Test Bank for Intermediate Accounting, Tenth Canadian Edition, Volume 1 and Volume 2 by Donald E Kie by Ace Test Banks

Intermediate Accounting, Tenth Canadian Edition, Volume 1 and Volume 2 By Donald E. Kieso

CHAPTER 1 THE CANADIAN FINANCIAL REPORTING ENVIRONMENT SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY

Note:

Item

LOD

Item

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

1 1 1 1 1 1 2 2

M E E E E M M E

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

31. 32. 33.

1 2 3

M H E

34. 35. 36.

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 2 M 17. 6 M 2 H 18. 6 M 3 E 19. 6 H 4 M 20. 6 M 4 H 21. 6 E 4 H 22. 6 M 4 M 23. 6 E 5 M 24. 6 M Exercises 3 H 37. 6 H 3 M 38. 6 M 4 H 39. 7 M

M = Medium

H = Hard

Item

LOD

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

7 8 9 9 9 9

E E M M H E

40. 41.

9 9

H H

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

1. 2.

MC MC

3. 4.

MC MC

11.

31.

12.

13.

16.

17. 18.

MC MC

19. 20.

MC MC

25.

39.

Item Type Item Type Learning Objective 1 5. MC 31. Ex 6. MC Learning Objective 2 9. MC 10. MC Learning Objective 3 33. Ex 34. Ex Learning Objective 4 14. MC 15. MC Learning Objective 5 Learning Objective 6 21. MC 23. MC 22. MC 24. MC Learning Objective 7

Item

Type

32.

35.

36.

37. 38.

Ex Ex

40.

Item

Type

41.

Learning Objective 8 26. 27.

MC MC

28.

Note: MC = Multiple Choice

Learning Objective 9 29. MC 30. MC Ex = Exercise

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CHAPTER STUDY OBJECTIVES 1. Explain how accounting makes it possible to use scarce resources more efficiently. Accounting provides reliable, relevant, and timely information to managers, investors, and creditors so that resources are allocated to the most efficient enterprises. Accounting also provides measurements of efficiency (profitability) and financial soundness. 2. Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one. Investors, creditors, management, securities commissions, stock exchanges, analysts, credit rating agencies, auditors, and standard setters are some of the major stakeholders. See Illustration 1-3.

3. Identify the objective of financial reporting. The objective of financial reporting is to communicate information that is useful to key decision makers such as investors and creditors in making resource allocation decisions (including assessing management stewardship) about the resources and claims to resources of an entity and how these are changing.

4. Explain how information asymmetry and bias interferes with the objective of financial reporting. Ideally, all stakeholders should have access to the same information in order to ensure that good decisions are made in the capital marketplace. (This is known as information symmetry.) However, this is not the case—there is often information asymmetry. Of necessity, management has access to more information so that it can run the company. It must also make sure that it does not give away information that might harm the company, such as in a lawsuit where disclosure might cause the company to lose. Aside from this, information asymmetry exists because of management bias whereby management acts in its own self-interest, such as wanting to maximize management bonuses. This is known as moral hazard in accounting theory. Information asymmetry causes markets to be less efficient. It may cause stock prices to be discounted or costs of capital to increase. In addition, it might detract good companies from raising capital in the particular market where relevant information is not available (referred to as adverse selection in accounting theory). The efficient markets hypothesis is felt to exist only in a semi-strong form, meaning that only publicly available information is assimilated into stock prices.

5. Explain the need for accounting standards. The accounting profession has tried to develop a set of standards that is generally accepted and universally practised. This is known as GAAP (generally accepted accounting principles). Without this set of standards, each enterprise would have to develop its own standards, and readers of financial statements would have to become familiar with every company’s particular accounting and reporting practices. As a result, it would be almost impossible to prepare statements that could be compared. In addition, accounting standards help deal with the information asymmetry problem.

6. Identify the major entities that influence the standard-setting process and explain how they influence financial reporting. The Canadian Accounting Standards Board (AcSB) is the main standard-setting body in Canada for private companies, pension plans, and not-for-profit entities. Its mandate comes from the Canada Business Corporations Act and Regulations as well as provincial acts of incorporation. For public companies, GAAP is International Financial

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Reporting Standards (IFRS) as established by the International Accounting Standards Board (IASB). Public companies are required to follow GAAP in order to access capital markets, which are monitored by provincial securities commissions. The Financial Accounting Standards Board (FASB) is also important as it influences IFRS standard setting. Private companies may choose to follow IFRS. Public companies that list on U.S. stock exchanges may choose to follow U.S. GAAP.

7. Explain the meaning of generally accepted accounting principles (GAAP). Generally accepted accounting principles are either principles that have substantial authoritative support, such as the CICA Handbook, or those arrived at through the use of professional judgement and the conceptual framework.

8. Explain the significance of professional judgement in applying GAAP. Professional judgement plays an important role in Accounting Standards for Private Enterprises (ASPE) and IFRS since much of GAAP is based on general principles, which need to be interpreted.

9. Discuss some of the challenges and opportunities for accounting. Some of the challenges facing accounting are oversight in the capital markets, centrality of ethics, standard setting in a political environment, principles versus rules-based standard setting, the impact of technology, and integrated reporting. All of these require the accounting profession to continue to strive for excellence and to understand how accounting adds value in the capital marketplace.

The Canadian Financial Reporting Environment

MULTIPLE CHOICE—Conceptual Answer d a c b d c b d a c b c c b d b c a c d b d b a c d b c c a

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Description Accounting characteristics Nature of financial accounting Definition of financial accounting Definition of management accounting Efficient use of resources Capital allocation process Stakeholders in the financial reporting environment Preparation of audited financial statements Auditor’s responsibility Causes of subprime lending crisis Objectives of financial reporting Preparation of biased information Existence of information asymmetry Efficient markets hypothesis Management bias Reduction of information asymmetry Responsibility of the AcSB Oversight of AcSB Authority over accounting standards in the U.S Development of financial reporting standards in Canada Adoption of IFRS Activities and authority of the OSC Use of ASPE IASB’s standard setting process Primary sources of GAAP under ASPE Exercise of professional judgement SOX Rules-based vs. principles-based approach Changing financial reporting environment Advancement of technology on financial reporting

EXERCISES Item 1-31 1-32 1-33 1-34 1-35 1-36 1-37 1-38 1-39 1-40 1-41

Description Effective capital allocation Stakeholders in the financial reporting environment Objectives of financial reporting Entity vs. proprietary perspective User needs Information asymmetry Role of securities commissions and stock exchanges Standard setting Source of GAAP SOX and standard setting Challenges facing financial reporting

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. The essential characteristic(s) of accounting is (are) a) communication of financial information to interested internal parties only. b) communication of economic information to external parties. c) identification and measurement of financial information only. d) identification, measurement, and communication of financial information.

2. Financial accounting is concerned with the process that culminates in a) the preparation of financial reports. b) specialized reports for inventory management and control. c) specialized reports for income tax calculation and recognition. d) reports on changes in stock prices and future estimates of market position.

3. Financial accounting can be broadly defined as the area of accounting that prepares financial statements to be used a) by parties internal to the business enterprise only. b) by investors only. c) by parties both internal and external to the business enterprise. d) primarily by external users and Canada Revenue Agency.

4. Management accounting can be broadly defined as the area of accounting that communicates financial information a) to investors only. b) to parties internal to the business enterprise only. c) to parties both internal and external to the business enterprise. d) primarily to external users and Canada Revenue Agency.

5. Whether a business is successful and thrives is determined by a) free enterprise or competition. b) competition and markets only. c) markets and competition only. d) markets, competition and free enterprise.

6. Which of the following is correct? a) Reported accounting numbers do not affect the transfer of resources. b) Credit rating agencies use accounting information to assess their assets. c) Efficient capital markets promote productivity and encourage innovation. d) Efficient capital markets promote productivity but do not encourage innovation.

7. Stakeholders who help in the efficient allocation of resources include a) investors and creditors. b) financial analysts and regulators. c) creditors and auditors. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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d) management and auditors.

8. Audited financial statements are prepared by a) auditors. b) financial analysts. c) Canada Revenue Agency. d) management. 9. The auditor’s primary responsibility is to a) review financial statements and discuss them with management. b) prepare financial statements. c) report to Canada Revenue Agency. d) report to standard setters.

10. The widely publicized subprime lending crisis was NOT caused by a) capital market participants who acted in their own self-interest. b) a lack of transparency. c) the practice of securitizing assets. d) a lack of investor understanding of the investment's true risk.

11. Objectives of financial reporting do NOT include a) providing information that is useful to users in making resource allocation decisions. b) providing information about the liquidation value of an enterprise. c) providing information about an entity’s economic resources, obligations, and equity/net assets. d) providing information about changes in an entity’s economic resources, obligations, and equity/net assets.

12. The preparation by some companies of biased information is sometimes referred to as a) conservative financial reporting. b) full disclosure of all material facts. c) aggressive financial reporting. d) stewardship.

13. Where information asymmetry exists, the capital market may attract the wrong kind of company. This is known as a) moral hazard. b) conservative accounting. c) adverse selection. d) an inefficient marketplace. 14. The “efficient markets hypothesis” proposes that a) market prices reflect information known only to internal stakeholders. b) market prices reflect all information about a company. c) market prices reflect information known only to external stakeholders. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) information asymmetry is required.

15. Which of the following does NOT describe a cause of management bias? a) the need to comply with contracts, such as debt covenants b) the desire to meet financial analysts’ expectations c) the tendency to downplay negative events d) the desire for all stakeholders to have access to all information

16. The problem of information asymmetry can be reduced by a) aggressive accounting. b) accounting standards. c) adverse selection. d) only focusing on positive events.

17. As of 2011, the responsibilities of the Accounting Standards Board (AcSB) in Canada relate to setting standards for a) publicly accountable entities only. b) both publicly accountable entities and private enterprises. c) private enterprises, not-for-profit entities and pension plans. d) not-for-profit entities and pension plans only.

18. In Canada, the body that has the responsibility of overseeing the Accounting Standards Board (AcSB) is the a) Accounting Standards Oversight Council (AcSOC). b) International Accounting Standards Board (IASB). c) Canadian Institute of Chartered Accountants (CICA). d) Financial Accounting Standards Board (FASB).

19. In the United States, the body that has the final authority over accounting standards is the a) Financial Accounting Standards Board (FASB). b) International Accounting Standards Board (IASB). c) Securities Exchange Commission (SEC). d) Accounting Standards Oversight Council (AcSOC).

20. In Canada, the body which is NOT instrumental in the development of financial reporting standards is the a) Accounting Standards Board (AcSB). b) Financial Accounting Standards Board (FASB). c) International Accounting Standards Board (IASB). d) American Institute of Certified Public Accountants.

21. The adoption of International Financial Reporting Standards in Canada is an example of a) the impact of technology on user's needs. b) the impact of globalization on capital markets. c) ethical behaviour. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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d) the desire of most private companies to expand internationally.

