeds = Carrying amount $6,000 − Loss on sale $5,000 = $1,000 Cash .......................................................... Accumulated Depreciation—Equipment Loss on Sale of Equipment ..................... Equipment ............................................

(4)

1,000 22,000 5,000 28,000

Cost of equipment purchased $492,000 + $28,000 − $480,000 = $40,000 Equipment................................................. Cash ......................................................

40,000 40,000

Taking It Further: A net cash inflow from investing activities can be either favourable or unfavourable. It is 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. When combined with low or negative cash from operating activities and cash inflows from financing activities, the company may be sacrificing long-term profitability for shortterm survival.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-5B (a)

Profit: Retained earnings, beginning of year ............... Add: Profit (calculated) ..................................... Less: Cash dividends ........................................ Stock dividends ....................................... Retained earnings, end of year .........................

$240,000 80,250 320,250 (6,250) (14,000) $300,000

(b) Cash inflows and outflows from financing activities 1.

Cash outflow: Repayment of note payable (Amount given in problem)

$170,000

Cash inflow: Issue of note payable

$60,000

Note payable, beginning of year ............................ $350,000 Less: Repayment of note ........................................ (170,000) Add: Issue of note payable (calculated) ................ 60,000 Note payable, end of year ....................................... $240,000

Cash outflows: Payment of cash dividends

$ 6,250

Dividends payable, beginning of year ..................... $ 6,250 Add: Dividends declared during the year ................ 6,250 Less: Dividends paid during the year (calculated) . (6,250) Dividends payable, end of year ................................ $ 6,250

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-5B (Continued) (b) (Continued) 4.

Cash outflows: Reacquisition of common shares

$26,500

Common shares, beginning of year ......................... $140,000 Plus: Common stock dividend distributed .............. 14,000 Less: Cost of reacquired shares ............................. (28,000) Common shares, end of year ................................... $126,000 Cost of common shares reacquired ...................... $28,000 Less: Gain on reacquisition [increase in Contributed Capital account ($1,500 − $0)] ............................... (1,500) Cash paid for common shares reacquired ............. $26,500

Cash inflow: Issue of preferred shares

$50,000

Preferred shares, beginning of year ...................... $125,000 Add: Issued for cash (calculated) .......................... 50,000 Preferred shares, end of year ................................. $175,000 6.

Note: Cash outflow for interest is an operating activity not a financing activity. Interest Expense .................................................... Add: Amortization of Bond premium .................... Cash paid for interest ............................................

$23,000 2,000 $25,000

Bonds payable, beginning of year ........................ $216,000 Less: Amortization of Bond premium................... (2,000) Bonds payable, end of year ................................... $214,000

(c)

Non-cash financing activities include the stock dividend of $14,000.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-6B WAYFARER INC. Cash Flow Statement Year Ended December 31, 2011

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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-6B (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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-7B WAYFARER INC. Cash Flow Statement Year Ended December 31, 2011

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 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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-7B (Continued) Calculations: (1) Cash receipts from customers Sales ..................................................................... Less: Increase in accounts receivable ............. (2) Cash receipts from interest Interest revenue ................................................... Less: non-cash interest from long-term debt Investments** ........................................... (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 .............

$1,137,600 (46,800) $1,090,800 $9,900 (900) $9,000 $772,200 111,600 883,800 (40,500) $843,300 $265,500 (69,300) $196,200 $25,200 0 3,600 $28,800

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

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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-7B (Continued) 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-8B GALENTI, INC. Cash Flow Statement—Indirect Method Year Ended December 31, 2011

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 securities............ 7,500 Proceeds from sale of trading securities 15,000 Payment for purchase of securities ......... (10,000) (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 ................................................................ 0 47,250 Cash, December 31 .......................................................... $102,700

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-8B (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) Payment for purchase of trading securities Trading securities, end of year .................................. $94,500 Plus: Carrying value of securities sold ($15,000 + $7,500) .......................................... 22,500 Less: Trading securities, beginning of year ............ (107,000) Payment for purchase of trading securities ............. $10,000 (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

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-8B (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: No. Realized gains and losses represent the difference between the cash received and the carrying value. Unrealized gains and losses represent the difference between the fair value and the carrying value. Neither type of gains and losses represent the cash received from selling an investment. The cash flow statement reflects cash received from the sale of investments. Any gain or losses, whether realized or unrealized, are not included.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-9B GALENTI, INC. Cash Flow Statement—Direct Method Year Ended December 31, 2011

Operating activities Cash receipts From customers ........................... $263,700 (1) From sale of trading securities* .. 15,000 $278,700 Cash payments To suppliers ................................. $(100,290) (2) For operating expenses .............. (25,400) (3) For purchase of trading securities* (10,000) For income tax............................. (32,670) For interest .................................. (2,940) (171,300) Net cash provided by operating activities .... 107,400 Investing activities Sale of equipment ............................ $15,550 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) Payment of cash dividends* .......... (36,500) Net cash provided by financing activities ......... Net increase in cash................................................. Cash, January 1 ........................................................ Cash, December 31 ..................................................

3,500 55,450 0 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-9B (Continued) Calculations: (1)

(2)

(3)

Cash receipts from customers Sales ............................................................ Less: Increase in accounts receivable .....

Cash payments for operating expenses Operating expenses ................................... Less: Decrease in prepaid expenses ....... Add: Decrease in accrued expenses payable

$307,500 (43,800) $263,700

$ 99,460 9,250 108,710 (8,420) $100,290

$24,670 (6,000) 6,730 $25,400

* Calculations are shown in Problem 17-8B. 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 fewer outstanding payables were paid during the year than credit purchases.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-10B MILK RIVER LTD. Cash Flow Statement Year Ended December 31, 2011

Operating activities Profit ................................................................................ $27,750 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense* ........................... $ 9,500 Impairment loss on goodwill ................. 11,000 Increase in accounts receivable ........... (14,000) Increase in inventory ............................. (7,000) Increase in accounts payable................ 2,000 Decrease in income taxes payable ....... (3,000) (1,500) Net cash provided by operating activities ........... 26,250 Investing activities Sale of equipment ........................................... $ 8,500 Purchase of equipment (Note X).................... (4,000) Net cash provided by investing activities 4,500 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 ................................................................... 05,000 Cash, December 31 ............................................................. $13,000 Note X: During the year, the company acquired equipment with a cost of $14,000 by paying $4,000 cash and incurring a note payable of $10,000.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-10B (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 ....... 10,000 62,750 Less: repayment of notes (calculated) .................... (26,750) Notes payable, ending .............................................. $36,000 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11B MILK RIVER LTD. Cash Flow Statement Year Ended December 31, 2011

Cash flows from operating activities Cash receipts from customers (1) ... Cash payments To suppliers (2)............................. $(145,000) For operating expenses (3) .......... (54,500) For interest ................................... (4,000) For income tax (4) ........................ (12,250) Net cash provided by operating activities

$242,000

(215,750) 26,250

Investing activities Sale of equipment ............................. $8,500 Purchase of equipment (Note X) ...... (4,000) Net cash provided by investing activities

4,500

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 05,000 $13,000

Note to the Cash Flow Statement: Note X During the year, the company acquired equipment with a cost of $14,000 by paying $4,000 cash and incurring a note payable.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11B (Continued) Calculations: (1)

Cash receipts from customers Sales ............................................................. Less: Increase in accounts receivable ....... Cash receipts from customers ....................

$256,000 ( (14,000) $242,000

(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 (77,000 147,000 (2,000) $145,000

(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 ...................

$ 9,250 3,000 $12,250

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-11B (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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 17-12B (a)

Net cash provided (used) by operating activities − net cash (provided) used by investing activities = free cash flow Reitmans: $128,995 − $70,913 = $58,082 Le Château: $41,821 − $11,756 = $30,065

(b)

Reitmans appears to be in the stronger financial position. It generates more cash from operating activities, has a higher profit, more cash and cash equivalents, and a higher free cash flow.

Taking it Further: It is difficult to tell since both companies are investing in property, plant, and equipment. Reitmans may be growing faster than Le Château. Its profit is higher, as is its cash provided by operating activities. It is investing heavily in property, plant, and equipment as evidenced by its use of investing activities. However, since the amounts given are in absolute dollars, it is difficult to tell how much of the difference is due to the relative size of the two companies as opposed to one company being in a growth stage. Also it must be noted that the fashion industry is quite volatile, and the differences between the companies may not be representative of growth.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (a)

Indirect method COOKIE & COFFEE CREATIONS LTD. Cash Flow Statement Year Ended October 31, 2012

Operating activities Net income .................................................................... $72,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ......................... $ 9,850 Increase in accounts receivable ........ (3,250) Increase in inventory .......................... (17,897) Increase in prepaid expenses ............ (6,300) Increase in accounts payable............. 5,306 Increase in income tax payable .......... 18,000 Increase in salaries payable ............... 2,250 Increase in interest payable ............... 210 8,169 Net cash provided by operating activities ......... 80,169 Investing activities Purchase of furniture .............................. $(12,500) Purchase of computer equipment .......... (4,200) Purchase of kitchen equipment (Note X) (66,000) Net cash used by investing activities ..................... (82,700) Financing activities Issue of preferred shares ........................ $12,500 Issue of common shares (Note X) .......... 21,250 Repurchase of shares ............................. (1,300) Payment of dividends (7) ........................ (625) Net cash provided by financing activities .............. 31,825 Net increase in cash.......................................................... 29,294 Cash, November 1, 2011 ................................................... 0 Cash, October 31, 2012 ..................................................... $29,294

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CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) Note X: During the year, the company acquired kitchen equipment with a cost of $15,000 by paying $4,500 cash and incurring a $10,500 note payable. The company also issued common shares in exchange for kitchen equipment with a fair value of $3,500. (b) Direct method COOKIE & COFFEE CREATIONS LTD. Cash Flow Statement Year Ended October 31, 2012

Operating activities Cash receipts from customers (1) ............................... $471,750 Cash payments To suppliers (2) ...................................... $(250,091) For operating expenses (3).................... (51,240) For salaries and wages (4) .................... (90,250) For interest (5) ........................................ 0 For income tax (6) .................................. 0 (391,581) Net cash provided by operating activities ......... 80,169 Investing activities Purchase of furniture ................................. $(12,500) Purchase of computer equipment ............. (4,200) Purchase of kitchen equipment (Note X) (8) (66,000) Net cash used by investing activities ..................... (82,700) Financing activities Issue of preferred shares ........................... $12,500 Issue of common shares (Note X) ............. 21,250 Repurchase of shares ................................ (1,300) Payment of dividends (7) ........................... (625) Net cash provided by financing activities .............. 31,825 Net increase in cash.......................................................... 29,294 Cash, November 1 ............................................................. 0 Cash, October 31 ............................................................... $ 29,294

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued) Note X: During the year, the company acquired kitchen equipment with a cost of $15,000 by paying $4,500 cash and incurring a $10,500 note payable. The company also issued common shares in exchange for kitchen equipment with a fair value of $3,500. Calculations: (1)

Cash receipts from customers Sales............................................................. Less: Increase in accounts receivable ..... Cash receipts from customers ...................