22. Which of the following statements does NOT describe the activities and authority of the Ontario Securities Commission (OSC)? a) The OSC reviews and monitors the financial statements of companies whose shares are listed on the Toronto Stock Exchange b) The OSC issues its own disclosure requirements for listed companies. c) The OSC has the ability to fine or delist companies. d) The OSC issues financial accounting standards for Canadian companies.

23. Which of the following does NOT support the use of Accounting Standards for Private Enterprises (ASPE)? a) Private enterprises usually have less complex business models. b) Private enterprises that are “going public.” c) Private enterprises usually have fewer users. d) Private enterprises’ financial statement users tend to have first-hand information. 24. Which of the following does NOT describe a step in the IASB’s standard setting process? a) appointing trustees to the IFRS Foundation b) development of an Exposure Draft c) provision of strategic advice by the IFRS Advisory Council d) public consultation

25. Under ASPE, the primary sources of GAAP include a) accounting textbooks and journals. b) International Financial Reporting Standards. c) the CICA Handbook and appendices. d) research studies.

26. The exercise of professional judgement does NOT involve a) the use of knowledge gained through education. b) the application of knowledge gained through experience. c) the use of ethical decision making. d) aggressive accounting.

27. The Sarbanes-Oxley Act (SOX) was NOT enacted to a) help prevent fraud and poor financial reporting practices. b) ensure the act was applied internationally. c) enable the SEC to increase its policing efforts. d) introduce new independence rules for auditors.

28. In a rules-based approach (such as U.S. GAAP), compared to a principles-based approach (such as Canadian GAAP), a) the body of knowledge is smaller. b) the importance of communicating the best information to users is emphasized. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) since it is more prescriptive, it may be easier to defend how to account for a particular item. d) companies frequently do not interpret the rules literally.

29. Which of the following is/are major factors in the rapidly changing financial reporting environment in Canada? a) increased demand for accountants and the impact of technology b) globalization and the unethical actions of accountants c) the growing number of institutional investors who want more information regarding environmental and social issues d) increased use of the Internet

30. Which of the following is likely to be an advantage of the advancement of technology on financial reporting? a) Users of financial information will have access to more information. b) The quality and reliability of the information may be compromised. c) Equal and fair access may be at issue. d) Internet reporting will increase costs.

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MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

d a c b d

6. 7. 8. 9. 10.

c b d a c

11. 12. 13. 14. 15.

b c c b d

16. 17. 18. 19. 20.

b c a c d

21. 22. 23. 24. 25.

b d b a c

26. 27. 28. 29. 30.

d b c c a

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 1-31 Effective capital allocation Explain the advantages of an effective capital allocation process. Solution 1-31 An effective capital allocation process encourages innovation, promotes productivity, and provides a platform for buying and selling securities and obtaining and granting credit.

Ex. 1-32 Stakeholders in the financial reporting environment Briefly describe the much-publicized subprime lending crisis in the United States, and identify the stakeholders and how they were affected. Solution 1-32 At the centre of this issue were securitized mortgage assets that were sold to investors. These assets were based on mortgages that had been extended to high-risk borrowers who could no longer afford their mortgage payments once interest rates rose. This led to a flooding of the housing market as borrowers walked away from their houses (and debt). The primary stakeholders were the lenders, borrowers and investors. Lenders (acting in their own self-interest) sold these investments to investors who may not have fully understood the high-risk nature of their investment. Borrowers lost their homes they could no longer afford, and investors suffered large losses due to the defaulted loans.

Ex. 1-33 Objectives of financial reporting What are the objectives of financial reporting by business enterprises? Solution 1-33 The objectives of financial reporting are to provide information 1. that is useful to investors, members, contributors, creditors and other users in making their resource allocation decisions and/or assessing management stewardship. 2. to help users in evaluating an entity’s economic resources, obligations and equity/net assets and the changes to these items. 3. to help users evaluate the economic performance of an entity.

Ex. 1-34 Entity vs. proprietary perspective Explain the difference between the entity perspective and the proprietary perspective. Solution 1-34 The entity perspective views companies as separate and distinct from their owners. e.g., corporate assets are viewed as assets of the company and not of a specific creditor or shareholder. Investors and creditors have liability or equity claims. On the other hand, the proprietary perspective holds that financial reporting should focus only on the needs of the shareholders, and is not considered appropriate. The entity perspective is adopted as part of the objective of general purpose financial reporting.

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Explain why providing information to users is a challenging task. Solution 1-35 First, users have very different knowledge levels. Some users have accounting designations or have worked in the finance industry for several years. Others have limited knowledge of how the information is gathered and reported. Second, users have very different needs. Some users are institutional investors who hold a large percentage of equity shareholdings and generally devote significant resources to managing their investment portfolios. Others are credit managers at banks or credit unions who deal mainly with small business or personal loans. Still others are labour negotiators whose knowledge of financial reporting is limited to periodic reviews of financial information for the purpose of negotiations.

Ex. 1-36 Information asymmetry In markets where information asymmetry exists, there can be adverse selection and moral hazard. Explain what these terms mean. Solution 1-36 Adverse selection refers to hidden knowledge, where the capital marketplace may attract the wrong type of company, such as companies who have the most to gain from not disclosing information. Given this situation, companies who do fully disclose all information may choose not to enter the marketplace if they are aware of the presence of adverse selection. Moral hazard refers to hidden actions, and occurs as a result of human nature. People or companies may shirk their responsibilities if they think they can get away with it, e.g., not disclose negative information since they know it may be detrimental to their share price. This is a form of management bias.

Ex. 1-37 Role of Securities Commissions and Stock Exchanges Explain the role of securities commissions and stock exchanges in financial reporting. Solution 1-37 The securities commissions and stock exchanges monitor the financial statements of companies whose shares are publicly traded to ensure that they provide full and plain disclosure of material information, and to ensure that the companies may continue to list shares on the stock exchanges. Securities commissions oversee and monitor the capital marketplace.

Ex. 1-38 Standard setting Explain the relationship between Canadian GAAP and International Financial Reporting Standards (IFRS). Solution 1-38 Since the decision to adopt IFRS was made, Canadian GAAP has been continuously adjusted (converged) to mirror IFRS. Even prior to that convergence, both standards were principles based (rather than rules-based).

Ex. 1-39 Sources of GAAP International Financial Reporting Standards (IFRS) are the primary source of GAAP for public enterprises in Canada. They are, however, insufficient to address all of the accounting issues Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

facing accountants. Explain why this is so and outline some other sources of GAAP that accountants use. Solution 1-39 Although IFRS outline the specific accounting treatment for a multitude of items, for some items the guidelines are very general. Also, the business environment is complex and constantly changing and, therefore, some items may not be discussed at all. Thus, accountants must use IFRS in conjunction with other sources like professional judgement, pronouncements of other standard-setting bodies, accounting literature, and accepted industry practices.

Ex. 1-40 SOX and standard setting After several highly-publicized accounting scandals in the U.S. such as Enron, Sunbeam and WorldCom, all of whom, coincidentally, were clients of the now basically defunct public accounting firm of Arthur Andersen, the U.S. regulators enacted the Sarbanes-Oxley Act (SOX). Pressure was put on Canada to follow a similar course. Explain what Canada has done to make public companies more accountable. Solution 1-40 First, the Canadian Public Accountability Board (CPAB) was created to supervise accounting issues similar to those addressed by SOX. These included establishing auditing, quality control and independence standards and rules. The Canadian Securities Administrators (CSA) has issued guidelines/rules that require (among other things) 1. company management to take responsibility for the appropriateness and fairness of the financial statements 2. public enterprises to have independent audit committees 3. management to report on the effectiveness of their internal controls 3. public accounting firms to be subject to CPAB 4. greater disclosures, such as ratings from rating agencies, legal proceedings, payments to stock promoters, details about corporate directors.

Ex. 1-41 Challenges Facing Financial Reporting In North America, the financial reporting environment is changing at a very rapid pace. Briefly describe four challenges facing the accounting profession today. Solution 1-41 1. Oversight in the capital marketplace. The Sarbanes-Oxley Act (SOX) instituted the Public Company Accounting Oversight Board (PCAOB), stronger independence rules for auditors, reporting on the effectiveness of the financial reporting internal control system, and disclosure of a code of ethics for senior financial officers. Canada has followed suit and developed the Canadian Public Accountability Board (CPAB). As well, the Canadian Securities Administrators (CSA) requires company management to take responsibility for the appropriateness and fairness of the financial statements, public companies to have independent audit committees, and public accounting firms to be subject to the CPAB. The CSA also requires much greater disclosures. The overall impact of these financial reforms has been to put more emphasis on government regulation and less on selfregulation.

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Centrality of ethics. Accountants are central in making the capital marketplace efficient and effective. However, ethical dilemmas are common, often precipitated by management bias. It is not always easy to “do the right thing.” Pressure to bend the rules, play the game or “just ignore it” are often there. There is no consensus (yet) among accounting professionals as to what a comprehensive ethical system is, and so it is up to the individual accountant to maintain a high standard of ethics at all times. 3. Standard setting in a political environment. Since standard setting is part of the real world, accounting standards often arise from political action. The stakeholders who lobby the hardest may unduly influence new or revised accounting standards. This is not surprising since many accounting standards have economic consequences. Thus standard setters such as the IASB must consider the needs of all stakeholders when creating or changing standards. The challenge is to find a balance between letting stakeholders have a say while not bowing to undue political pressure. 4. Principles vs. rules. Rules-based, prescriptive systems (such as U.S. GAAP or the Canadian income tax system) have a significantly larger body of knowledge than a principles-based approach such as IFRS and ASPE. However, there is a tendency to interpret the rules literally with a rules-based approach, possibly because it may be easier to defend the accounting for a particular item. A disadvantage of the rules-based approach is that it may not always communicate the best information to the user. The principles-based approaches are based on professional judgement, resulting in carefully reasoned application of the principle to the business facts. Since the body of knowledge is smaller with principles-based approaches, the standard setters must ensure it rests on a cohesive set of principles and conceptual framework, which is sufficiently flexible, and sufficiently detailed to provide good guidance. Other challenges are the impact of technology and integrated reporting.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

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.

CHAPTER 2 CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL REPORTING SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY

Note:

Item

LOD

Item

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

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

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

14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26.

53. 54. 55.

1 2,3,4 3

M H M

56. 57. 58.

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 3 E 27. 4 E 3 E 28. 4 M 3 M 29. 4 H 3 M 30. 4 M 3 H 31. 4 M 3 H 32. 4 M 3 E 33. 4 M 4 M 34. 4 M 4 M 35. 4 H 4 M 36. 4 H 4 M 37. 4 H 4 M 38. 4 H 4 E 39. 4 M Exercises 4 M 59. 4 M 4 M 60. 4 M 4 H 61. 4 M

M = Medium

Item

LOD

40. 41. 42. 43. 44. 45. 46. *47. *48. *49. *50. *51. *52.

4 5 5 5 6 6 6 7 7 7 7 7 7

M H H H M H H M M M M M H

62. 63. 64.

5 5 5

M M E

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

3. 4.

MC MC

5. 6.

MC MC

14. 15.

MC MC

16. 17.

MC MC

21. 22. 23. 24. 25.

MC MC MC MC MC

26. 27. 28. 29. 30.

MC MC MC MC MC

41.

42.

44.

45.

*47.

*48.

Note: MC = Multiple Choice

Item Type Item Type Learning Objective 1 53. Ex Learning Objective 2 7. MC 9. MC 8. MC 10. MC Learning Objective 3 18. MC 20. MC 19. MC 54. Ex Learning Objective 4 31. MC 36. MC 32. MC 37. MC 33. MC 38. MC 34. MC 39. MC 35. MC 40. MC Learning Objective 5 43. MC 62. Ex Learning Objective 6 46. MC Learning Objective 7 *49. MC *50. MC

Item

Type

Item

Type

11. 12.

MC MC

13. 54.

MC Ex

55.

56. 57. 58. 59. 54.

Ex Ex Ex Ex Ex

60. 61.

Ex Ex

63.

64.

*51.

*52.

Ex = Exercise

*This topic is dealt with in an Appendix to the chapter.

Conceptual Framework Underlying Financial Reporting

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CHAPTER STUDY OBJECTIVES 1. Indicate the usefulness and describe the main components of a conceptual framework for financial reporting. A conceptual framework is needed to (1) create standards that build on an established body of concepts and objectives, (2) provide a framework for solving new and emerging practical problems, (3) increase financial statement users’ understanding of and confidence in financial reporting, and (4) enhance comparability among different companies’ financial statements. The first level deals with the objective of financial reporting. The second level includes the qualitative characteristics of useful information and elements of financial statements. The third level includes foundational principles and conventions.

2. Identify the qualitative characteristics of accounting information. The overriding criterion by which accounting choices can be judged is decision usefulness; that is, the goal is to provide the information that is the most useful for decision-making. Fundamental characteristics include relevance and faithful representation. These two characteristics must be present. Enhancing characteristics include comparability, verifiability, timeliness, and understandability. There may be trade-offs.

3. Define the basic elements of financial statements. The basic elements of financial statements are (1) assets, (2) liabilities, (3) equity, (4) revenues, (5) expenses, (6) gains, and (7) losses.

4. Describe the foundational principles of accounting. (1) Economic entity: the assumption that the activity of a business enterprise can be kept separate and distinct from its owners and any other business unit. (2) Control: the entity has the power to make decisions and reap the benefits or be exposed to the losses (which are variable). (3) Revenue recognition: revenue is generally recognized when it is (a) earned, (b) measurable, and (c) collectible (realizable). (4) Matching assists in the measurement of income by ensuring that costs (relating to long-lived assets) incurred in earning revenues are booked in the same period as the revenues earned. (5) Periodicity: the assumption that an enterprise’s economic activities can be divided into artificial time periods to facilitate timely reporting. (6) Monetary unit: the assumption that money is the common denominator by which economic activity is conducted, and that the monetary unit gives an appropriate basis for measurement and analysis. (7) Going concern: the assumption that the business enterprise will have a long life. (8) Historical cost principle: existing GAAP requires that many assets and liabilities be accounted for and reported based on their acquisition price. Many assets are later revalued. (9) Fair value principle: assets and liabilities are valued at fair value— that is, an exit price—and viewed from a market participant perspective. (10) Full disclosure principle: accountants follow the general practice of providing information that is important enough to influence an informed user’s judgement and decisions.

5. Explain the factors that contribute to choice and/or bias in financial reporting decisions. Choice is the result of many things, including principles-based standards, measurement uncertainty, and increasingly complex business transactions. The conceptual framework is the foundation that GAAP is built on. If there is no primary source of GAAP for a

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

specific decision, then professional judgement must be used, making sure that the accounting policies chosen are consistent with the primary sources of GAAP and the conceptual framework. Financial engineering is the process of legally structuring a business arrangement or transaction so that it meets the company’s financial reporting objective. This is a dangerous practice since it often results in biased information. Fraudulent financial reporting often results from pressures on individuals or the company. These pressures may come from various sources, including worsening company, industry, or economic conditions; unrealistic internal budgets; and financial statement focal points related to contractual, regulatory, or capital market expectations. Weak internal controls and governance also contribute to fraudulent financial reporting.

6. Discuss current trends in standard setting for the conceptual framework. The IASB and FASB will continue to work toward a common conceptual framework. The project on objectives and qualitative characteristics is complete. The boards are focusing on defining elements and the recognition/measurement frameworks.

Conceptual Framework Underlying Financial Reporting

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MULTIPLE CHOICE—Conceptual Answer c d c b b d a c d a a c c b c a d b c b d c a d c b d b b a b a b d c c b b c a b c d c b d b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. *47.

Description Conceptual framework Objectives of financial reporting Fundamental qualitative characteristics Relevance Relevance Representational faithfulness Criterion for accounting information Enhancing qualitative characteristics Comparability Timeliness Comparability Timeliness Costs of providing useful information Common characteristic of assets and liabilities Equitable obligations Items included in equity under IFRS Definition of gains Other comprehensive income Statements prepared using ASPE Components of comprehensive income Economic entity assumption Timing of revenue recognition Example of full disclosure Economic entity assumption Recognition and measurement Periodicity assumption Going concern assumption Historical cost principle Matching principle Use of allowance for doubtful accounts Historical cost principle Economic entity assumption Matching principle Recording of depreciation Fair value of an asset Full disclosure principle Measurement uncertainty Full disclosure principle Management Discussion and Analysis Items included in MD&A Principles-based GAAP Financial engineering Fraudulent financial reporting Proposed new definition of asset Proposed new examples of assets Proposed new examples of liabilities Input levels for estimating fair value

Test Bank for Intermediate Accounting, Tenth Canadian Edition

2-6

a b c d c

*48. *49. *50. *51. *52.

Definition of the cost model Definition of the income model Definition of the market model Use of discounted cash flow model Remeasuring a liability at fair value

*This topic is dealt with in an Appendix to the chapter.

EXERCISES Item 2-53 2-54 2-55 2-56 2-57 2-58 2-59 2-60 2-61 2-62 2-63 2-64

Description Conceptual framework Accounting terminology – fill in the blanks Equitable obligations Foundational principles Identification of foundational accounting principles Identification of foundational accounting principles and qualitative characteristics Foundational accounting principles and qualitative characteristics – matching Fair value measurement Matching concept Principles vs. rules based GAAP Financial engineering Fraudulent financial reporting

Conceptual Framework Underlying Financial Reporting

2-7

MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT part of the conceptual framework for financial reporting? a) Elements of financial statements b) Qualitative characteristics of accounting information c) Notes to financial statements d) Foundational principles

2. Which of the following is NOT an objective of financial reporting? a) To provide information about an entity’s economic resources, obligations and equity/net assets b) To provide information that is useful to investors and creditors and other users in making resource allocation decisions and/or assessing management stewardship c) To provide information that is useful in assessing the economic performance of the entity d) To provide the most useful information possible even if the costs exceed the benefits

3. Fundamental qualitative characteristics include a) relevance and comparability. b) representational faithfulness and timeliness. c) relevance and representational faithfulness. d) verifiability and relevance.

4. Which of the following does NOT relate to the concept of relevance? a) The information must be capable of making a difference in a decision. b) Both material and immaterial information is important. c) The information has predictive value. d) The information has feedback/confirmatory value.

5. Accounting information is considered to be relevant when it a) can be depended on to represent the economic conditions and events that it is intended to represent. b) is capable of making a difference in a decision. c) is understandable by reasonably informed users of accounting information. d) is verifiable and neutral.

6. Representational faithfulness includes a) completeness, neutrality and comparability. b) neutrality, completeness, and understandability. c) relevance, completeness and freedom from material error. d) neutrality, completeness and freedom from material error.

7. The overriding criterion by which accounting information can be judged is that of a) usefulness for decision making.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b) freedom from bias. c) timeliness. d) comparability.

8. Which statement is correct regarding enhancing qualitative characteristics? a) Full discussion of the information presented is a substitute for comparable information. b) Numbers that are easily verifiable with a reasonable degree of accuracy are called soft numbers. c) Information must be available before it loses its ability to influence users’ decisions. d) Financial information must be of sufficient quality and clarity that even uninformed readers can understand it.

9. Comparability allows any financial statement user to a) make timely decisions. b) understand all the information presented. c) verify all the data provided. d) identify the real similarities and differences in economic phenomena.

10. Timeliness is increased by a) quarterly reporting. b) comparative financial statements. c) representational faithfulness. d) annual reporting.

11. Sunbury Ltd. operates in both Canada and the United States. The company wants to improve the qualitative characteristics of its financial statements. Which of the following would MOST likely improve the comparability of Sunbury’s financial statements? a) The restatement of its financial statements from Canadian GAAP to US GAAP for its American investors. b) The preparation of monthly financial statements. c) The introduction of a policy that specifies how Sunbury's capital assets should be depreciated. d) The use of U.S.-trained accountants.

12. You want to improve the qualitative characteristics of your firm's financial statements. Which of the following options would MOST likely improve the timeliness of your company's financial statements? a) increasing the number of disclosures b) changing the timing of when revenues are recognized c) increasing the frequency of statements from annually to quarterly d) decreasing the useful life of property, plant and equipment from ten years to five

13. The costs of providing useful information do NOT include a) collecting, processing and distributing information. b) auditing financial statements.

Conceptual Framework Underlying Financial Reporting

2-9

c) disclosure to competitors. d) users’ allocation of resources.

14. The common characteristic of both assets and liabilities is that they BOTH a) provide an economic benefit. b) result from a past transaction or event. c) represent a present responsibility. d) represent contractual or other rights.

15. Equitable obligations arise due to a) statutory requirements. b) contractual obligations. c) moral or ethical considerations. d) union agreements.

16. Under IFRS, equity does NOT include a) long term leases. b) common and/or preferred shares. c) accumulated other comprehensive income. d) retained earnings.

17. Gains are defined as a) increases in economic resources resulting from an entity’s ordinary activities. b) decreases in economic resources resulting from an entity’s ordinary activities. c) the residual interest remaining after liabilities are deducted from assets. d) increases in equity resulting from an entity’s peripheral or incidental transactions. 18. Under IFRS, “other comprehensive income” does NOT include a) unrealized holding gains and losses on certain securities. b) gains and losses on disposal of property, plant and equipment. c) gains and losses related to certain types of hedges. d) certain gains and losses related to foreign exchange transactions.

19. Financial statements prepared under ASPE include a a) statement of comprehensive income. b) statement of cash flows and a statement of changes in shareholders’ equity. c) balance sheet and a statement of retained earnings. d) statement of retained earnings and a statement of comprehensive income.

20. Which of the following elements of financial statements is NOT a component of comprehensive income? a) Revenues b) Distributions to owners c) Losses

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) Expenses

21. A local businessman owns several different companies. His accountant prepares separate financial statements for each of these businesses. This is an application of the a) full disclosure principle. b) periodicity assumption. c) going concern assumption. d) economic entity assumption.

22. Generally, revenue from sales should be recognized at a point when a) management decides it is appropriate to do so. b) the product is available for sale. c) an exchange has taken place and the earnings process is substantially complete. d) the entire amount receivable has been collected from the customer and there remains no further warranty liability.