(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 .......................

(3)

$237,500 17,897 255,397 (5,306) $250,091

Cash payments for operating expenses Operating expenses .................................... Add: increase in prepaid expenses ........... Cash payments for operating expenses ....

(4)

$475,000 ( (3,250) $471,750

$44,940 6,300 $51,240

Cash payments to employees Salaries and wages expense ...................... Less: increase in salaries payable ............ Cash payments to employees ....................

$92,500 (2,250) $90,250

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CONTINUING COOKIE CHRONICLE (Continued) (b) (Continued) (5)

Cash payments for interest Interest expense .......................................... Less: Increase in interest payable ............ Cash payments for interest ........................

(6)

Cash payments for income tax Income tax expense .................................... Less: Increase in income tax payable....... Cash payments for income tax...................

(7)

$18,000 (18,000) $ 0

Cash payments for dividends Dividends ($625 + $625) .............................. Less: Increase in dividends payable ........ Cash payments for dividends.....................

(8)

$210 (210) $ 0

$1,250 (625) $ 625

Cash payments for kitchen equipment Total kitchen equipment purchased .......... Less: Paid with note payable..................... Less: Paid with common shares ................ Cash payment for kitchen equipment ........

$80,000 (10,500) (3,500) $66,000

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BYP 17-1 FINANCIAL REPORTING PROBLEM

(a)

Forzani’s financial statements do not include any definition of cash.

(b) Per Forzani’s 2009 cash flow statement, cash decreased by $44,010,000. (c)

The two significant investing activities reported in Forzani’s cash flow statement were the purchase of capital assets for $52,139,000, and other assets for $2,998,000.

(d) The two most significant financing activities on Forzani’s cash flow statement was the repayment of long-term debt of $51,199,000 and share repurchases of $44,027,000. Other financing activities included cash provided from a revolving credit facility $17,130,000, cash provided from sale of shares, $2,384,000, cash received from lease inducements, $4,221,000 and cash used to pay dividends, $9,327,000. (e)

Forzani did not report any significant non-cash investing and financing activities in 2009.

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BYP 17-2 INTERPRETING FINANCIAL STATEMENTS (a)

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 $13.7 million in cash from operating activities in 2009. The fact that operating activities are generating a significant cash flow means there is less cause for concern.

(b) The loss for the year was calculated using accrual accounting. Several expenses or losses on the income statement do not use cash. Depreciation is an example. Also, decreases in non-cash current assets and increases in non-cash current liabilities can result in cash provided from operations even if there is a loss. (c)

Free Cash Flow = Cash provided by operating activities − Cash used in investing activities = $13.7 million − $24.1 million = $(10.4) 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)

The stakeholders in this situation are: Phil Monat, president of Paradis Corporation Rick Rodgers, controller Rick’s assistant The Board of Directors The shareholders of Paradis Corporation

(b) 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 unethical. Controller Rick Rodgers' reclassification (intentional misclassification) of a cash inflow from a “long-term nontrade note issue” (financing activity) to an "increase in trade payables" (operating activity) is inappropriate and unethical. (c)

It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company's transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Paradis Corporation's cash flow statement. It is also possible that close scrutiny of the balance sheet showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the cash flow statement.

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BYP 17-6 “ALL ABOUT YOU”– ACTIVITY (b) My Cash Flow Statement Year Ended August 31, 2011 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 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, 2010 Cash, August 31, 2011

2011

2010

$ 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)

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, 2010 is close to half of the cash you had at September 1, 2009. If you were to maintain the same spending patterns over the next year you could be completely out of cash by August 31, 2011.

(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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Legal Notice Copyright

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CHAPTER 18 Financial Statement Analysis ASSIGNMENT CLASSIFICATION TABLE Brief Exercises 1

Exercises

Problems Set A

Problems Set B

3, 4, 5, 6, 7

2, 3, 4, 5

1, 3, 4

1, 2

3. Explain and apply vertical analysis.

5, 6, 7, 8, 9

5, 6, 7

2, 3, 4

2, 3

4. Identify and use ratios to analyze a company’s liquidity, solvency, and profitability.

10, 11, 12, 13, 14, 15, 16, 17

8, 9, 10, 11, 12, 13, 14, 15

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

3, 4, 5, 6, 7, 8, 9

5. Recognize the limitations of financial statement analysis.

18, 19, 20, 21, 22, 23

Study Objectives 1. Identify the need for, and tools of, financial analysis.

Questions 1, 2

2. Explain and apply horizontal analysis.

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Accounting Principles, Fifth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare horizontal analysis and identify changes.

Simple

60-70

Interpret horizontal and vertical analysis.

Moderate

25-30

Prepare vertical analysis, calculate profitability ratios, and compare.

Moderate

50-60

Determine impact of transactions on liquidity ratios.

Complex

20-25

Calculate ratios.

Moderate

35-40

Calculate and compare ratios.

Moderate

70-80

Calculate and evaluate ratios for two companies.

Moderate

45-55

Evaluate ratios for two companies.

Moderate

25-35

Evaluate ratios for two companies.

Moderate

15-20

10A

Identify impact of different accounting policies.

Moderate

25-35

Prepare horizontal analysis and identify changes.

Simple

60-70

Interpret horizontal and vertical analysis.

Moderate

25-30

Prepare vertical analysis, calculate profitability ratios, and compare.

Moderate

50-60

Determine impact of transactions on profitability ratios.

Complex

20-25

Calculate ratios.

Moderate

35-40

Calculate and compare ratios.

Moderate

70-80

Calculate and evaluate ratios for two companies.

Moderate

45-55

Evaluate ratios for two companies.

Moderate

25-35

Evaluate ratios for two companies.

Moderate

15-20

10B

Identify impact of different accounting policies.

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. Identify the need for, and tools of, financial analysis. 2. Explain and apply horizontal analysis.

Knowledge BE18-1

Comprehension Q18-1 Q18-2

Application

Analysis

Q18-3

Q18-4 Q18-5 Q18-6 Q18-7

BE18-2 BE18-3 BE18-5 E18-1 E18-3

BE18-4 E18-4

P18-1A P18-2A P18-1B P18-2B

Explain and apply vertical analysis.

Q18-8

Q18-5 Q18-6 Q18-7 Q18-9

BE18-5 BE18-6 BE18-7 E18-2 E18-3

E18-4 P18-3A P18-3B

P18-2A P18-2B

Identify and use ratios to analyze a company’s liquidity, solvency, and profitability.

Q18-10 BE18-8

Q18-11 Q18-14 Q18-16 BE18-9 E18-5

BE18-12 BE18-13 E18-9 E18-11 P18-5A P18-5B

Recognize the limitations of financial statement analysis.

Q18-18 Q18-19 Q18-20 Q18-23

Q18-12 Q18-13 Q18-15 Q18-17 BE18-10 BE18-11 BE18-14 BE18-15 E18-6 E18-7 E18-8 E18-10 E18-12 Q18-21 Q18-22 BE18-15 P18-10A P10-10B

Broadening Your Perspective

BYP18-4

P18-3A P18-4A P18-6A P18-3B P18-4B P18-6B

Synthesis

Evaluation

E18-13 P18-7A P18-8A P18-9A P18-7B P18-8B P18-9B

E18-13

BYP18-1 BYP18-2 BYP18-3 BYP18-4 BYP18-5 BYP18-6 Continuing Cookie Chronicle

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ANSWERS TO QUESTIONS 1.

(a) Comparison of financial information can be made on an intracompany basis, an intercompany basis, and an industry average basis. (1) An intracompany basis 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. (2) An intercompany basis compares the same item with one or more other company’s financial statements. The intercompany basis of comparison provides insight into a company's competitive position in relation to other companies. (3) The industry average basis compares an item with the average of that item for the industry. For example, a department store may compare its sales per square foot of floor space with the average sales per square foot of floor space for department stores. (b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company. The intercompany basis of comparison provides insight into a company's competitive position in relation to other companies. The industry average basis provides information as to a company's relative position within the industry. The use of all three comparisons, when combined with economic and non-financial measures provides the investor with an in-depth analysis of the investment potential of the company.

(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 all three 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.

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QUESTIONS (Continued) 4.

(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.

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 statement is compared with the amount of that same item on one or more earlier statements. Vertical 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.

Analysis of Visa’s 2009 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.

Graphs portray in visual terms proportions of amounts and direction of performance far more quickly than figures in a table can. Trends can be illustrated more effectively as well as the relationship of financial statement elements. As well, problem areas can be more easily spotted.

(a) On a balance sheet, total assets and total liabilities and shareholders’ equity are assigned a value of 100%. (b) On an income statement, the figure for net sales is assigned a value of 100%.

Yes, it can. By converting the accounting numbers to percentages, companies of vastly different sizes with different currencies can be compared.

10.

(a) Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. (b) 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. (c) Profitability ratios measure the profit or operating success of a company for a specific period of time.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 11.

(a) Asset turnover (b) Acid-test ratio (c) Operating cycle (d) Return on equity (e) Interest coverage

12.

A high current ratio does not always mean that a company is liquid. 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.

13.

Aubut Corporation is collecting its receivables much more slowly than the industry average. Aubut collects its receivables, on average, every 81 days (365 ÷ 4.5), compared to the industry average of 56 days (365 ÷ 6.5). This could indicate that Aubut is not using the same credit checks or collection policies as the rest of the industry. However, a slower receivables turnover than the industry does not always indicate a problem. The receivables turnover ratio can be misleading in that some companies encourage credit and revolving charge sales and slow collections, in order to earn a healthy return on the outstanding receivables in the form of high rates of interest.

14.

Wong’s solvency is better than that of the industry. It is carrying a slightly lower percentage of debt than the industry (37% versus 39%) and has a higher interest coverage ratio (3 versus 2.5).

15.

Profit margin and asset turnover are profitability ratios that combine to determine the return on assets ratio. Together, these two ratios measure the performance of a business with respect to the assets that are needed to generate sales and profit. By looking at the composition of the return on assets ratio, we can determine whether a change in the return on assets ratio is primarily because of a change in profitability (profit margin) or efficiency (asset turnover). Return on Assets Profit Average total assets

Profit Margin Profit Net sales

Asset Turnover Net sales Average total assets

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 16.

Yes, McDonald’s has made effective use of leverage. McDonald’s earned a higher return using borrowed money to increase the return to the shareholders.

17.

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 priceearnings ratio indicates that investors expect this company’s earnings 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 earnings 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 its earnings as dividends and therefore has a higher dividend payout ratio.

18.

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.

Diversification. Today, many companies are so diversified that intercompany comparisons or the use of industry statistics becomes impossible, as these companies cannot be classified into one industry.

Quality of information. The information used for financial analysis is only good if it is of high quality—fulsome, relevant, transparent, and easily understood.

Inflation. Where inflation is significant, the use of cost which is not adjusted for price-level changes may lead to inaccurate conclusions about information such as the company’s rate of growth.

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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QUESTIONS (Continued) 19.