23. During a major renovation project of its head office, a worker was seriously injured. While the company believes that it was not at fault, it does include the incident in the notes to its financial statements. This is consistent with the a) full disclosure principle. b) periodicity assumption. c) going concern assumption. d) economic entity assumption.

24. The economic entity assumption a) is inapplicable to unincorporated businesses. b) recognizes the legal aspects of business organizations. c) requires periodic income measurement. d) is applicable to all forms of business organizations.

25. When deciding whether to recognize a financial statement element (or not), and how to measure it, the accountant should a) always use estimates. b) record “hard” numbers and ignore “soft” numbers. c) determine an acceptable level of uncertainty. d) recognize a financial statement element even if it cannot be measured.

26. During the lifetime of an entity, accountants produce financial statements at arbitrary points in time in accordance with the a) full disclosure principle. b) periodicity assumption. c) going concern assumption. d) economic entity assumption.

Conceptual Framework Underlying Financial Reporting

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27. The assumption that a business enterprise will NOT be sold or liquidated in the near future is known as the a) economic entity assumption. b) monetary unit assumption. c) fair value principle. d) going concern assumption.

28. Valuing assets at their liquidation values rather than their cost is inconsistent with the a) periodicity assumption. b) historical cost principle. c) matching principle. d) economic entity assumption.

29. Which of the following is NOT a good example of the matching principle? a) A machine that produces certain goods is depreciated over its useful life. The depreciation expense is matched with the proceeds from the sale of those goods. b) The entire amount of a two-year insurance premium is expensed in the first year. c) An uncollectible receivable is written off in the year that the sale was made. d) Recognition of revenue for which associated expenses cannot yet be determined is delayed until such determination can be made.

30. Use of an allowance for doubtful accounts is an application of the a) matching principle. b) revenue recognition principle. c) historical cost principle. d) full disclosure principle.

31. Which of the following statements does NOT apply to the historical cost principle? a) Historical cost represents a value at a point in time. b) The principle does not apply to financial instruments. c) Historical cost results from a reciprocal or two-way exchange. d) Over time, historical cost becomes irrelevant in terms of predictive value.

32. Preparation of consolidated financial statements when a parent-subsidiary relationship exists is an example of a) the economic entity assumption. b) the matching principle. c) comparability. d) reliability.

33. The matching principle is best demonstrated by a) not recognizing any expense unless some revenue is realized. b) associating effort (expense) with accomplishment (revenue). c) recognizing prepaid rent received as revenue. d) measuring expenses correctly.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

34. Which of the following serves as the justification for the periodic recording of depreciation expense? a) association of efforts (expense) with accomplishments (revenue) b) minimization of income tax liability c) immediate recognition of an expense d) systematic and rational allocation of cost over the periods benefited

35. Fair value (of an asset) is a) an entry price. b) an entity-specific measure. c) an exit price. d) not used when following IFRS.

36. Application of the full disclosure principle a) is theoretically desirable but not practical because the costs of complete disclosure exceed the benefits. b) is violated when important financial information is buried in the notes to the financial statements. c) is demonstrated by the inclusion of information such as information about contingencies. d) requires that the financial statements be consistent and comparable.

37. Where there is a significant uncertainty with respect to the measurement of an item, a) do not record anything in the financial statements. b) recognize the item in the financial statements and disclose the measurement uncertainty in the notes to the financial statements. c) do not record anything in the financial statements but disclose the measurement uncertainty in the notes to the financial statements. d) record the maximum amount in the financial statements.

38. The operations of a resource company's oil sands operations results in environmental damage. While the extent of the damage cannot be determined at this time, the situation is disclosed in its financial statements. This BEST demonstrates a) the application of professional judgement. b) the full disclosure principle. c) representational faithfulness. d) good management stewardship.

39. Management Discussion and Analysis (MD&A) is a) notes on meetings between management and auditors. b) internal documents not released to shareholders. c) supplementary information included in the annual report. d) supplementary information included in the notes to the financial statements.

Conceptual Framework Underlying Financial Reporting

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40. Management Discussion and Analysis (MD&A) does NOT include a) notes to the financial statements. b) key performance drivers. c) the company’s vision and strategy. d) the company’s capabilities (capital and other resources).

41. Principles-based GAAP is sometimes criticized for being a) too inflexible. b) too flexible. c) too inconsistent. d) too difficult for the reader to understand.

42. Which of the following situations does NOT demonstrate an attempt at financial engineering? a) creating complex legal arrangements and financial instruments b) structuring debt financing so that it meets the GAAP definition of equity rather than debt c) accounting for bona fide business transactions in a transparent manner d) aggressively interpreting GAAP so that the impact on critical ratios is minimized

43. Fraudulent financial reporting is a business reality. While it cannot be eliminated, the risk of fraudulent reporting can be decreased. Which of the following considerations is LEAST likely to lessen that risk? a) an independent audit committee b) an internal audit function c) vigilant management d) an increased focus on tying bonuses to short-term company performance

44. The IASB and FASB are currently working on a joint project to complete a common conceptual framework. Which of the following statements best describes the proposed (new) definition of an asset? a) The asset must involve future economic resources and the entity has a right or access to the resources, while others do not. b) The asset must involve future economic resources and the resource must be freely available to all. c) The asset must involve present economic resources and the entity has a right or access to the resources, while others do not. d) The asset must involve present economic resources and the resource must be freely available to all.

45. The IASB and FASB are currently working on a joint project to complete a common conceptual framework. According to the proposed (new) definition, which of the following would be considered assets? a) accounts receivable, accounts payable, and patents b) insurance contracts and accounts receivable c) land, accounts receivable and unearned revenue d) property, plant and equipment and constructive obligations

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

46. The IASB and FASB are currently working on a joint project to complete a common conceptual framework. According to the proposed (new) definition, which of the following would be considered liabilities? a) accounts receivable and accounts payable b) constructive obligations, long term leases and insurance contracts c) accounts payable, unearned revenue, and copyrights d) lawsuits – both settled and in progress

*47. Which of the following statements is correct regarding the levels of inputs required for estimating fair value of financial statement elements? a) Level 3 inputs are the highest quality inputs. b) The lower the level of input, the greater the required disclosures. c) Level 2 inputs are generally not observable and hence more subjective. d) Level 1 inputs are the lowest quality inputs.

*48. Valuation models may be categorized into three groups. Cost models a) attempt to reflect the amount that would be required to replace the asset’s service capacity. b) convert future amounts to current amounts, using, for example, discounted cash flows or options pricing models. c) use prices and other information generated from market transactions involving identical or similar transactions. d) use either discounted cash flows methods, or prices and other information generated from market transactions involving identical or similar transactions.

*49. Valuation models may be categorized into three groups. Income models a) attempt to reflect the amount that would be required to replace the asset’s service capacity. b) convert future amounts to current amounts, using, for example, discounted cash flows or options pricing models. c) use prices and other information generated from market transactions involving identical or similar transactions. d) use either discounted cash flows methods or prices and other information generated from market transactions involving identical or similar transactions. *50. Valuation models may be categorized into three groups. Market models a) attempt to reflect the amount that would be required to replace the asset’s service capacity. b) convert future amounts to current amounts, using, for example, discounted cash flows or options pricing models. c) use prices and other information generated from market transactions involving identical or similar transactions. d) use either discounted cash flows methods or prices and other information generated from market transactions involving identical or similar transactions.

Conceptual Framework Underlying Financial Reporting

2 - 15

*51. Fair value estimates arrived at by using discounted cash flow models would NOT use a) estimates of cash flows. b) time value of money. c) uncertainty (risk). d) original cost of an asset.

*52. A formerly profitable company is currently experiencing losses and, as a result, is cashsqueezed. Thus, it may not be able to repay its bank debt according to the loan’s terms. If fair value is being used to measure this liability, then a) the company’s credit risk has decreased. b) the debit to equity ratio will increase. c) the present value of the liability will decrease, resulting in a gain booked through other comprehensive income. d) the present value of the liability will decrease, resulting in a gain booked through profit and loss.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CONCEPTUAL Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

c d c b b d a c

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

d a a c c b c a

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

d b c b d c a d

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

c b d b b a b a

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

b d c c b b c a

41. 42. 43. 44. 45. 46. *47. *48.

b c d c b d b a

*49. *50. *51. *52.

b c d c

Conceptual Framework Underlying Financial Reporting

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EXERCISES Ex. 2-53 Conceptual framework Briefly describe the objectives of a soundly developed conceptual framework. Solution 2-53 A soundly developed conceptual framework should 1. increase financial statement users' understanding of and confidence in financial reporting, 2. enhance comparability among companies' financial statements, 3. allow new and emerging practical problems to be solved more quickly.

Ex. 2-54 Accounting terminology - fill in the blanks Fill in the blanks below with the accounting term(s) that best completes each sentence. 1. A soundly developed conceptual framework is a _____________ set of standards and rules. ____________ and ____________________ are the fundamental qualitative characteristics that make accounting information useful for decision-making. 2. Enhancing qualitative characteristics are __________, ___________, _____________ and _________________________. 3.

Liabilities have three essential characteristics: 1. They represent a __________________, 2. the entity has a ______________________, and 3. ___________________________.

4. While consolidated financial statements are prepared from the perspective of the _______________, taxes are paid from the perspective of the _______________. 5. Collectability is one of the three conditions of the revenue recognition principle. Assuming the other two conditions are met, revenue should only be recognized if collectability is ______________________. 6. The __________________ stipulates that anything that is relevant to decisions should be included in the financial statements. 7. A company’s Management Discussion and Analysis (MD&A) is an example of ____________________________. 8. A _______________- based approach, as used in Canadian GAAP and IFRS, is sometimes criticized for being too ______________. 9. Under the _____________ principle, ___________ incurred during a particular period are matched with ___________ earned during that same period. 10. The ____________________ is based on the assumption that a business enterprise will continue to operate for the foreseeable future. 11. One of the assumptions of the ____________________ is valuation at a particular point in

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

time. 12. ______________ is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” 13. Standard setters have given companies the option to use _________________ instead of historical costs. Solution 2-54 1. coherent, relevance, representational faithfulness 2.

comparability, verifiability, timeliness, understandability

present duty or obligation, present enforceable obligation, the liability results from a past transaction or event

economic entity, legal entity

reasonably assured

full disclosure principle

supplementary information

principles, flexible

matching, expenses, revenues

10. going concern assumption 11. historical cost principle 12. Fair value 13. fair value

Ex. 2-55 Equitable obligations Due to the current poor economic conditions, Latimer Corp, a medium size manufacturer in Burnaby, is downsizing its Shipping Dept, and has to let go two of the employees, Jinder and Tang. Both are excellent workers and have been with the company for several years. The Shipping Dept supervisor, Jane Kowalski, goes to the company CEO to see if there is another alternative for these employees (other than termination of their employment). Jane suggests that Jinder could be retrained to learn how to operate a forklift and Tang would like to learn how to be a first aid attendant. Since Latimer always needs employees with these skills, the CEO agrees to try this. Latimer’s work force is not unionized.