The implementation of the IFRS for public companies had a deadline date for implementation. It also required that comparative past financial statements be prepared on the same basis where practical. Some companies’ implementation did not start at exactly the same point in time because of the date of their fiscal year end. Some confusion and misinterpretation of performance, particularly with respect to comparisons to years prior to the implementation of the IFRS, will undoubtedly occur.

20.

If Irving chooses to adopt Canadian GAAP for Private Enterprises, it will have to be careful in comparing its financial results to any published benchmarks for financial analysis purposes. Most industry averages are based on public company information, which will use IFRS. Certain accounting policies differ under Canadian GAAP for Private Enterprises and IFRS, which may lead to distortions for comparative purposes. Note that it is unlikely that Irving’s financial statements will be available for comparison by any of its competitors, because it is a private company and its financial statements are not publicly available.

21.

In order to be able to make sensible comparisons and perform analysis that is meaningful, it is best to use the segmented information of a single product taken from the business with the different product lines. This information would have similar characteristics to a business with a single product line used for comparison purposes. Taking this approach will provide a performance comparison that will be more meaningful.

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Accounting Principles, Fifth Canadian Edition

QUESTIONS (Continued) 22.

(a) The use of FIFO in periods of rising prices causes cost of goods sold to be lower and profit to be higher, and the inventory on the balance sheet to be higher. The ratios that would the most obviously affected by the cost formula choice for inventory would be the inventory turnover and days sales in inventory ratios. Other affected ratios would include the gross profit margin, profit margin, debt to total assets, asset turnover, return on assets, and return on equity. (b) Diminishing-balance depreciation generates a higher expense than straight-line depreciation in the early years of an asset’s life, but becomes lower in the later years. Therefore, if straight-line depreciation is used, profit will be higher initially but will be lower in later years. The straight-line method will also result in a higher carrying amount on the balance sheet in the early years. Total assets will be affected in the denominators of the debt to total assets, asset turnover, and return on asset ratios. As well, the profit margin, asset turnover, return on assets, and return on equity ratios will be affected in the numerators by the reduced depreciation expense. (c) Discontinued operations, although highlighted in their classification on the income statement, do have a direct impact on profit. When comparing businesses’ profitability, using the profit margin, return on assets, or return on equity ratios, one should be mindful of the impact of the discontinued operations on the profit being used in the ratios.

23.

Depending on the pace of recovery and the particular industries being studied, one needs to pay particular attention to the basis of some of the comparisons for assessing trends. When doing horizontal analysis for example, using 2008 as the base year should be discouraged. A prior normal year of performance should be selected to assess the impact of both the downturn and the recovery businesses are experiencing. Information other than financial statements will need to be used to provide adequate interpretation of the results being analyzed.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18-1 1. 2. 3. 4. 5. 6. 7. 8.

Intracompany Horizontal percentage Intercompany Industry Horizontal analysis Horizontal percentage change for period Vertical analysis Ratio analysis

(g) (a) (d) (b) (f) (e) (c) (h)

BRIEF EXERCISE 18-2 Cash Accounts receivable Inventory Prepaid expenses Property, plant, and equipment Intangible assets Total assets

2011 80% 136% 126% 220% 108% 160% 115%

2010 150% 115% 122% 0% 105% 130% 110%

2011 (47%) 18% 4% n/a 2% 23% 5%

2010 50% 15% 22% (100%) 5% 30% 10%

2009 100% 100% 100% 100% 100% 100% 100%

BRIEF EXERCISE 18-3 Cash Accounts receivable Inventory Prepaid expenses Property, plant, and equipment Intangible assets Total assets

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-4 The information in the graph implies a deterioration in profit in 2010 and an increase in profits in 2011. If the graph were redone to depict the absolute amount of profit or loss as opposed to the components of the income statement, this would be confirmed. As it stands, the graph demonstrates the most dramatic changes come from income tax expense, and yet this would be the smallest amount of the four figures graphed. In 2010, sales decreased and expenses increased, (except for tax) causing a drop in profit. In 2011, sales increased and expenses (cost of goods sold and operating expenses, not income tax) decreased and so there was an increase in profit. Since the base of the graph is 2009, we are unable to assess any profit trends for that year.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-5 (a) Cash Accounts receivable Inventory Property, plant, and equipment Total assets

2011 200% 133% 111%

2010 233% 89% 86%

2009 100% 100% 100%

110% 114%

98% 98%

100% 100%

(b) 2009 Cash Accounts receivable Inventory Property, plant, and equipment Total assets

Amount $ 75,000 450,000 700,000

Percentage 1.8% 11.0% 17.2%

2,850,000 $4,075,000

69.9% 100.0%

Note: The percentages shown in the above table do not add to 100% because of rounding discrepancies that occur from rounding the results to one decimal place. 2010 Cash Accounts receivable Inventory Property, plant, and equipment Total assets

Amount $ 175,000 400,000 600,000

Percentage 4.4% 10.1% 15.1%

2,800,000 $3,975,000

70.4% 100.0%

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-5 (Continued)

Cash Accounts receivable Inventory Property, plant, and equipment Total assets

2011 Amount Percentage $ 150,000 3.2% 600,000 12.9% 780,000 16.7% 3,130,000 $4,660,000

67.2% 100.0%

BRIEF EXERCISE 18-6

Net sales Cost of goods sold Gross profit Operating expenses Profit before income tax Income tax expense Profit

2011 Amount Percent $1,934 100.0% 1,612 83.4% 322 16.6%

2010 Amount Percent $2,073 100.0% 1,674 80.8% 399 19.2%

218

11.3%

240

11.6%

104 31 $ 73

5.4% 1.6% 3.8%

159 48 $ 111

7.7% 2.3% 5.4%

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.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-7 (a)

Profit as a percentage of sales for Waubons increased in 2010 and 2011. Since 2009 is the base year in the bar graph, we are unable to comment on any changes or trends for 2009.

(b)

The reason profit increased in each of the 2010 and 2011 years is because cost of goods sold and operating expenses both decreased each year and income taxes remained relatively unchanged.

BRIEF EXERCISE 18-8

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Ratio Return on assets Receivables turnover Earnings per share Payout ratio Acid-test ratio Debt to total assets Free cash flow Inventory turnover Return on equity Interest coverage

Classification P L P P L S S L P S

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-9 (a)

Deterioration: A decrease in the receivables turnover would be viewed as deterioration. It is taking longer to collect the accounts receivable.

(b) 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. (c)

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."

(d) 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. (e)

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.

(f)

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.

(g) 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. (h) 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.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-10 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.

BRIEF EXERCISE 18-11 (a) 2011

Inventory turnover

Days sales in = inventory

$4,540,000 = ($1,020,000 + $980,000)÷2

4.5

times

days

$4,550,000 = ($980,000 + $840,000) ÷ 2

5.0

times

days

365 ÷

4.5

2010

Inventory turnover

Days sales in = inventory

365 ÷

5.0

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-11 (Continued) (b) 2011

Receivables turnover

Collection period

$6,420,000 = ($850,000 + $750,000) ÷ 2

8.0

times

days

$6,240,000 = ($750,000 + $650,000) ÷ 2

8.9

times

days

365 ÷

8.0

2010

Receivables turnover

Collection period

365 ÷

8.9

(c) Operating cycle = Days sales in inventory + Collection period 2011: 127 days = 81 days + 46 days 2010: 114 days = 73 days + 41 days (d) Management should be concerned with the fact that inventory is moving more slowly in 2011 than it did in 2010, 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 2011.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-11 (Continued) (d) (Continued) 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 18-12 ($ in thousands) (a)

(b)

Debt to = total assets

$2,841,215 $6,419,306

$882,502* Interest = = coverage $63,952 *$882,502 = $565,212 + $253,338 + $63,952

$478,989

–

$664,566 =

44.3%

13.8 times

$(185,577)

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-13 (a) ($ in millions) Profit = margin

$109 $6,718

Asset turnover

$6,718 ($13,943 + $13,814) ÷ 2

Return on assets

$109 ($13,943 + $13,814) ÷ 2

(b)

1.6%

0.5 times

0.8%

All of the three above ratios are profitability ratios. The return on assets can be determined by multiplying the profit margin by the asset turnover. Together, the three ratios measure the performance of Loblaw with respect to the assets that are needed to generate sales and profit.

BRIEF EXERCISE 18-14 Investors who purchase shares in Research In Motion do so not because of any dividend income but for growth reasons. Since this company is primarily based on the delivery of innovative technology products, hopes for growth in capturing larger portions of the market are always on the minds of investors. Investors who purchase shares in the Bank of Montreal do so primarily for income reasons. The payout ratio is extremely high to reward investors with dividends since the room for growth in revenues and profits is somewhat limited.

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Accounting Principles, Fifth Canadian Edition

BRIEF EXERCISE 18-15 (a)

In times of falling prices, the company which has the lowest inventory is using the FIFO cost formula. Sterling is therefore the business using FIFO and Apple is using average.

(b) Sterling $200,000 Inventory turnover = $10,000 Apple $180,000 Inventory turnover = $12,000

times

The difficulty in interpreting the above results is to determine whether Sterling’s higher inventory turnover is really higher than that of Apple, or only the result of using different inventory cost formulas. You can expect the company using FIFO to have a higher inventory turnover ratio in a period of falling prices anyway, just because of the higher cost of goods sold and lower inventory. (c)

Based on the knowledge of falling prices and the choice of cost formulas adopted by the two companies compared, the affected ratios (e.g., inventory turnover, gross profit, etc.) should be adjusted for the impact of any inventory cost formula in order to facilitate the interpretation of trends and results. This means, the ratios should be recalculated assuming both companies used the same formulas (average, for example).

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 18-1 DRESSAIRE INC. Balance Sheet 2011 $120,000 400,000 90,000

2010 $ 80,000 350,000 70,000

2009 $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

2011 120% 133% 138%

2010 80% 117% 108%

2009 100% 100% 100%

97% 150% 159%

83% 115% 141%

100% 100% 100%

(b)

2011

Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings

2010

50% 14% 29%

(20%) 17% 8%

16% 30% 13%

(17%) 15% 41%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-2 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

2011 Amount Percent $800,000 100.0% 550,000 68.8% 250,000 31.3% 175,000 21.9%

2010 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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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-3 (a)

OLYMPIC CORPORATION Income Statement Year Ended December 31

2011 Sales $610,000 Cost of goods sold 460,000 Gross profit 150,000 Operating expenses 55,000 Profit before income tax 95,000 Income tax 32,000 Profit $ 63,000 (b)

2010 $540,000 400,000 140,000 50,000

Increase (Decrease) Amount Percentage $70,000 13.0% 60,000 15.0% 10,000 7.1% 5,000 10.0%

90,000 30,000 $ 60,000

5,000 2,000 $ 3,000

5.6% 6.7% 5.0%

OLYMPIC CORPORATION Income Statement Year Ended December 31

2011 Amount Percent Sales $610,000 100.0% Cost of goods sold 460,000 75.4% Gross profit 150,000 24.6% Operating expenses 55,000 9.0% Profit before income tax 95,000 15.6% Income tax 32,000 5.2% Profit $ 63,000 10.3%

2010 Amount $540,000 400,000 140,000 50,000

Percent 100.0% 74.1% 25.9% 9.3%

90,000 30,000 $ 60,000

16.7% 5.6% 11.1%

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, Fifth Canadian Edition

EXERCISE 18-4 (a) MOUNTAIN EQUIPMENT CO-OPERATIVE Balance Sheet December 31 ($ in thousands)

Assets Current assets Property, plant and equipment

Liabilities and Members' Equity Current liabilities Long-term liabilities Total liabilities Members' equity Total liabilities and members' equity

Increase (Decrease) Amount Percentage

2008

2007

$ 67,525

$ 62,437

$ 5,088

8.1%

104,920

83,782

21,138

25.2%

$172,445

$146,219

$26,226

17.9%

$ 33,786

$ 29,167

$ 4,619

15.8%

3,439 37,225 135,220

1,684 30,851 115,368

1,755 6,374 19,852

104.2% 20.7% 17.2%

$172,445

$146,219

$26,226

17.9%

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-4 (Continued) (b) MOUNTAIN EQUIPMENT CO-OPERATIVE Balance Sheet December 28 ($ in thousands)

Assets Current assets Property, plant and equipment Liabilities and Members' Equity Current liabilities Long-term liabilities Total liabilities Members' equity Total liabilities and members' equity

(c)

2008 Amount Percent $ 67,525 39.2%

2007 Amount Percent $ 62,437 42.7%

104,920 $172,445

60.8% 100.0%

83,782 $146,219

57.3% 100.0%

$ 33,786 3,439 37,225 135,220

19.6% 2.0% 21.6% 78.4%

$ 29,167 1,684 30,851 115,368

19.9% 1.2% 21.1% 78.9%

$172,445

100.0%

$146,219

100.0%

During 2008, there was a 25.2% increase in the amount of property, plant, and equipment, which was financed primarily through an increase in long-term debt. Both short-term debt (current liabilities) and members’ equity decreased marginally as a percentage of total assets in 2008 while long-term debt increased.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-5 Ratio Acid-test Asset turnover Collection period Current ratio Days sales in inventory Debt to total assets Earnings per share Free cash flow Gross profit margin Interest coverage Inventory turnover Price-earnings ratio Profit margin Receivables turnover Return on assets Return on equity

(a) (b) Classification Higher Result L B P B L W L B L W S W P B S B P B S B L B P B P B L B P B P B

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-6 ($ in millions) (a)

Working capital = $1,430 – $890 = $540 Current ratio = 1.6:1 ($1,430  $890) Acid-test ratio = 0.9:1 [($30 + $55 + $676)  $890] Receivables turnover = 6.6 times ($4,190  [($676 + $586) ÷ 2]) Collection period = 55 days (365 ÷ 6.6 times) Inventory turnover = 5.0 times ($2,900  [($628 + $525) ÷ 2]) Days sales in inventory = 73 days (365 ÷ 5.0 times) Operating cycle = 128 days (73 + 55)

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-6 (Continued) (b) (1) Canadian Ratio Nordstar Tire Working capital ($ in millions) $540 $1,978.9 Current ratio 1.6:1 2.0:1 Acid-test ratio 0.9:1 0.6:1 Receivables turnover 6.6x 11.8x Collection period 55 days 31 days Inventory turnover 5.0x 7.6x Days sales in inventory 73 days 48 days Operating cycle 128 days 79 days

(2) Industry Average n/a 2.5:1 1.2:1 18.3x 20 days 7.6x 48 days 68 days

Nordstar is less liquid than Canadian Tire and the industry. One must be cautious in interpreting Nordstar’s current ratio, even though it is lower than that of Canadian Tire and the industry. It is likely artificially high because the company is having problems with its receivables collection and inventory turnover. The collection period is significantly higher than that of Canadian Tire, and more importantly, the industry in general. The inventory turnover is also well below the industry average. Its operating cycle—the time it takes to purchase inventory, sell it on account, and collect the cash—is much higher than that of Canadian Tire and the industry. Nordstar needs to focus its efforts on increasing its turnover of receivables and inventory. One of the business segments of Canadian Tire involves the sale of gasoline which will turnover quickly and therefore improve its overall inventory turnover ratio compared to other businesses.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-7 (a)

The company’s collection of its accounts receivables 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 accounts receivable 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.

EXERCISE 18-8 (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.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-9 (a) ($ in thousands)

(b)

Xtreme Corporation

Industry

F or U

$500 – $375 $500

= 25.0%

27.5%

Profit margin

$33.5 $500

= 6.7%

7.5%

Asset turnover

$500 ($275 + $350) ÷ 2

1.5 times

Return on assets

$33.5 ($275 + $350) ÷ 2

= 10.7%

12%

Return on equity

$33.5 = 28.7% ($100 + $133.5) ÷ 2

40%

Gross profit margin

1.6 times

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-10 (a)

Imperial Oil is more profitable. Its profit margin of 12.4% is significantly higher than that of Suncor’s, at 7.1%. In addition, its return on equity of 45.7% is also much larger than that of Suncor’s, at 16.2%. Note that earnings per share are not comparable between companies because of differing capital structures.

(b)

Investors favour Suncor over Imperial Oil. Suncor has a higher price-earnings ratio—10.4 times earnings compared to Imperial Oil’s 9.4. Despite Suncor’s lower profitability picture in the current period, investors must believe it has a better opportunity for future profitability than Imperial Oil.

(c)

Investors would purchase shares in Imperial Oil and Suncor primarily for growth reasons. The payout ratio is not overly large for either company, so investors would expect to purchase shares for future profitable resale while still earning a dividend.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-11 ($ in thousands except for share price) (a)

(b)

Asset turnover

$940,399 2.1 = times ($487,506 + $421,004) ÷ 2

Debt to total assets

$256,616 $487,506

= 52.6%

Earnings per share

$30,650 24,675

$93,907

4. Free cash flow

–

$ 49,149

$1.24

= $44,758

Interest coverage

$30,650 + $15,077 + $309 149.0 = times $309

PriceP earnings ratio

$11.00 $1.24

Profit margin

$30,650 $940,399

= 3.3%

Return on assets

$30,650 = 6.7% ($487,506 + $421,004) ÷ 2

Return on equity

$30,650 = 14.1% ($230,890 + $203,754) ÷ 2

8.9 times

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-12 (a)

Husky is likely more liquid than Suncor. It has a higher current and acid-test ratio, although its receivables turnover ratio is worse. This could be artificially driving its current and acid-test ratios up, however, a receivables turnover of 16.7 times (365 ÷ 16.7 = 22 days) is still a reasonable one as it is less than 30 days (assuming Husky’s credit terms are 30 days).

(b)

Husky is far more solvent than Suncor. It has a lower proportion of debt and covers its interest cost more times.

(c)

Husky is far more profitable than Suncor. It has a higher profit margin and return on equity than Suncor, although it has the same asset turnover.

(d)

Investors favour Suncor. Its shares are trading at 10.4 times its EPS. This is not consistent with the findings above. Share price is often based, to a large extent, upon expectations about future earnings. It seems as though investors see a brighter future for Suncor than they do for Husky.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-13 1. (a) The operating loss from discontinued operations of Company A would reduce the profit margin as the profit is reduced but the net sales remain the same. (b) Company B would appear to have a better (higher) profit margin as Company A’s profit would be lower while net sales are unchanged in the calculation of profit margin. 2. (a) The asset turnover ratio would be affected by the reduced amount of years for the estimated useful life of assets in the depreciation method. The higher the number of years, the lower the amount of the expense and the higher the carrying amount of the equipment on the balance sheet. The equipment carrying amount is included in the total assets denominator of the asset turnover ratio. Since Company A has assumed a lower number of year of useful life, its asset turnover ratio will be higher than that of Company B. (b) The asset turnover ratio for Company A would look better because Company B because it would be higher and so it would appear as if it is using assets more efficiently. 3. (a) Assuming that Company A increased its selling price to compensate for inflation, its profit would increase due to the inflated currency. Since the equity values would not increase, the return on equity would increase. On the other hand, if Company A was unable to pass on the increased costs to its customers, the opposite would occur.

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Accounting Principles, Fifth Canadian Edition

EXERCISE 18-13 (Continued) 3. (b) If Company A was able to increase its selling prices, it will have a higher return on equity than Company B as its profits will be higher and so will be viewed as performing better. If, not, Company B will have a higher return on equity. 4. (a) If the ratio is calculated using net credit sales, it will not matter that Company A sells most of its merchandise for cash. But, if the receivables turnover ratio is calculated using net sales, this ratio will be significantly higher for Company A due to the small accounts receivable balance. (b) If the receivables turnover ratio is calculated using net sales (rather than net credit sales), Company A will look better as it would have the higher receivables turnover ratio, since it has so few accounts receivable. 5. (a) The debt to total assets ratio will be affected by the difference in the accounting treatment of the development costs of the two companies. Company A will have higher assets than Company B, because the assets are increased by the amount of the capitalized development costs and so will have a lower debt to total assets ratio, as the debt remains unaffected. (b) Company A will be viewed as having a lower (better) debt to total assets ratio as it will be perceived as having less risk as it has used debt to buy more assets that are used to produce profits.

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Accounting Principles, Fifth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 18-1A

(a) BIG ROCK BREWERY INCOME TRUST Income Statement Horizontal Analysis Year Ended December 31

Net revenue Cost of goods sold Gross profit Operating expenses Profit for operations Other income Profit before income taxes Income tax expense (recovery) Profit

2008 93% 98% 90% 105% 54% n/a

2007 90% 93% 88% 99% 62% n/a

2006 95% 90% 98% 92% 113% -

2005 100% 100% 100% 100% 100% -

57%

68%

113%

100%

(47%) 75%

(15%) 83%

32% 127%

100% 100%

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PROBLEM 18-1A (Continued) (a) (Continued) BIG ROCK BREWERY INCOME TRUST Balance Sheet Horizontal Analysis December 31

Assets Current assets Non-current assets Total assets

2008

2007

2006

2005

52% 101% 86%

44% 104% 86%

90% 106% 101%

100% 100% 100%

141% 40% 73% 91%

112% 92% 99% 102%

100% 100% 100% 100%

86%

101%

100%

Liabilities and Unitholders’ Equity Current liabilities 120% Non-current liabilities 77% Total liabilities 91% Unitholders' equity 84% Total liabilities and unitholders' equity 86%

(b) Although the profit increased in 2006 from 2005, it started to decrease dramatically in 2007 and continued in 2008. Some of the profit in 2007 and 2008 came from other income. Net revenues decreased in 2007 but the cost of goods sold increased. This is a bad trend. The increase in cost of goods sold in 2008 outpaced the increase in net revenue. Operating expenses kept climbing, also outpacing the increase in sales in 2008. On the balance sheet, current assets have decreased significantly while current liabilities have increased. This means the company’s liquidity has deteriorated. In addition, its non-current liabilities increased sharply in 2008, after having dropped the prior year.