Conceptual Framework Underlying Financial Reporting

2 - 19

What type of obligation is this? Discuss. Solution 2-55 This would be an equitable obligation, which does not arise from a contractual obligation, but rather from moral or ethical considerations. Theoretically (since there is no union contract with attendant language regarding layoffs and terminations), the company has no obligation to Jinder and Tang and could let them go without any further ado. However, it appears that both Ms Kowalski and the CEO feel a moral obligation to help the employees by retraining them. This will have future benefits for Latimer. For example, the company will not lose good workers; it will benefit from their new skills; and it will improve morale among other workers who may feel threatened by potential future job losses.

Ex. 2-56 Foundational principles Briefly explain the foundational principles of recognition, measurement, presentation and disclosure that underlie financial accounting. Solution 2-56 These concepts help explain which, when, and how financial elements and events should be disclosed. Recognition focuses on whether something should be included in a company's financial statements. It includes the economic entity assumption, control, revenue recognition and matching principles. Measurement relates to the "conversion" of information into numbers. It includes the periodicity, monetary unit and going concern assumptions, and the historical cost and fair value principles. Presentation/disclosure relates to how (and how much) information is conveyed to the user. It includes the general practice of providing information that is important enough to influence an informed user's judgement and decisions.

Ex. 2-57 Identification of foundational accounting principles State the accounting principle or assumption that is most applicable in the following situations: 1. A company prepares consolidated financial statements for a subsidiary that it owns. 2. The decision to remove an asset from the balance sheet 3. A large sale on account is not recognized as revenue because collectability is an issue. 4. Disclosure of the liability from a lawsuit in the financial statements 5. Preparation of monthly financial statements 6. Using the Canadian dollar in financial statements 7. An energy company includes detailed information about its reserves in its notes to the financial statements. Solution 2-57 1. Control or economic entity assumption 2.

Derecognition

Revenue recognition principle

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Full disclosure principle

Periodicity assumption

Monetary unit assumption

Full disclosure principle

Ex. 2-58 Identification of foundational accounting principles and qualitative characteristics Presented below are a number of accounting procedures and practices followed by January Corp. For each of these items, list the assumption, principle, or qualitative characteristic that is NOT being followed. 1. Because the company's income is low this year, January switched from accelerated depreciation to straight-line depreciation. 2. The president of January believes it is foolish to report financial information on a yearly basis. She believes that financial information should be disclosed only when significant new information is available related to the company's operations. 3. January decides to establish a large loss and related liability this year because of the possibility that it may lose a pending lawsuit. The possibility of loss is considered remote by the corporation’s lawyers. 4. One of the corporation’s executives purchased a new home computer for personal use with company money, charging Miscellaneous Expense. 5. The corporation has not established an Allowance for Doubtful accounts, even though there are a significant number of their accounts that are either slow paying or may not pay their debts in full. Solution 2-58 1. Representational Faithfulness/ Neutrality 2.

Periodicity assumption

Matching principle

Economic entity assumption

Matching principle

Ex. 2-59 Foundational accounting principles and qualitative characteristics - matching Listed below are several foundational accounting principles and qualitative characteristics. Match the letter of each with the appropriate phrase describing its application. Note that each item may be used more than once or not at all. a. Economic entity assumption g. Matching principle b. Going concern assumption h. Full disclosure principle c. Monetary unit assumption i. Relevance d. Periodicity assumption j. Reliability e. Historical cost principle k. Comparability

Conceptual Framework Underlying Financial Reporting

f. Revenue recognition principle ____ 1. ____ 2. ____ 3. ____ 4. ____ 5. ____ 6. ____ 7. ____ 8. ____ 9. ____ 10. ____ 11. ____ 12.

2 - 21

Representational faithfulness

Using the Canadian dollar in the financial statements The earning process is completed and realized or realizable. Accounting information reflects the economic substance of the event or transaction. Quarterly financial reports The use of accruals and deferrals in adjusting the accounts Useful standard measuring unit for business transactions Including explanatory notes as part of the financial statements The affairs of the business are distinguished from those of its owners. A business enterprise is assumed to have a long life. Valuing assets at amounts originally paid for them Application of the same accounting principles as in the preceding year Presentation of timely information with predictive and feedback value

Solution 2-59 1. c 2.

10. e 11. k 12. i

Ex. 2-60 Fair value measurement The ongoing trend toward using fair value has both its supporters and its critics. Briefly explain arguments in favour of and against the use of fair value. Solution 2-60 Arguments in favour: Fair values are current and therefore more relevant. The cost at which an asset is carried (using the cost at which it was acquired, say, twenty years ago) may bear little resemblance to its

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

current replacement cost. Arguments against: Fair values may be difficult to ascertain, especially when markets for the underlying assets do not exist. Fair values may subject financial statements to a significant degree of variability in volatile markets.

Ex. 2-61 Matching concept A concept is a group of related ideas. Matching could be considered a concept because it includes ideas related to both revenue recognition and expense recognition. Briefly explain the theory behind a) revenue recognition and b) expense recognition. Solution 2-61 a) The basis of revenue recognition includes the following: 1. Revenues are inflows of net assets from delivering or producing goods or services or other earning activities that are the major operations of an enterprise during a period. 2. Recognition is recording and reporting in the financial statements. 3. Revenues are realized when goods or services are exchanged for cash or claims to cash. 4. Revenues are earned when the earnings process is complete or virtually complete. The revenue recognition principle says that revenue is recognized when performance is achieved (earned) and measurability and collectability are reasonably assured (realized/realizable). b)

The basis of expense recognition includes "expense" and "matching": 1. Expenses are outflows of net assets during a period from delivering or producing goods or services or other activities that are the major operations of the entity. 2. Expenses are recognized when the goods or services (efforts) make their contribution to revenue. The matching principle says that expenses are matched with revenues. Expenses are matched three ways: 1. When there is an association with revenue, expenses are matched with revenues in the period the revenues are recognized. 2. When no association with revenue is evident, expenses are allocated on some systematic and rational basis. 3. When no association with revenue is evident and no future benefits are expected, expenses are recognized immediately.

Ex. 2-62 Principles vs. rules based GAAP There has been much discussion about principles-based standards versus rules-based standards. Discuss the advantages and disadvantages of a principles-based approach. Solution 2-62 Advantages of a principles based approach: 1. Decisions are based on the conceptual framework – so they should be consistent.

Conceptual Framework Underlying Financial Reporting

2. 3.

2 - 23

Flexibility – allows for making decisions about new or unusual transactions based on principles. Allows accountants to use their professional expertise and professional judgement.

Disadvantages of a principles based approach: 1. Flexibility may result in reduced comparability between different firms. 2. Flexibility may be abused and bias may creep into decisions.

Ex. 2-63 Financial engineering Explain the practice of financial engineering and how it relates to fraudulent financial reporting. Solution 2-63 Financial engineering is a process whereby a business arrangement or transaction is structured legally such that it meets the company’s financial reporting objective within GAAP. This is often done by using complex legal arrangements and financial instruments. This produces a transaction or item that may have the form of one kind of transaction or item when the substance is something different. Enron was involved in many transactions of this type. Since the substance of these arrangements is to obscure the real nature of the transactions or items involved, they are potentially fraudulent.

Ex. 2-64 Fraudulent financial reporting Identify several factors that contribute to fraudulent financial reporting. Solution 2-64 1. Unrealistic internal budgets and financial statement focal points arising from contractual, regulatory, or capital market expectations 2.

Weak internal control and governance

Worsening economic conditions or industry

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVES Item

Note:

LOD

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

1 1 1 1 2 2 3 4 4

E E E M E M M M M

36. 37. 38. 39. 40.

5 5 5 5 5

E E E M H

54. 55.

5 5

H M

61. 62.

1 4

E E

69. 70. 71.

4 5 5

E E M

E = Easy

Item

LOD

Item

LOD

Multiple Choice - Conceptual 10. 4 E 19. 5 E 11. 4 M 20. 5 M 12. 4 M 21. 5 E 13. 4 E 22. 5 E 14. 4 M 23. 5 H 15. 4 E 24. 5 H 16. 4 E 25. 5 H 17. 4 E 26. 5 H 18. 5 M 27. 5 H Multiple Choice - Computational 41. 5 M 46. 5 H 42. 5 M 47. 7 H 43. 5 M 48. 7 H 44. 5 M 49. 7 H 45. 5 H 50. 7 H Multiple Choice - CPA Adapted 56. 5 M 58. 5 H 57. 5 H 59. 5 H Exercises 63. 4 E 65. 5 M 64. 5 M 66. 7 M Problems 72. 5,8 M 75. 5,7 M 73. 5,7 H 76. 7 E 74. 5,7 M 77. 7 M

M = Medium

Item

LOD

28. 29. 30. 31. 32. 33. *34. *35.

7 7 7 7 7 8 9 9

E E E E M M M H

51. 52. *53.

7 7 9

H H M

*60.

67. 68.

7 7

M M

78. 79. 80.

8 8 8

M H M

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

Type

Item

Type

Item

Type

Learning Objective 1 3. MC 4. MC Learning Objective 2

61.

69.

57. 58. 59. 64. 65. 70.

MC MC MC Ex Ex Pr

75. 76. 77.

Pr Pr Pr

80.

Item

Type

71. 72. 73. 74. 75.

Pr Pr Pr Pr Pr

Learning Objective 3 7.

8. 9. 10.

MC MC MC

11. 12. 13.

MC MC MC

18. 19. 20. 21. 22. 23.

MC MC MC MC MC MC

24. 25. 26. 27. 36. 37.

MC MC MC MC MC MC

28. 29. 30. 31.

MC MC MC MC

32. 47. 48. 49.

MC MC MC MC

33.

72.

*34.

*35.

Note: MC = Multiple Choice

Learning Objective 4 14. MC 17. MC 15. MC 62. Ex 16. MC 63. Ex Learning Objective 5 38. MC 44. MC 39. MC 45. MC 40. MC 46. MC 41. MC 54. MC 42. MC 55. MC 43. MC 56. MC Learning Objective 6 Learning Objective 7 50. MC 67. Ex 51. MC 68. Ex 52. MC 73. Pr 66. Ex 74. Pr Learning Objective 8 78. Pr 79. Pr Learning Objective 9 *53. MC *60. MC Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

The Accounting Information System

3-3

CHAPTER STUDY OBJECTIVES 1. Understand basic accounting terminology. It is important to understand the following terms: (1) event, (2) transaction, (3) account, (4) permanent and temporary accounts, (5) ledger, (6) journal, (7) posting, (8) trial balance, (9) adjusting entries, (10) financial statements, and (11) closing entries.

2. Explain double-entry rules. The left side of any account is the debit side; the right side is the credit side. All asset and expense accounts are increased on the left or debit side and decreased on the right or credit side. Conversely, all liability and revenue accounts are increased on the right or credit side and decreased on the left or debit side. Shareholders’ equity accounts, Common Stock, and Retained Earnings are increased on the credit side, whereas Dividends is increased on the debit side.

3. Explain how transactions affect the accounting equation. In a double-entry accounting system, for every debit there must be a credit, and vice versa. This leads us to the basic accounting equation for corporations: Assets = Liabilities + Shareholders’ Equity. The effect of individual transactions on the statement of financial position can be explained using the basic accounting equation. The shareholders’ equity portion of the equation can also be expanded to illustrate the effect of transactions on components of equity such as common shares and retained earnings. Whenever a transaction occurs, the elements of the equation change, but the equality of the two sides of the equation remains unaffected.

4. Identify the steps in the accounting cycle and the steps in the recording process. The basic steps in the accounting cycle are (1) identification and measurement of transactions and other events, (2) journalizing, (3) posting, (4) the unadjusted trial balance, (5) adjustments, (6) the adjusted trial balance, (7) statement preparation, and (8) closing. The first three steps in the accounting cycle form the basis of the recording process used by most medium-sized companies on a daily basis. The simplest journal form is a chronological listing of transactions and events that are expressed as debits and credits to particular accounts. The items entered in a general journal must then be transferred (posted) to the general ledger. To help prepare financial statements, an unadjusted trial balance should be prepared at the end of a specific period (usually a month, quarter, or year) after the entries have been recorded in the journals and posted to the general ledger.

5. Explain the reasons for and prepare adjusting entries. Adjustments achieve a proper matching of revenues and expenses, which is needed to determine the correct net income for the current period and to achieve an accurate statement of the end-of-the-period balances in assets, liabilities, and owners’ equity accounts. When preparing adjusting journal entries, you must first determine how the original transaction was recorded. For example, was an asset created earlier in the fiscal year (such as prepaid rent) when the initial payment was made? If so, an adjustment for the related expense is required. Alternatively, if a statement of comprehensive income account was used initially, an adjustment may be required to set up the proper statement of financial position account at the end of the period.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

6. Explain how the type of ownership structure affects the financial statements. The type of ownership structure that a business enterprise uses determines the types of accounts that are part of the equity section. In a corporation, ordinary or common shares, contributed surplus, retained earnings, and accumulated other comprehensive income are commonly shown separately on the statement of financial position. In a proprietorship or partnership, a capital account is used to indicate the investment in the company by the owner(s). A drawings or withdrawal account may be used to indicate withdrawals by the owner(s). These two accounts are grouped or netted under owners’ equity.

7. Prepare closing entries and consider other matters relating to the closing process. In the closing process, all of the revenue and expense account balances (income statement items) are transferred to a clearing account called Income Summary, which is used only at the end of the fiscal year. Revenues and expenses are matched in the Income Summary account. The net result of this matching, which represents the net income or net loss for the period, is then transferred to a shareholders’ equity account (retained earnings for a corporation and capital accounts for proprietorships and partnerships). Under a perpetual inventory system there are a few additional items to consider. For example, the balance in the inventory account should represent the ending inventory amount. When the inventory records are maintained in a periodic inventory system, a purchases account is used; the inventory account is unchanged during the period. The inventory account balance represents the beginning inventory amount throughout the period. At the end of the accounting period, the inventory account must be adjusted by closing out the beginning inventory amount and recording the ending inventory amount.

8. Prepare a 10-column work sheet and financial statements. The 10-column work sheet provides columns for the first trial balance, adjustments, adjusted trial balance, statement of comprehensive income, and statement of financial position. The work sheet does not replace the financial statements. Instead, it is the accountant’s informal device for accumulating and sorting the information that is needed for the financial statements.

9. Identify adjusting entries that may be reversed. Reversing entries are usually used for reversing two types of adjusting entries: accrued revenues and accrued expenses. Prepayments may also be reversed if the initial entry to record the transaction is made to an expense or revenue account.

The Accounting Information System

MULTIPLE CHOICE QUESTIONS—Conceptual Answer d b a b d b d a c b a d c c b b d b c d c b a c c b a d c b a a d b c

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. *34. *35.

Description Purpose of an accounting system Definition of transaction Definition of ledger Identification of a temporary account Double-entry system Account increased by debit Accounting equation Criteria for recording transactions Internal event Definition of journal Transaction analysis Transaction analysis Transaction analysis Event recording Definition of posting Purpose of the trial balance Trial balance Uses of adjusting entries Adjusting for accrued expenses Adjusting for accrued revenues Factors to consider in estimating depreciation Contra-asset account Effect of not recording depreciation Adjusting for bad debts Definition of accrued revenue Definition of unearned revenue Fair value adjustments for investments Income Summary account Closing net income or loss Post-closing trial balance Trial balance – correct statement Effect of understating ending inventory Work sheet Identification of reversing entries Required reversing entry

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE QUESTIONS—Computational Answer b a c b c a a d b c d b a c c b c a

No. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. *53.

Description Adjusting entry for prepaid lease Adjusting entry for interest receivable Adjusting entry for interest expense Adjusting entry for bad debts Adjusting entry for bad debts Adjusting entry for unearned rent Adjusting entry for interest receivable Calculate property tax adjustment Calculate balance in unearned revenue Adjusting entry for investments Adjusting entry for investments Calculate cash received for interest Calculate cash paid for salaries Calculate cash paid for insurance Calculate insurance expense Calculate interest revenue Calculate salary expense Payment after reversing entry

MULTIPLE CHOICE QUESTIONS—CPA Adapted Answer c b b c b c d

No. 54. 55. 56. 57. 58. 59. *60.

Description Calculate accrued interest payable Calculate balance of unearned revenues Calculate prepaid insurance Calculate interest receivable Calculate accrued salaries Calculate royalty revenue Payment after reversing entry

*This topic is dealt with in an Appendix to the chapter.

The Accounting Information System

EXERCISES Item E3-61 E3-62 E3-63 E3-64 E3-65 E3-66 E3-67 E3-68

Description Definitions The accounting cycle Recordable events Adjusting entries Adjusting entries Calculation of expense Calculation of expense Calculation of revenue

PROBLEMS Item P3-69 P3-70 P3-71 P3-72 P3-73 P3-74 P3-75 P3-76 P3-77 P3-78 P3-79 P3-80

Description Transaction journal entries Adjusting entries Adjusting entries and calculation of pre-tax income Adjusting entries and account classification Adjusting entries Adjusting and closing entries Adjusting and closing entries Closing entries Accrual accounting Eight-column work sheet Preparation of financial statements Trial balance correction

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE - Conceptual 1. Which of the following statements is true regarding accounting information systems? a) Both large and small firms should use the same type of accounting system. b) All firms should have the same types of transactions. c) The volume of data to be handled should not vary between firms. d) The kind of information that management requires of an accounting system will vary, depending on the type of firm.

2. An external event involving a transfer or exchange between two or more entities or parties is called a(n) a) account. b) transaction. c) ledger. d) accounting system.

3. The book (or electronic database) containing the accounts is called the a) ledger. b) transaction. c) journal. d) financial statement.

4. An example of a temporary account is a) Unearned Revenue. b) Salary Expense. c) Inventory. d) Retained Earnings.

5. The double-entry accounting system is a) the procedure of transferring journal entries to the ledger accounts. b) an accounting system first developed by Canada Revenue Agency. c) the procedure of entering transaction data in the journal. d) a system that records the dual effect of each transaction in appropriate accounts.

6. Which of the following accounts is increased by a debit? a) Liability b) Asset c) Retained earnings d) Revenue

7. Which of the following equations is correct? a) Assets plus Liabilities = Equity. b) Assets = Liabilities minus Equity. c) Liabilities = Assets plus Equity. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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d) Equity = Assets minus Liabilities.

8. Which of the following criteria does NOT have to be met before an event or transaction should be recorded for accounting purposes? a) The event or transaction must be an external event. b) The event or transaction can be measured objectively in financial terms. c) The event or transaction is relevant and reliable. d) The event or transaction must meet the definition of an element.

9. Which of the following is an internal event? a) Sale of goods or services b) Payment of dividends c) Using raw materials in production d) Purchase of materials

10. The book of original entry where transactions and other selected events are first recorded is called the a) ledger. b) journal. c) account. d) statement of financial position.

11. The debit and credit analysis of a transaction normally takes place a) before an entry is recorded in a journal. b) when the entry is posted to the ledger. c) when the trial balance is prepared. d) when the financial statements are prepared.

12. Performing a service for a client on account will a) increase one asset and decrease another asset. b) decrease an asset and decrease a liability. c) increase an asset and decrease equity. d) increase an asset and increase equity.

13. The account credited for a receipt of cash on account is a) Cash. b) Service Revenue. c) Accounts Receivable. d) Accounts Payable.

14. Some events are NOT recorded in the accounting information system because a) the service has been provided but the cash has not yet been received. b) the service has not been provided but the cash has already been received. c) their measurement is too complex. d) the amounts are not material. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

15. The process of transferring the essential facts and figures from the book of original entry to the ledger accounts is called a) journalizing. b) posting. c) double-entering. d) adjusting.

16. A trial balance a) is a list of all the accounts in the ledger. b) is a list of all the accounts and their balances at a specific date. c) cannot be used in the preparation of financial statements. d) cannot be used as a basis for preparation of adjusting entries.

17. A trial balance will NOT balance if a) an amount is posted to the wrong account. b) a transaction has been entered twice. c) a transaction has been omitted. d) only the debit side of a journal entry has been posted.

18. Adjusting entries are NOT used to a) obtain a proper matching of revenues and expenses. b) adjust nominal accounts to zero at the end of the fiscal year. c) report an accurate picture of assets, liabilities and equity. d) report proper net income and comprehensive income.

19. If, during an accounting period, an expense item has been incurred and consumed but not yet paid for or recorded, then the end-of-period adjusting entry would involve a) a liability account and an asset account. b) an asset or contra-asset and an expense account. c) a liability account and an expense account. d) a receivable account and a revenue account.

20. For adjusting entries relating to accrued revenues, a) a liability-revenue account relationship exists. b) the adjusting entry involves a credit to an asset account and a debit to a revenue account. c) if an adjustment is not made, assets will be overstated. d) before adjustment, both assets and revenues are understated.

21. Which of the following must be considered in estimating depreciation on an asset for an accounting period? a) only the original cost of the asset b) only the asset’s useful life c) both the original cost of the asset and its useful life d) the decline in its fair market value Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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22. The type of account and normal balance of “Accumulated Depreciation, Equipment” is a) Asset, Credit. b) Contra-asset, Credit. c) Contra-asset, Debit. d) Liability, Credit.

23. If the accountant forgets to record an adjustment for Accumulated Depreciation, Building at the end of the accounting period, this will cause a) an overstatement of assets. b) an understatement of assets. c) an overstatement of expenses. d) an overstatement of liabilities.

24. An adjusting entry for bad debts will generally a) increase an expense account and decrease an asset account. b) increase an expense account and increase an asset account. c) increase an expense account and increase a contra-asset account. d) increase an expense account and increase a liability account.

25. An accrued revenue can best be described as an amount a) collected and currently matched with expenses. b) collected and not currently matched with expenses. c) not collected and currently matched with expenses. d) not collected and not currently matched with expenses.

26. An unearned revenue can best be described as an amount a) collected and currently matched with expenses. b) collected and not currently matched with expenses. c) not collected and currently matched with expenses. d) not collected and not currently matched with expenses.