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PROBLEM 18-1A (Continued) Taking It Further:

Total liabilities Unitholders' equity Total liabilities and unitholders' equity

2008 30% 70%

2007 24% 76%

2006 28% 72%

2005 29% 71%

100%

The business is financed more with equity than debt as the above percentages show.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-2A (a)

The horizontal and vertical analysis statements demonstrate that the company’s control over cost of goods sold was steady in 2009 and 2010 but went somewhat out of control in 2011, when costs of goods sold increased 2.4% of revenue.

(b)

Although the profit before income taxes has remained constant as a percentage of each year’s revenue, over the last four years, the amounts have increased in absolute terms each year, as shown in the horizontal analysis statement. This demonstrates that the percentage increase in profit before income taxes is increasing at the same pace as the percentage increase in revenue.

(c)

Although most expenses have grown in similar proportions to the increase in revenue, this is not the case for interest expense. Interest expense is reducing 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 a major increase of 140% over a three year period turns out to have a modest effect on the profit.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-2A (Continued) Taking It Further: The financial statements themselves, along with some ratio analysis, would also be useful in assessing this company’s performance and financial position. Comparisons of this company to other businesses in the industry, as well as understanding any external economic or other factors, would also be useful.

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PROBLEM 18-3A (a)

CHEN AND CHUAN COMPANIES Income Statements Year Ended December 31, 2011

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%

279,470 103,800 $ 175,670

15.1% 5.6% 9.5%

110,780 38,300 $ 72,480

20.6% 7.1% 13.4%

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 = $175,670 ÷ $1,849,035 = 9.5%

Chuan = $72,480 ÷ $539,038 = 13.4%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-3A (Continued) (b) (Continued) Asset Turnover: Net sales ÷ Average total assets Chen Average total assets = ($977,090 + $812,410) ÷ 2 = $894,750 Asset turnover = $1,849,035 ÷ $894,750 = 2.1 times

Chuan Average total assets = ($297,346 + $205,279) ÷ 2 = $251,313 Asset turnover = $539,038 ÷ $251,313 = 2.1 times

Return on Assets: Profit ÷ Average total assets Chen = $175,670 ÷ $894,750 = 19.6%

Chuan = $72,480 ÷ $251,313 = 28.9%

Return on Equity: Profit ÷ Average shareholders’ equity Chen Chuan Average shareholders’ equity Average shareholders’ equity = ($802,265 + $646,595) ÷ 2 = ($222,478 + $149,998) ÷ 2 = $724,430 = $186,238 Return on Equity Return on Equity = $175,670 ÷ $724,430 = $72,480 ÷ $186,238 = 24.2% = 38.9% (c)

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 very similar to Chen’s. Finally Chuan’s investors are enjoying a much better return on their investment.

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Accounting Principles, Fifth 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.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-4A (a)

(a)

(b)

(c)

(d)

Transaction Buys merchandise on account. Pays an account payable. Sells merchandise on account at a profit. Collects account receivable.

Current Ratio (1.5:1)

Acidtest Ratio (1.0:1)

Receivables Inventory Turnover Turnover (15 times) (10 times)

Taking It Further: (a) (b) (c) (d)

The current ratio would now increase. The current ratio would now decrease. The current ratio would still increase. The current ratio would still not be affected.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-5A Liquidity Ratios 1. Working capital $318,900 2.

Current ratio

Acid-test ratio

–

$208,500

$318,900 $208,500

= 1.5

$68,100 + $107,800 $208,500

= 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

365

$110,400

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, Fifth Canadian Edition

PROBLEM 18-5A (Continued) Solvency Ratios Debt to 9. total assets

10.

$312,500 $998,200

= 31.3%

$407,000* Interest = coverage $28,000 * $407,000 = $265,300 + $113,700 + $28,000 =

$ 313,900 –

Profitability Ratios Gross profit 12. = margin

11. Free cash flow

$161,000

$152,900

$923,000 $1,948,500

47.4%

13.6%

13.

Profit margin

$265,300 $1,948,500

14.

Asset turnover

$1,948,500 = ($998,200 + $852,800) ÷ 2

15. Return on assets

14.5 times

$265,300 = ($998,200 + $852,800) ÷ 2 =

2.1 times

28.7%

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-5A (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

18.

Payout ratio

$15,000

$265,300

= 5.7%

Taking It Further: Johnson Cables’ liquidity is strong mainly because of the fast receivables and inventory turnovers. Its operating cycle of 67 days is likely reasonable, considering the product Johnson Cables sells. With respect to solvency, since most of the assets are financed with equity, the interest coverage ratio is very strong. Finally, profitability is superior mainly because of the high gross profit margin and return on equity ratios. Industry averages would also be useful to confirm this assessment.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (a) and (b) Liquidity Ratios

– $187,000 = $177,000

Current ratio

Acid-test ratio

$675,000 Receivables = = 7.0 turnover ($98,000* + $95,000**)÷2

$364,000 $187,000

= 1.9

Solutions Manual

$343,000 $182,000

= 1.9

$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 times

*$98,000 = $94,000 + $4,000 **$95,000 = $90,000 + $5,000 Collection period

$343,000 – $182,000 = $161,000

2011

1. Working capital $364,000

2010

(b) Change

365

7.0

= 52

days

$630,000 = 6.8 ($95,000* + $91,000**)÷2 *95,000 = $90,000 + $5,000 **$91,000 = $88,000 + $3,000 365

6.8

= 54

times

days

Chapter 18

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (Continued) (a) and (b) (Continued) Liquidity Ratios (Continued) 2011 2010 $620,000 $575,000 Inventory 6. = = 4.9 times = 4.8 times turnover ($130,000 + $125,000) ÷ 2 ($125,000 + $115,000) ÷ 2

Days sales in inventory

Operating = cycle

Solutions Manual

365

4.9

74 days

52 days

= 74

days

= 126 days

(b) Change F

365

4.8

= 76 days

76 days

54 days

= 130 days

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (Continued) (a) and (b) (Continued)

2011 Solvency Ratios Debt to 9. = total assets

10.

Interest coverage

11.

Free cash flow

Solutions Manual

$377,000 $754,000

2010 $332,000 $648,000

= 50.0%

$121,000* $35,000

(b) Change =

51.2%

$105,000* = 5.3 times $20,000 *$105,000 = $65,000 + $20,000 + *$121,000 = $64,000 + $22,000 + $35,000 $20,000

$68,000

– $120,000

= 3.5

times

= $(52,000)

$60,000

– $50,000 =

$10,000

Chapter 18

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (Continued) (a) and (b) (Continued)

2011

(b) Change

2010

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

Solutions Manual

Chapter 18

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (Continued) (a) and (b) (Continued) Profitability Ratios (Continued) $64,000 Earnings 17. = per share 20,000 18. Payout ratio =

Solutions Manual

$8,000

2011

(b) Change

2010 = $3.20

$65,000 20,000

$64,000 = 12.5%

$8,000

$65,000

= $3.25

= 12.3%

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6A (Continued) Taking It Further: Liquidity: Stayed essentially the same The overall liquidity of Click and Clack is slightly better than the previous year, but the changes are small. 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 2011 which in turn increased the debt and corresponding interest charges. Free cash consequently turned negative and the interest coverage ratio has deteriorated. 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

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-7A (a) ($ in millions of CAD dollars for Tim Hortons and US dollars for Starbucks) Liquidity Ratios

Tim Hortons

Current ratio

$465.0 $366.0

= 1.3

Receivables turnover

$2,043.7 $132.2

= 15.5

Collection period

Inventory turnover

Days sales in inventory

Operating cycle

Solutions Manual

365

÷ 15.5 = 24

$1,181.0 $65.9

= 17.9

times days

times

Starbucks

Ind.

$1,748.0 $2,189.7

= 0.8

1.8

$10,383.0 $308.7

= 33.6

365

times

36.1

days

= 6.7

times

51.9

÷ 33.6 = 11

$4,645.3 $692.3

365

÷ 17.9 = 20

days

365

6.7

= 54

days

= 65

days

= 44

Chapter 18

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-7A (Continued) (a) (Continued) Solvency Ratios Debt to total 7. assets

Tim Hortons =

Profitability Ratios Gross profit 8. = margin

Starbucks

Ind.

$852.2 $1,992.6

= 42.8%

$3,181.7 $5,672.6

= 56.1%

36.7%

$862.7 $2,043.7

= 42.2%

$5,737.7 $10,383.0

= 55.3%

26.6%

$315.5 $10,383.0

= 3.0%

3.5%

$10,383.0 $5,508.3

Profit margin

$284.7 $2,043.7

= 13.9%

10.

Asset turnover

$2,043.7 $1,894.9

11.

Return on assets

$284.7 $1,894.9

= 15.0%

$315.5 $5,508.3

= 5.7%

5.2%

12.

Return on equity

$284.7 $1,071.2

= 26.6%

$315.5 $2,387.5

= 13.2%

9.7%

Solutions Manual

1.1

times

1.9

times

1.5

Chapter 18

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-7A (Continued) (b)

Liquidity: When looking at the liquidity ratios, one can conclude that Tim Hortons is 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 twice as much time to collect accounts receivable compared to Starbucks. Consequently, its operating cycle is more than double as well. 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. Both businesses seem to have done poorly on inventory turnover when compared to the industry, but this might have been caused by the companies included in the industry that do not operate as franchises and so the comparison is not appropriate. Solvency: The debt to total assets ratio is better for Tim Hortons than for Starbucks. Both companies are significantly worse (higher) than the industry. Profitability: Tim Hortons is more profitable than Starbucks on all profitability ratios except its gross profit margin and asset turnover. It is better than the industry on all ratios, except its asset turnover.

Taking It Further: The differing year ends of Tim Hortons and Starbucks do not affect the comparative analysis because both companies are reporting profit results of the same length of time and their businesses are not seasonal in nature. Consequently, it is anticipated that the balances on the balance sheet will not be affected by seasonality.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-8A (a) Paperclip’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. Paperclip’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, Paperclip’s receivables turnover is better than Stapler and the industry average indicating Paperclip’s management is doing a better job at controlling the collection of the company’s receivables. (b) Paperclip’s ability to manage its inventory can be measured by the inventory turnover ratio. Currently Paperclip 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 Stapler and the industry average it appears that Paperclip is turning over its inventory faster than the competition. (c) Stapler is the more solvent of the two companies. Stapler has a much lower debt to total assets ratio indicating that Stapler has a lower percentage of its assets financed by debt. As well, Stapler has a higher interest coverage ratio, which is more in line with the industry average. This ratio indicates that Stapler has a better ability to service its debt as interest payments become due. When looking at the debt to total assets, Paperclip appears to be on a par with the average company in the industry. However, when assessing Paperclip’s ability to service its debt (as indicated by the interest coverage ratio), it can be seen that Paperclip is not as solvent as the average firm in the industry.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-8A (Continued) (d) Paperclip’s lower gross 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 its inventory than the competition. This may occur if, for example, Paperclip is not able to purchase inventory in the same quantity for the same price as its competition. • Paperclip 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. (e) 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 Stapler has the better possibility for growing its earnings and dividends. Because Stapler has been able to outperform its competitors, particularly in its gross profit percentage, this expectation is likely justified. Taking It Further: Return on assets is influenced directly by both the asset turnover and profit margins ratios. In both cases, Paperclip reports a higher ratio than Stapler so both are contributing to the higher return on assets ratio (13% for Paperclip vs. 8.8% for Stapler). However, Paperclip’s profit margin of 5% is 25% more than that of Stapler’s profit margin of 4%, while its asset turnover ratio of 2.6 times is “only” 18% larger than that of Stapler’s at 2.2 times. One could speculate that while both are contributing to the larger return on assets ratio, the profit margin has contributed slightly more than the asset turnover.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-9A

(a) Potash is more liquid. Its inventory turnover is much faster than Agrium’s, while its receivables turnover is the same. Consequently, its operating cycle is also much better than Agrium’s, as well as that of the industry. Its current ratio is not as strong as that of Agrium, or the industry, but it is possible that Agrium’s current ratio is somewhat inflated by slow moving inventory. (b) Potash is more solvent with a lower debt to total assets ratio and a better interest coverage ratio than Agrium. Nonetheless, both companies are covering their interest adequately, even though Agrium is below the industry average. (c) Overall, Potash is more profitable. It has a much higher gross profit margin, profit margin, return on assets, and return on equity. Its asset turnover is slightly lower than Agrium’s, but still better than that of the industry. Taking It Further: Based on its slightly higher price-earnings ratio and much higher payout ratio, investors favour Potash over Agrium. This is consistent with Potash’s superior solvency and profitability.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-10A (a) and (b)

(1) Current ratio

(c)

(a) Higher

(b) Higher

No impact

Company A

(2) Debt to total assets Company B

Company B

(3) Profit margin

Company A

An analyst must also consider other comprehensive income and the quality of the information. If one company has a significant amount of other comprehensive income compared to the other, the profitability comparison could be skewed. In addition, if the quality of the information provided is poor, its value for financial analysis will also be poor. Given that the companies are similar and in the same industry, it is unlikely that other limitations of financial analysis, such as diversification, inflation, and economic factors, would affect one company more than the other but it cannot be ruled out.

Taking It Further: The impact the different accounting policies will have on each company’s financial position and resulting ratios must be considered so that the comparison performed by the analyst is meaningful. The analyst can recast the information concerning the classification of the investments to one that is consistent between the two companies. Doing so will yield ratios that will be more comparable. As for the depreciation method, the impact of the differing methods can be calculated or simply taken into account when drawing conclusions from the ratios calculated.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-1B (a) WESTJET AIRLINES LTD. Income Statement Horizontal Analysis Year ended December 31

Revenue Operating expenses Profit for operations Other expenses Profit before income taxes Income tax expense Profit

2008 184% 175% 290% 78%

2007 153% 142% 298% 131%

2006 127% 122% 197% 71%

2005 100% 100% 100% 100%

490% 275% 742%

456% 157% 804%

315% 175% 479%

100% 100% 100%

WESTJET AIRLINES LTD. Balance Sheet Horizontal Analysis Year ended December 31

Assets Current assets Non-current assets Total assets

2008

2007

2006

2005

289% 124% 148%

224% 120% 135%

143% 120% 123%

100% 100% 100%

157% 124% 132% 142%

123% 125% 124% 120%

100% 100% 100% 100%

135%

123%

100%

Liabilities & Shareholders’ Equity Current liabilities 196% Non-current liabilities 125% Total liabilities 142% Shareholders' equity 162% Total liabilities & shareholders' equity 148%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-1B (Continued) (b) Over the last years, the increase in current assets has far outpaced the increase the current liabilities, and therefore WestJet’s liquidity has improved. The percentage increases each year in the non-current assets and non-current liabilities are practically the same. On the other hand, the increase in shareholders’ equity is far stronger as the company ages and is able to retain more of its profits. Operating expenses have been growing at a slower pace than revenues. Other expenses have been kept in check in spite of the increase in the revenues.

Taking It Further:

Total liabilities Shareholders' equity Total liabilities and shareholders' equity

2008 67% 33%

2007 68% 32%

2006 70% 30%

2005 70% 30%

100%

The business is financed more (twice more) with debt than equity, although the debt to equity proportions have declined marginally over the last four years.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth 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 a good control over the operating expenses.

(b)

The change in the percentage increase in profit before tax and income tax expense is the same 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 will change in the same proportion as the change in profit before income taxes. As demonstrated in the vertical analysis 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.

(c)

Although most expenses have grown in similar proportions to the increase in revenue, this is not the case for interest expense. 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 a major increase of 240% over a three year period turns out to have a modest effect on the profit.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-2B (Continued) Taking It Further: Horizontal and vertical analysis of the balance sheet, as well as the financial statements themselves along with some ratio analysis would be useful in assessing this company’s performance and financial position. Comparisons of this company to other businesses in the industry, as well as understanding any external economic or other factors, would also be useful.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-3B (a)

Income Statement Year Ended June 30, 2011

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%

Muskoka = $336,960 ÷ $1,400,000 = 24.1%

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-3B (Continued) Asset Turnover: Net sales ÷ Average total assets Manitou: Average total assets = ($535,000 + $380,000) ÷ 2 = $457,500 Asset Turnover $360,000 ÷ $457,500 = 0.8 times

Muskoka Average total assets = ($1,900,000 + $1,550,000) ÷ 2 = $1,725,000 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: Average shareholders’ equity = ($249,600 + $160,000) ÷ 2 = $204,800 Return on Equity $89,600 ÷ $204,800 = 43.8% (c)

Muskoka Average shareholders’ equity = ($911,960 + $575,000) ÷ 2 = $743,480 Return on Equity $336,960 ÷ $743,480 = 45.3%

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 it has a lower amount of rental income. Manitou has good control over its operating expenses, compared to Muskoka. Its return on equity is also better. Its asset turnover is the same, and its return on assets slightly lower, than that of Manitou.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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 sells, as is demonstrated by its gross profit percentage.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-4B

(a)

(b)

(c)

(d)

Profit Margin Transaction (10%) Issues common NE shares for cash Sells equipment D at a loss Pay principal on mortgage NE note payable Share price decreases from $16 NE per share to $12 per share

Asset Turnover (1.5 times)

Earnings per Share ($2)

PriceEarnings Ratio (8 times)

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-4B (Continued) Taking It Further: In the case of the price-earnings ratio, since there is a loss, there can be no meaningful price-earnings ratio calculated (N/A). The following table shows the effect of the change in the ratios when there is a negative profit margin and negative earnings per share.

(a)

(b)

(c)

(d)

Transaction Issues common shares for cash Sells equipment at a loss Pay principal on mortgage note payable Share price decreases from $16 per share to $12 per share

Profit Margin (–10%)

Asset Turnover (1.5 times)

I (more negative)

N/A

I (more negative)

N/A

Loss per Share (–$2)

Priceearnings Ratio (N/A)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-5B Liquidity Ratios 1. Working capital 2.

Current ratio

$250,500

– $180,150

$250,500 $180,150

= $70,350 = 1.4

$154,100* Acid-test = ratio $180,150 *$154,100 = $23,100 + $24,800 + $106,200

= 0.9

$790,000 Receivables = = 7.5 turnover ($111,700* + $98,300**)÷2 *$111,700 = $106,200 + $5,500 **$98,300 = $93,800 + $4,500

Collection period

Inventory turnover

Days sales in = inventory

Operating cycle

365 ÷

7.5

$540,000 ($96,400 + $74,000) ÷ 2

times

= 49

days

= 6.3

times

365

6.3

= 58

days

= 107

days

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-5B (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

$110,420

Profitability Ratios Gross profit 12. = margin

–

$53,500

$56,920

$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%

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-5B (Continued) Profitability Ratios (Continued) 17.

Earnings per share

$73,270 15,000

Payout ratio

$15,420

= $4.88 ÷

$73,270

= 21.0%

Taking It Further: It is hard to assess Rosen’s liquidity without knowing what kind of product it sells. Its receivables and inventory turnover appear to be slow at first glance depending on what the usual terms are for this industry. As for solvency, since most of the assets are financed with equity, the interest coverage ratio is strong. Profitability appears to be strong mainly because of the high gross profit margin, but again it depends on what is usual for this kind of industry. All other profitability ratios also appear to be strong when viewed on their own.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6B

Liquidity Ratios Working = 1. capital

$415,000

Current ratio

$415,000 $337,750

= 1.2

Acid-test ratio

$50,000 + $100,000 $337,750

= 0.4

2011

Change

2010

– $337,750 = $77,250

$360,000 –

$315,000 = $45,000

$360,000 $315,000 $42,000 + $87,000 $315,000

= 1.1

= 0.4

$1,000,000 $940,000 Receivable = = 10.2 times = 10.8 times s turnover ($105,000* + $91,000**)÷2 ($91,000* + $83,000**)÷2) *$105,000 = $100,000 + $5,000 *$91,000 = $87,000 + $4,000 **$91,000 = $87,000 + $4,000 **$83,000 = $80,000 + $3,000 Collection period

Solutions Manual

365

10.2

= 36

days

365

10.8

= 34

days

Chapter 18

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PROBLEM 18-6B (Continued) Liquidity Ratios (Continued) 2011 6.

Inventory turnover

Days sales = in inventory

Operating cycle

Solutions Manual

Chan -ge

2010

$650,000 = 3.0 ($240,000 + $200,000) ÷ 2

times

$635,000 = 2.8 ($200,000 + $250,000) ÷ 2

times

365

3.0

= 122

days

365

2.8

= 130

days

122

= 158

days

130

= 164

days

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6B (Continued) Solvency Ratios 2011 9.

Debt to total assets

10.

Interest coverage

11.

Free cash flow

Solutions Manual

$437,750 $1,240,000

Chan -ge

2010 = 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 $92,000 –

$80,000

= $12,000

$65,000 –

$50,000

= $15,000

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6B (Continued) Profitability Ratios 2011

Chan -ge

2010

Gross 12. profit margin

$350,000 $1,000,000

= 35.0%

$305,000 $940,000

= 32.4%

13.

Profit margin

$97,750 $1,000,000

= 9.8%

$76,500 $940,000

= 8.1%

14.

Asset turnover

$1,000,000 $940,000 = 0.8 times =0.9 times ($1,240,000 + $1,135,000)÷2 ($1,135,000 + $1,075,000)÷2

15.

Return on assets

$97,750 = 8.2% ($1,240,000 + $1,135,000)÷2

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$76,500 = 6.9% ($1,135,000 + $1,075,000)÷2

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-6B (Continued) Profitability Ratios (Continued)

16.

Return on equity

17.