27. Which of the following statements is INCORRECT regarding fair value adjustments for investments? a) Both FV-NI investments and FV-OCI investments could include equity investments or investments in debt securities. b) FV-OCI investments exclude debt securities. c) At each period end, an estimate is made of the fair value of both FV-NI and FV-OCI investments. d) An adjusting entry is required to record a holding gain or loss on FV-NI investments.

28. In the closing process, all the revenue and expense accounts are transferred to a clearing or suspense account called a) Other Comprehensive Income. b) Common Shares. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) Retained Earnings. d) Income Summary. 29. A corporation’s net income or loss is closed at year end to a) Accumulated Other Comprehensive Income. b) Common Shares. c) Retained Earnings. d) Other Comprehensive Income.

30. A post-closing trial balance a) includes temporary accounts only. b) includes permanent accounts only. c) includes both temporary and permanent accounts. d) may include expense accounts.

31. Which of the following statements about the trial balance is correct? a) The debits and credits must balance. b) The equality of credits and debits ensures that no errors were made. c) The post-closing trial balance includes temporary accounts only. d) The post-closing trial balance is used to prepare the financial statements.

32. If the inventory account at the end of the year is understated, the effect will be to a) overstate the cost of goods sold. b) understate the net purchases. c) overstate the gross profit on sales. d) overstate the goods available for sale.

33. Which of the following statements is INCORRECT regarding the work sheet? a) The work sheet is an informal device for accumulating and sorting information required for the financial statements. b) It is often used to make end-of-period procedures easier. c) It helps the accountant prepare financial statements on a more timely basis. d) It can be used in place of financial statements.

*34. Reversing entries are usually used for a) accrued revenues and bad debts. b) accrued expenses and accrued revenues. c) accrued expenses and depreciation. d) accrued revenues and depreciation.

*35. If the purchase of Office Supplies was originally debited to an expense account and correctly adjusted at year end, the reversing entry required in the next period would a) Debit Office Supplies, Credit Office Supplies Expense. b) Debit Office Supplies Expense, Credit Income Summary. c) Debit Office Supplies Expense, Credit Office Supplies. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

d) Debit Office Supplies Expense, Credit Cash.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS - Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

d b a b d

6. 7. 8. 9. 10.

b d a c b

11. 12. 13. 14. 15.

a d c c b

16. 17. 18. 19. 20.

b d b c d

21. 22. 23. 24. 25.

c b a c c

26. 27. 28. 29. 30.

b a d c b

31. 32. 33. *34. *35.

a a d b c

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MULTIPLE CHOICE QUESTIONS - Computational 36. On September 1, 2013, Brown Corp. made the annual lease payment of $9,000 for its fleet of delivery trucks. The payment covered the period September 1, 2013 to August 31, 2014. Assuming the entire amount had originally been debited to Lease Expense, the required adjustment at December 31, 2013 is a) debit Lease Expense and credit Prepaid Lease $6,000. b) debit Prepaid Lease and credit Lease Expense $6,000. c) debit Prepaid Lease and credit Lease Expense $9,000. d) debit Lease Expense and credit Prepaid Lease $9,000.

37. White Resources determines that it has not yet recorded the 2013 accrual for interest revenue to be received in 2014. Assuming the amount to be recorded for 2013 is $4,000, the required adjustment at December 31, 2013 is a) debit Interest Receivable and credit Interest Revenue $4,000. b) debit Interest Revenue and credit Interest Receivable $4,000. c) debit Interest Payable and credit Interest Revenue $4,000. d) Silly question: no adjusting entry is required.

38. On November 1, 2013, Green Corp. purchased equipment by signing a 3-month, 9% note for $100,000. The December 31, 2013 adjusting entry required in connection with this note is a) debit Interest Expense and credit Interest Payable, $9,000. b) debit Interest Expense and credit Interest Payable, $750. c) debit Interest Expense and credit Interest Payable, $1,500. d) debit Interest Expense and credit Cash, $1,500.

39. Blue Corp.'s account balances at December 31, 2013 included: Accounts Receivable, $385,000 debit; Allowance for Doubtful Accounts, $1,000 credit. From a review of the receivables, Blue estimates that $20,000 of the December 31 receivables will be uncollectible. The required adjusting entry would include a credit to the allowance account for a) $ 1,000. b) $19,000. c) $20,000. d) $21,000.

40. Yellow Corp.'s account balances at December 31, 2013 included: Accounts Receivable, $860,000 debit; Allowance for Doubtful Accounts, $600 debit. Sales during 2013 were $1,500,000. It is estimated that 2% of sales will be uncollectible. The required adjusting entry would include a credit to the allowance account for a) $18,000. b) $29,400. c) $30,000. d) $30,600.

41. On August 1, 2013, Black Corporation received $6,000 cash from a tenant for one year's rent Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

in advance, and recorded the transaction with a credit to Rent Revenue. The December 31, 2013 required adjusting entry in connection with this would be a) debit Rent Revenue and credit Unearned Rent, $3,500. b) debit Rent Revenue and credit Unearned Rent, $2,500. c) debit Unearned Rent and credit Rent Revenue, $2,500. d) debit Cash and credit Unearned Rent, $6,000.

42. On December 1, 2013, Pink Inc. lent $52,000 to Zinc Inc. in return for a three-month, 4.5% interest-bearing note. What adjusting entry should Pink Inc. make on December 31, 2013, in connection with this note? a) Debit Interest Receivable and credit Interest Revenue, $195. b) Debit Cash and credit Interest Revenue, $195. c) Debit Interest Receivable and credit Interest Revenue, $585. d) Debit Interest Revenue and credit Interest Receivable, $585.

43. Lime Limited has received its invoice for $85,000 for property taxes for the calendar year 2013. The invoice was received and paid in June 2013 and the entire amount was debited to property tax expense. Assuming Lime does NOT prepare interim financial statements, the required adjustment on December 31, 2013 related to the property taxes is a) debit property tax expense and credit prepaid property tax $49,583. b) debit prepaid property tax and credit property tax expense $49,583. c) debit property tax expense and credit prepaid property tax $35,417. d) Silly question: no adjusting entry is required.

44. On December 10, 2013 Peach Inc. received a cheque for $60,000 from a customer for services that Peach will be performing in December 2013 and January 2014. By December 31, 2013, Peach had earned 40% of that amount. Assuming the appropriate year end adjustments were made, the 2013 balance in Peach's Unearned Revenue account will be a) $60,000. b) $36,000. c) $24,000. d) zero.

45. On May 15, 2014, Grey Corp. purchased 1,000 common shares of Regal Bank for $25,000, as a Fair Value through Other Comprehensive Income (FV-OCI) equity investment. At December 31, 2014, the fair value of these shares was $27,200. The required adjusting entry to reflect this fact is a) debit Fair Value—OCI Investment, Cr Holding Gain on Investment (OCI) $27,200. b) debit Holding Gain on Investment (OCI), credit Fair Value—OCI Investment $27,200. c) debit Fair Value—OCI Investment, Cr Holding Gain on Investment (OCI) $2,200. d) debit Holding Loss on Investment (OCI), credit Fair Value—OCI Investment $2,200.

46. On May 15, 2014, Cream Corp. purchased 1,000 common shares of Regal Bank for $25,000, as a Fair Value through Net Income (FV-NI) equity investment. At December 31, 2014, the fair value of these shares was $22,800. The required adjusting entry to reflect this fact is a) debit Fair Value—Net Income Investment, Cr Holding Gain on Investment (OCI) $22,800. b) debit Holding Gain on Investment (OCI), credit Fair Value—Net Income Investment Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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$22,800. c) debit Fair Value—Net Income Investment, Cr Investment Income $2,200. d) debit Investment Loss, credit Fair Value—Net Income Investment $2,200.

Use the following information for questions 47 through 49: Orange Corp reported the following items on its calendar 2013 statement of comprehensive income: Interest revenue $75,500 Salaries expense 65,000 Insurance expense 9,600 As well, their statements of financial position showed the following balances: December 31, 2013 December 31, 2012 Accrued interest receivable $9,100 $7,500 Accrued salaries payable 8,900 4,200 Prepaid insurance 1,100 1,500

47. The cash received for interest during 2013 was a) $66,400. b) $73,900. c) $75,500. d) $77,100.

48. The cash paid for salaries during 2013 was a) $60,300. b) $60,800. c) $69,700. d) $73,900.

49. The cash paid for insurance premiums during 2013 was a) $ 8,100. b) $ 8,500. c) $ 9,200. d) $10,000.

Use the following information for questions 50 through 52: During calendar 2013, Purple Corp. paid or collected the following items: Insurance premiums paid $ 12,400 Interest collected (revenue) 25,900 Salaries paid 125,200 As well, their statements of financial position showed the following balances: December 31, 2013 December 31, 2012 Prepaid Insurance $ 1,200 $ 1,500 Interest Receivable 3,700 2,900 Salaries Payable 12,300 10,600

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50. The insurance expense on the 2013 statement of comprehensive income was a) $9,700. b) $12,100. c) $12,700. d) $15,100.

51. The interest revenue on the 2013 statement of comprehensive income was a) $32,500. b) $26,700. c) $25,100. d) $19,300.

52. The salary expense on the 2013 statement of comprehensive income was a) $102,300. b) $123,500. c) $126,900. d) $148,100.

*53. At December 31, 2013, Aquamarine Corp. has not yet received its December invoice for utilities, and accrues an estimate of $10,000. On January 15, 2014 Aquamarine receives the utilities invoice for $11,000 and pays the invoice in cash. Assuming the accrual had already been reversed, the entry on January 15, 2014 is a) debit utilities expense and credit cash $11,000. b) debit cash and credit utilities expense $11,000. c) debit utilities expense and credit cash $1,000. d) debit cash and credit utilities expense $1,000.

The Accounting Information System

MULTIPLE CHOICE ANSWERS - Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38.

b a c

39. 40. 41.

b c a

42. 43. 44.

a d b

45. 46. 47.

c d b

48. 49. 50.

a c c

51. 52. *53.

b c a

DERIVATIONS - Computational No. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. *53.

Answer b a c b c a a d b c d b a c c b c a

Derivation $9,000 – ($9,000 x 4/12) = $6,000. $100,000 x 9% × 2/12 = $1,500. $20,000 – $1,000= $19,000. $1,500,000 × 2% = $30,000. (ADA balance is irrelevant). 7/12 × $6,000 = $3,500. $52,000 x 4.5% x 1/12 = $195. $60,000 x 60% = $36,000. $27,200 - $25,000 = $2,200 gain. $22,800 - $25,000 = $2,200 loss. $7,500 + $75,500 – $9,100 = $73,900. $4,200 + $65,000 – $8,900 = $60,300. $9,600 – $1,500 + $1,100 = $9,200. $12,400 + $1,500 - $1,200 = $12,700. $25,900 – $2,900 + $3,700 = $26,700. $125,200 – $10,600 + $12,300 = $126,900.

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MULTIPLE CHOICE QUESTIONS - CPA Adapted 54. On September 1, 2013 Culver Corp. issued an 8% note payable to National Bank for $900,000, payable in three equal annual principal payments of $300,000, plus interest. On this date, the bank's prime rate was 7%. The first payment for interest and principal was made on September 1, 2014. At December 31, 2014, Culver should record accrued interest payable of a) $24,000. b) $21,000. c) $16,000. d) $14,000.