Earnings per share

18. Payout ratio =

Solutions Manual

2011 $97,750 ($802,250 + $720,000) ÷ 2

Chan -ge

= 11.1%

= $0.61

$76,500

= 20.3%

Chapter 18

$97,750 − $15,500 100,000 $15,500

$97,750

= 12.8%

2010 $76,500 ($720,000 + $659,000) ÷ 2

= $0.82 = 15.9%

$76,500 − $15,500 100,000 $15,500

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PROBLEM 18-6B (Continued) Taking It Further: (a) Liquidity: Slight improvement for most ratios Star Track’s overall liquidity has improved slightly compared to the previous year and the changes are modest in size. The only liquidity ratio that has deteriorated slightly is the receivables turnover ratio. However, overall the operating cycle improved. (b) Solvency: Improved The debt to total assets ratio improved slightly. The interest coverage ratio improved significantly, so overall solvency improved. A larger amount of cash was used in investing activities during 2011 compared to 2010 which resulted in a decrease in free cash flow. (c) Profitability: Improved Profitability, with the exception of the asset turnover ratio which decreased slightly, has improved overall.

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-7B (a) ($ in thousands) Liquidity Ratios

The Brick

Leon's

Ind.

Current ratio =

$296,029 $307,509

= 1.0

$264,777 $129,585

= 2.0

2.3

Receivables turnover

$1,427,113 $71,186

= 20.0 times

$740,376 $31,988

= 23.1 times

23.1

Collection period

365

= 18

days

365

= 16

days

Inventory turnover

= 3.8

times

$440,360 $84,272

= 5.2

times

7.2

Days sales in inventory

Operating cycle

Solutions Manual

20.0

$846,577 $222,165

23.1

365

3.8

= 96

days

365

÷ 5.2

= 70

days

= 114

days

= 86

days

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Accounting Principles, Fifth Canadian Edition

PROBLEM 18-7B (Continued) Solvency Ratios Interest 7. coverage 8.

Debt to total assets

The Brick

Leon's

Not applicable — loss incurred

Not applicable — no interest exp.

$565,559

= 80.3%

$160,050

Ind.

= 31.2%

17.4%

4.3%

Profitability Ratios Profit 9. = margin

$(200,756) $1,427,113

= (14.1%)

$63,390 $740,376

= 8.6%

10.

Asset turnover

$1,427,113 $835,494

= 1.7

$740,376 $494,317

= 1.5

11.

Return on assets

$(200,756) $835,494

= (24.0%)

$63,390 $494,317

= 12.8%

8.2%

12.

Return on equity

$(200,756) $269,900

= (74.4%)

$63,390 $337,682

= 18.8%

17.7%

Solutions Manual

times

Chapter 18

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PROBLEM 18-7B (Continued) (b) Before conclusions can be drawn concerning the comparison of the liquidity, solvency and profitability between The Brick and Leon’s, it would be important to determine what is the source of the other expenses charge in the amount of $279,751,000 for The Brick. Operational results can be used for comparison, but profitability results cannot be fairly compared without a better understanding of the source of this expense. Liquidity: The Brick’s liquidity ratios are weaker than those of Leon’s. They are below industry averages for the receivables and inventory turnover ratios, with a resulting longer operating cycle. That said, its collection period is still very good at only 18 days. Leon’s, on the other hand, is close to the industry averages for its liquidity ratios, with the exception of inventory turnover and operating cycle, where it is worse than the industry average. Solvency: Leon’s debt to total assets is reasonable, yet it is worse than the industry average. The Brick’s debt to assets ratio is very high, perhaps because of its organization structure as an income fund. Profitability: The Brick’s only positive profitability ratio is its asset turnover which is also stronger than Leon’s but below industry average. As for other profitability ratios, they are all negative and the comparison of The Brick’s results cannot be made for the reasons stated earlier. Leon’s profit margin, return on assets, and return on equity are better than the industry averages, indicating that Leon’s is profitable.

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PROBLEM 18-7B (Continued) Taking It Further: The Brick’s structure as an income fund means that it would have less equity than a corporation such as Leon’s. This makes comparisons somewhat meaningless with respect to nonoperational ratios. As an income fund, the income tax treatment is also different from that of a regular corporation. As well, the other expenses affect several financial results and balances, rendering some comparisons meaningless.

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PROBLEM 18-8B

(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 worse than that of Refresh, but still better than the average company in the industry (365 ÷ 9.3 = 39 days). (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 for Flavour and the industry average, it appears that Refresh is turning over its inventory at a much slower rate than the competition. (c) 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 18-8B (Continued) (d) 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 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 (e) 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 earnings and dividends. The fact that Refresh has been able to outperform its competitors particularly in its gross profit and profit percentages, this expectation is likely justified.

Taking It Further: Return on assets is influenced directly by both the asset turnover and profit margins ratios. Refresh reports a higher profit margin than Flavour and the same asset turnover as Flavour. Consequently, it is the profit margin—profitability— that is the reason for Refresh’s higher return on assets ratio (11.2% for Refresh vs. 9.3% for Flavour).

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PROBLEM 18-9B

(a)

Snap-On is more liquid than Black & Decker. It has a higher current and acid-test ratio and is turning over inventory faster and has a better operating cycle. The receivables turnover is slightly lower, but very close, to that of Black & Decker.

(b) Snap-On is more solvent. Snap-On has less debt to total assets than Black & Decker. Although not meeting the industry average, Snap-On also has a better interest coverage ratio than Black & Decker. Snap-On’s ratios are more in line with the industry average with respect to solvency ratios. (c)

Both companies are profitable, exceeding the industry average for all ratios except for Black & Decker’s gross profit margin. Snap-On has stronger profitability demonstrated by its higher gross profit margin and higher profit margin. Black & Decker has slightly better returns on assets and equity compared to Snap-On.

Taking It Further: Investors seem to favour Snap-On as it has a slightly higher price-earnings ratio. This is consistent with (b) as investors would likely favour a company with a better solvency position and (c) as investors favour the more profitable company.

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PROBLEM 18-10B (a) and (b)

(c)

(a) Higher

(b) Higher

(1) Current ratio

Company A

Company A (i.e., current portion of lease liability)

(2) Debt to total assets

Company B

(3) Gross profit margin

Company A

No impact

An analyst must also consider comprehensive income and the quality of the information. If one company has a significant amount of comprehensive income compared to the other, the profitability comparison could be skewed. In addition, if the quality of the information provided is poor, its value for financial analysis will also be poor. Given that the companies are similar and in the same industry, it is unlikely that other limitations of financial analysis, such as diversification, inflation, and economic factors, would affect one company more than the other but it cannot be ruled out.

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PROBLEM 18-10B (Continued) Taking It Further: The impact the different accounting policies will have on each company’s financial position and resulting ratios must be considered so that the comparison performed by the analyst is meaningful. The analyst can recast the information of Company B concerning the capital lease (excluding the asset and the liability from the balance sheet) so that the adjusted balance sheet is consistent with Company A. Doing so will yield ratios that will be comparable. As for the inventory cost formula, the impact of the differences can be calculated, or more simply, taken into account when drawing conclusions from the analysis as the differences are not likely to be significant.

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CONTINUING COOKIE CHRONICLE (a) 1.

Current ratio

$56,741 $29,891

1.9 :1

Acid-test ratio

$29,294 + $3,250 $29,891

1.1 :1

Receivables turnover

146.2 times

Collection period

2 days

Inventory turnover

13.3 times

Days sales in inventory

27 days

Operating cycle

2 27 29

Debt to total assets

$36,891 $143,591

$475,000 $3,250 365

146.2

$237,500 $17,897 365

13.3

days days days

= 25.7%

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Accounting Principles, Fifth Canadian Edition

CONTINUING COOKIE CHRONICLE (Continued) (a) (Continued) $72,000 + $18,000 + $210 = $210

Interest coverage

10.

Gross profit margin

$237,500 $475,000

50.0%

11.

Profit margin

$72,000 $475,000

15.2%

12.

Asset turnover

$475,000 $143,591

13.

Return on assets

$72,000 $143,591

50.1%

14.

Return on equity

$72,000 $106,700

67.5%

429.6 times

3.3 times

(b) The company had a good year. It was very profitable and has a healthy balance sheet. The company is carrying very little debt and can cover the interest charges easily. There are no liquidity or solvency problems.

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CONTINUING COOKIE CHRONICLE (Continued) (c) The bank should have no qualms about lending money to the company, under certain conditions. The new debt to total assets ratio would still be reasonable [($36,891 + $25,000) ÷ ($143,591 + $25,000) = 36.7%]. Even if there were no increases in revenue, operating profit would still be adequate to cover the additional interest expense. The company is profitable and is an acceptable credit risk for the bank. However, what might be of concern to the bank is that there are insufficient assets to take as security against this bank loan. That is, the fair value of the total assets is not likely sufficient as security. The bank will most likely ask for a personal guarantee as security for this loan. (d) Instead of bank financing, Cookie & Coffee Creations Ltd. could lease the equipment. Cookie & Coffee Creations Ltd. could also consider equity financing (issuing additional shares).

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BYP 18-1 FINANCIAL REPORTING PROBLEM (a) THE FORZANI GROUP LTD. Consolidated Balance Sheets (in thousands) 2009 2008 ASSETS Current Cash Accounts receivable Inventory Prepaid expenses Total current assets Capital assets Goodwill and other intangibles Other assets Future income tax asset Total assets

Solutions Manual

3,474 84,455 291,497 2,827 382,253 196,765 91,481 9,280 9,681 $689,460

$ 47,484 75,506 319,445 14,501 456,936 188,621 89,335 3,863 16,209 $754,964

Increase (Decrease) Amount Percentage $(44,010) 8,949 (27,948) (11,674) (74,683) 8,144 2,146 5,417 (6,528) $(65,504)

-92.7% 11.9% -8.7% -80.5% -16.3% 4.3% 2.4% 140.2% -40.3% -8.7%

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BYP 18-1 (Continued) (a) Continued THE FORZANI GROUP LTD. Consolidated Balance Sheets (in thousands) 2009 2008 LIABILITIES Current Indebtedness under revolving credit Accounts payable and accrued liabilities Current portion of long-term debt Total current liabilities Long-term debt Deferred lease inducements Deferred rent liability

$ 17,130 277,820 7,501 302,451 126 47,811 5,893

Total liabilities SHAREHOLDERS’ EQUITY Share capital Contributed surplus Accumulated other comprehensive earnings Retained earnings Total shareholders' equity Total liabilities and shareholders' equity

Solutions Manual

Increase (Decrease) Amount Percentage

$279,910 51,863 331,773 6,586 55,089 6,033

$ 17,130 (2,090) (44,362) (29,322) (6,460) (7,278) (140)

n/a -0.7% -85.5% -8.8% -98.1% -13.2% -2.3%

356,281

399,481

(43,200)

-10.8%

147,161 6,401 863 178,754 333,179 $689,460

157,105 7,210 (8) 191,176 355,483 $754,964

(9,944) (809) 871 (12,422) (22,304) $(65,504)

-6.3% -11.2% n/a -6.5% -6.3% -8.7%

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BYP 18-1 (Continued) (a) (Continued)

THE FORZANI GROUP LTD. Consolidated Statements of Operations (in thousands) 2009 2008

Revenue Retail Wholesale Cost of sales Gross margin Operating and administrative expenses Store operating General and administrative Operating earnings Amortization of capital assets Interest expense Loss on sale of investments Earnings before income taxes Provision for income taxes Current Future Net earnings

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Increase (Decrease) Amount Percentage $ 24,787 2.6% (9,038) -2.5% 15,749 1.2% 10,631 1.2% 5,118 1.1%

$ 994,043 352,715 1,346,758 863,239 483,519

$ 969,256 361,753 1,331,009 852,608 478,401

277,089 109,328 386,417 97,102 47,613 5,175 52,788 44,314

251,630 103,801 355,431 122,970 44,468 5,797 864 51,129 71,841

25,459 5,527 30,986 (25,868) 3,145 (622) (864) 1,659 (27,527)

10.1% 5.3% 8.7% -21.0% 7.1% -10.7% -100.0% 3.2% -38.3%

6,273 8,716 14,989 $ 29,325

27,439 (3,049) 24,390 $ 47,451

(21,166) 11,765 (9,401) $(18,126)

-77.1% -385.9% -38.5% -38.2%

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BYP 18-1 (Continued) (b) Note: The vertical percentages shown in part (b) of this question may not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

ASSETS Current Cash Accounts receivable Inventory Prepaid expenses Total current assets Capital assets Goodwill and other intangibles Other assets Future income tax asset Total assets

Solutions Manual

THE FORZANI GROUP LTD. Consolidated Balance Sheets (in thousands) 2009 Amount Percentage $ 3,474 84,455 291,497 2,827 382,253 196,765 91,481 9,280 9,681 $689,460

0.5% 12.2% 42.3% 0.4% 55.4% 28.5% 13.3% 1.3% 1.4% 100.0%

2008 Amount Percentage $ 47,484 75,506 319,445 14,501 456,936 188,621 89,335 3,863 16,209 $754,964

6.3% 10.0% 42.3% 1.9% 60.5% 25.0% 11.8% 0.5% 2.1% 100.0%

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BYP 18-1 (Continued) (b) (Continued) THE FORZANI GROUP LTD. Consolidated Balance Sheets (in thousands) 2009 2009 Amount Percentage LIABILITIES Current Indebtedness under revolving credit $ 17,130 Accounts payable and accrued liabilities 277,820 Current portion of long- term debt 7,501 Total current liabilities 302,451 Long-term debt 126 Deferred lease inducements 47,811 Deferred rent liability 5,893 Total liabilities 356,281 SHAREHOLDERS’ EQUITY Share capital 147,161 Contributed surplus 6,401 Accumulated other comprehensive earnings 863 Retained earnings 178,754 Total shareholders' equity 333,179 Total liabilities and shareholders' equity $689,460

Solutions Manual

2008 Amount

2008 Percentage

2.5% 40.3% 1.1% 43.9% 0.0% 6.9% 0.9% 51.7%

$279,910 51,863 331,773 6,586 55,089 6,033 399,481

37.1% 6.9% 43.9% 0.9% 7.3% 0.8% 52.9%

21.3% 0.9% 0.1% 25.9% 48.3% 100.0%

157,105 7,210 (8) 191,176 355,483 $754,964

20.8% 1.0% n/a 25.3% 47.1% 100.0%

Chapter 18

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BYP 18-1 (Continued) (b) (Continued)

THE FORZANI GROUP LTD. Consolidated Statements of Operations (in thousands) 2009 Revenue Amount Percentage Retail $ 994,043 73.8% Wholesale 352,715 26.2% 1,346,758 100.0% Cost of sales 863,239 64.1% Gross margin 483,519 35.9% Operating and administrative expenses Store operating 277,089 20.6% General and administrative 109,328 8.1% 386,417 28.7% Operating earnings 97,102 7.2% Amortization of capital assets 47,613 3.5% Interest expense 5,175 0.4% Loss on sale of investments 52,788 3.9% Earnings before income taxes 44,314 3.3% Provision for income taxes Current 6,273 0.5% Future 8,716 0.6% 14,989 1.1% Net earnings $ 29,325 2.2%

Solutions Manual

2008 Amount Percentage $ 969,256 72.8% 361,753 27.2% 1,331,009 100.0% 852,608 64.1% 478,401 35.9% 251,630 103,801 355,431 122,970 44,468 5,797 864 51,129 71,841

18.9% 7.8% 26.7% 9.2% 3.3% 0.4% 0.1% 3.8% 5.4%

27,439 (3,049) 24,390 $ 47,451

2.1% -0.2% 1.8% 3.6%

Chapter 18

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Accounting Principles, Fifth Canadian Edition

BYP 18-1 (Continued) (c) On the balance sheet, the noticeable decrease in cash is explained by the presence of the new revolving line of credit which provides the necessary cash when needed. We also note a horizontal increase in accounts receivable of 11.9%, which is much larger than the increase in revenue during the same period of 1.2%. Debt that come due in 2009 was also paid off without new long term debt secured. Note that while total liabilities changed noticeably in the horizontal analysis (a decrease of 10.8%), it decreased much less as a percentage of total assets in the vertical analysis because assets decreased as well. On the income statement (or statement of operations as it is called by Forzani), retail revenue increases were offset by wholesale revenue decreases. Store operating, general and administrative expenses rose faster than revenue (8.7% versus 1.2% on the horizontal analysis). This was confirmed on the vertical analysis as well, with expenses increasing as a percentage of revenue between the two years from 26.7% to 28.7%. Interest costs decreased with the elimination of most of the long-term debt. These factors combined to bring profit down by 38.2%, using the horizontal analysis.

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BYP 18-2 INTERPRETING FINANCIAL STATEMENTS (a) In terms of liquidity, both companies have very low ratios, but this is in line with the industry. CN is outpacing CP and the industry for its receivables turnover by a considerable margin. Neither company has inventory (they don’t sell a product, they sell a service). (b) CN is more solvent than CP and the industry in all of the solvency ratios. (c) CN is more profitable. All of its ratios are equal to or better than the industry average and better than those of CP. In particular, CN’s profit margin is far superior and driving its higher return on assets ratio as its asset turnover is the same as that of CP. (d) Where financial results are significantly different because of accounting differences between Canadian GAAP and U.S. GAAP, the ratios should be adjusted and interpreted with care. However, the major differences between the two accounting standards (e.g., inventory, investments, etc.) do not appear to apply here. Consequently the results, expressed in ratios, are not likely to materially differ and cause any difficulty in ratio comparisons to assess financial performance and position.

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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 To: Self 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. To address this issue, I have identified the following two questions to raise at the audit committee: 1.

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?

Alternative accounting policies: What accounting policies are being used? Has EasyMix commenced the transition to IFRS as yet? If so, or even if not, have any of its accounting policies changed during the year? How do the policies of this company compare to those used by its key competitors in the cement industry?

Other limitations, believed to be of lesser importance to the company, could include: 1.

Comprehensive income: Does EasyMix have any comprehensive income? If so, what is the impact on the profitability ratios presented?

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BYP 18-4 (Continued) 2.

Diversification: How diversified is this company? I don’t imagine that it is highly diversified from the description given. Are its competitors similar enough for comparisons to be made?

Quality of information: How would you describe the quality of earnings reported by the company? What significant estimates have been used in preparing the financial statements? How reliable are these estimates? Are there any bonus plans or stock option plans that may add pressure to management to produce higher profits?

Inflation: To what extent is inflation an issue for the company? It is likely not an issue in Canada, but it may be an issue in some of the countries around the world that the company is operating in.

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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)

The purpose of the Management Discussion and Analysis (MD&A) of Canadian Tire’s is to provide a description of the economic, financial, and other factors behind the business usually broken down by its main products, services, or departments. It provides management’s perspective on such topics as the company’s past plans, current performance, and future goals. This section of the annual report is not audited, and is prepared from the point of view of management. It is not intended to be used in isolation.

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BYP18-6 (Continued) (b) ($ in millions) 2009 1.

Current ratio

Inventory 2. = turnover Debt to 3. total assets

$5,112.5 $2,564.1 $7,788.1* ($933.6 + $917.5) ÷2

$5,101.6 $8,789.5

2.0:1

= 8.4

times

58.0%

2008

Change

2.0:1

No change

7.6

times

54.2%

Interest 4. = coverage

$335.0 + $144.2 + $130.0 + $17.0 $130.0 + $17.0

= 4.3

Gross 5. profit margin

$8,686.5 – $7,788.1* $8,686.5

10.3%

10.1%

$335.0 $8,686.5

3.9%

4.1%

Profit margin

times

5.4

times

* Note that this calculation uses, for comparative purposes, the cost of goods sold and other operating expenses given in the income statement. It could be further refined by using the number given for cost of goods sold in Note 3.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP18-6 (Continued) (b) (Continued)

Return = on assets

2009 = $335.0 ($8,789.5 + $7,783.8) ÷ 2

Return = on equity

= $335.0 ($3,687.9 + $3,565.0) ÷ 2

10.

Price= earnings ratio

$57.50 $4.10

Payout ratio

$68.7 $335.0

2008

Change

4.0%

5.1%

9.2%

11.2%

14.0 times

9.8 times

20.5%

18.3%

The perspective of whether the change in the price-earnings and payout ratio is favourable or unfavourable will depend on whether an investor is interested in purchasing Canadian Tire’s shares for growth or dividend income or both.

(c)

The closing price of the Canadian Tire CTC.A** shares on the Toronto Stock Exchange at the following dates was: 1. 2. 3. 4.

January 4, 2008 December 31, 2008 January 5, 2009 December 31, 2009

$67.32 $43.45 $45.60 $57.50

** Note that Canadian Tire has two classes of shares. The CTC.A (Class A non-voting) shares are Canadian Tire’s primary share class. It also has a much smaller number of CTC (common) shares issued.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP18-6 (Continued) (d)

Between 2005 and 2009, Canadian Tire’s share price has been volatile within each year, but has not changed very much overall in the five years. The shares were trading around $56 at the beginning of 2005 and closed at $57 at the end of 2009. The share price peaked about mid-2007 and hit a low point in the first quarter of 2009 before starting to recover. This interpretation will change depending on the five year period used in the chart.

(e)

Yes, I think an investment in Canadian Tire shares is a sound investment as Canadian Tire is a relatively “recession-proof” business. Its liquidity improved between 2008 and 2009, as did its gross profit margin. It must be noted though that its profit margin and return ratios declined as did its solvency. This was not surprising given the economic and credit conditions in 2009. The Chief Financial Officer notes that the company will be able to retire a significant amount of debt maturing in 2010. The MD&A also notes that the decline in profitability was affected by higher loan loss provisioning due to the economic environment and higher interest expense attributable to carrying excess liquidity in their Financial Services division. This is likely why, despite these declines in solvency and profitability, Canadian Tire’s price-earnings ratio improved significantly, indicating that investors believe there is growth in Canadian Tire’s future. It also improved its payout ratio so an investment, whether for growth or for income, would appear to be warranted.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

BYP18-6 (Continued) (f)

Both fundamental analysis and technical analysis should be used in investment decisions. Most investors rely on the work done by analysts who follow the company carefully and provide rating and recommendations as well as expectations of the performance of the stock in the future.

Weygandt, Kieso, Kimmel, Trenholm, Kinnear

Accounting Principles, Fifth Canadian Edition

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