55. Rathbone Corp. sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to Unearned Service Revenues. This account had a balance of $1,100,000 at December 31, 2013 before year-end adjustment. Service contract costs are charged as incurred to the Service Contract Expense account, which had a balance of $325,000 at December 31, 2013. Service contracts still outstanding at December 31, 2013 expire as follows: During 2014 $170,000 During 2015 250,000 During 2016 110,000 What amount should be reported as Unearned Service Revenues on Rathbone's December 31, 2013 statement of financial position? a) $775,000 b) $530,000 c) $325,000 d) $250,000

56. On December 1, 2013, Flynn Consulting paid $18,000 for a three-year insurance policy (December 1, 2013 to November 30, 2016) and debited the entire amount to prepaid insurance. The December 31, 2013 required adjusting entry in connection with this policy would be a) debit prepaid insurance and credit insurance expense $500. b) debit insurance expense and credit prepaid insurance $500. c) debit insurance expense and credit prepaid insurance $17,500. d) debit prepaid insurance and credit insurance expense $17,500.

57. On June 1, 2013, Carr Corp. loaned Farr Corp. $500,000 on a 6% note, payable in five annual instalments of $100,000 (plus interest), beginning January 2, 2014. Interest on the note is payable on the first day of each month beginning July 1, 2013. Farr made timely payments through November 1, 2013. On January 2, 2014, Carr received payment of the first principal instalment plus all interest due. At December 31, 2013, Carr's interest receivable on this loan is a) $0. b) $2,500. c) $5,000. d) $7,500.

58. Grant Limited pays all salaried employees on a biweekly basis. Overtime pay, however, is Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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paid in the next biweekly period. Grant accrues salaries expense only at its December 31 year end. Data relating to salaries earned in December 2013 are as follows: Last payroll was paid on Dec 27, 2013, for the two-week period ended Dec 27, 2013. Overtime pay earned in the two-week period ended Dec 27, 2013 was $5,000. Remaining work days in 2013 were December 29, 30, 31, on which days there was no overtime. The regular biweekly salaries total $80,000. Assuming a five-day work week, Grant should record a liability at December 31, 2013 for accrued salaries of a) $24,000. b) $29,000. c) $48,000. d) $53,000.

59. Mark-Wall Corp.'s trademark was licensed to Rodgers Inc. for royalties of 12% of sales of the trademarked items. Royalties are payable semi-annually on March 15 for sales in July through December of the previous year, and on September 15 for sales in January through June of the same year. Mark-Wall received the following royalties from Rodgers: March 15 September 15 During 2012 $6,000 $8,000 During 2013 7,000 9,000 Rodgers estimates that sales of the trademarked items would total $75,000 for July through December 2013. On their statement of comprehensive income for calendar 2013, Mark-Wall’s royalty revenue should be a) $9,000. b) $16,000. c) $18,000. d) $20,000.

*60. Douglas Corp is reviewing their payroll accruals for December 2013. Salaries for the month of December total $165,000 and will be paid on January 14, 2014. Assuming year end accruals were reversed on January 1, 2014, the entry to record the January 14 payment to employees is a) no entry is required. b) debit salaries payable and credit salaries expense $165,000. c) debit cash and credit salaries expense $165,000. d) debit salaries expense and credit cash $165,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS - CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

54. 55.

c b

56. 57.

b c

58. 59.

b c

*60.

DERIVATIONS - CPA Adapted No. 54. 55. 56. 57. 58. 59. *60.

Answer c b b c b c d

Derivation ($900,000 – $300,000) × 8% × 4/12 = $16,000. $170,000 + $250,000 + $110,000 = $530,000. $18,000 x 1/36 = $500. $500,000 × 6% × 2/12 = $5,000. $5,000 + ($80,000 ÷ 10 × 3) = $29,000. $9,000 + ($75,000 × 12%) = $18,000.

The Accounting Information System

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EXERCISES Ex. 3-61 Definitions Define the following terms: 1. Event 2. Work sheet 3. Permanent accounts 4. Temporary accounts 5. Income summary 6. General ledger Solution 3-61 1. An event is something of consequence that happens. For a business, an event is generally the source or cause of changes in assets, liabilities and equity. 2.

Work sheets are used as informal tools to help accountants prepare financial statements.

Permanent accounts (also called real accounts) are assets, liability and equity accounts. Unlike temporary accounts, permanent accounts are NOT closed.

Temporary accounts are revenue and expense accounts. Unlike permanent accounts, they are periodically closed.

The income summary is an account that is used as part of the closing process. It facilitates the closing of the temporary accounts at year end.

A general ledger is a collection of all the business’ accounts and may include subsidiary ledgers for specific accounts.

Ex. 3-62 The accounting cycle Summarize the steps in the accounting cycle. Solution 3-62 The accounting cycle may be summarized in 9 steps as follows: 1. Identification and measurement of transactions and other events 2.

Journalization of current period's entries into journals

Posting of journals to the general ledger

Preparation of trial balance (unadjusted)

Preparation and posting of adjusting entries

Preparation of adjusted trial balance

Preparation of financial statements

Preparation and posting of closing entries

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Preparation of post-closing trial balance

10. Preparation and posting of reversing entries (optional)

Ex. 3-63 Recordable events Before transactions are entered into a corporation's accounting system, the underlying event must be analyzed, to determine how (and if) it should be recorded. The situations below relate to Maxwell Corporation. Instructions Indicate whether the items below are recordable events. 1. A new mortgage contract for its new factory building is signed. 2. The first mortgage payment is made. 3. Wages for the current month are paid. 4. A new secretary is hired. 5. Property taxes are paid. 6. HST collections for the current month are forwarded to the CRA. Solution 3-63 1. Not recordable 2.

Recordable

Not recordable

Recordable

Ex. 3-64 Adjusting entries Present, in journal form, the adjustments that would be made on July 31, 2013, the end of the fiscal year, for each of the following: 1. The supplies inventory on August 1, 2012 was $8,350. Supplies costing $16,650 were purchased during the fiscal year and debited to Supplies Inventory. A count on July 31, 2013 indicated supplies on hand of $6,810. 2. On April 30, a ten-month, 4% note for $40,000 was received from a customer. 3. On March 1, $8,400 was collected as rent for one year and a nominal (temporary) account was credited. Solution 3-64 1. Supplies Expense (8,350 + 16,650 – 6,810) .......................... Supplies Inventory ....................................................... 2.

Interest Receivable (40,000 x 4% x 3/12) ............................... Interest Revenue ..........................................................

18,190 18,190 400 400

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The Accounting Information System

Rent Revenue (8,400 x 7/12 unearned) ................................. Unearned Revenue ......................................................

4,900 4,900

Ex. 3-65 Adjusting entries Amadeus Ltd. wishes to record receipts and payments in such a manner that adjustments at the end of the period will not require reversing entries at the beginning of the next period. Instructions Record the following transactions in the desired manner; as well, record the adjusting entry on December 31, 2013. (Two entries for each part.) 1. An insurance policy for two years was purchased on April 1, 2013 for $4,800. 2. Rent of $4,200 for six months for a portion of the building was received on November 1, 2013. Solution 3-65 1. Prepaid Insurance ................................................................... Cash ............................................................................. Insurance Expense (4,800 x 9/24) .......................................... Prepaid Insurance......................................................... 2.

Cash ....................................................................................... Unearned Rent ............................................................. Unearned Rent (4,200 x 2/6) ................................................. Rent Revenue...............................................................

4,800 4,800 1,800 1,800 4,200 4,200 1,400 1,400

Ex. 3-66 Calculation of expense Sales salaries paid during 2013 were $90,000. Advances to salesmen were $1,300 on January 1, 2013, and $800 on December 31, 2013. Sales salaries payable were $1,300 on January 1, 2013, and $1,400 on December 31, 2013. Instructions Calculate the Sales Salaries Expense for calendar 2013. Solution 3-66 $90,000 + $1,300 – $800 – $1,300 + $1,400 = $90,600.

Ex. 3-67 Calculation of expense The records for Jay Inc. showed the following for 2013: Accrued expenses Prepaid expenses Cash paid during the year for expenses, $55,000.

Jan. 1 $2,000 900

Dec. 31 $3,600 800

Instructions Calculate the total amount of expenses that should be reported on the 2013 statement of comprehensive income.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 3-67 $55,000 – $2,000 + $3,600 + $900 – $800 = $56,700.

Ex. 3-68 Calculation of revenue The records for Oriole Corp. showed the following for 2013: Unearned revenue Accrued revenue Cash collected during the year from revenue, $85,000.

Jan. 1 $3,000 1,400

Dec. 31 $3,400 1,100

Instructions Show the calculation of the amount of revenue that should be reported on the 2013 statement of comprehensive income. Solution 3-68 $85,000 + $3,000 – $3,400 – $1,400 + $1,100 = $84,300.

The Accounting Information System

3 - 27

PROBLEMS Pr. 3-69 Journal Entries Jonathan Green owns Green Palms, a gardening centre (as a sole proprietorship). His first year of operations included the following selected events and transactions: January: 1. He invested $400,000 in his business. 2. He buys a greenhouse for $200,000 cash. May: 3. He hires a greenhouse supervisor at an annual salary of $40,000. June: 4. He orders and pays for a shipment of flowers costing $110,000. 5. He sells flowers for $50,000. Half of these sales are made on account. August: 6. He receives a deposit of $7,000 from a customer to put merchandise "on hold". 7. He pays current month's salaries of $4,000. Instructions Prepare all required journal entries. Solution 3-69 1. Cash ....................................................................... Jonathan Green, Capital ............................ 2. Building ................................................................... Cash ..........................................................

400,000 400,000 200,000 200,000

3. No entry required. 4. Inventories .............................................................. Cash ..........................................................

110,000

5. Cash ................................................................... Accounts Receivable ............................................... Sales ..........................................................

25,000 25,000

6. Cash

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

7,000

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

4,000

110,000

50,000

7,000

4,000

Pr. 3-70 Adjusting entries The information shown below relates to Flower Corporation. At December 31, 2013 Flower's general ledger shows the following balances: Prepaid lease $6,000 Debit Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Prepaid insurance Unearned revenue

$900 Debit $78,000 Credit

In addition, the following information is available: 1. The entire amount shown as prepaid lease has expired. 2. One third of the amount shown as prepaid insurance has expired. 3. Half of the amount shown as unearned revenue has now been earned. Instructions Prepare all adjusting entries that are required at December 31, 2013. Solution 3-70 1. Lease Expense.............................................................................. Prepaid Lease ................................................................... 2.

6,000 6,000

Insurance Expense (900 x 1/3) ..................................................... Prepaid Insurance .............................................................

300

Unearned Revenue (78,000 x ½).................................................. Revenue ............................................................................

39,000

300

39,000

Pr. 3-71 Adjusting entries Part I – Maison Corp. has reported pre-tax income of $400,000 for calendar 2013, before considering the five items below. Prepare the adjusting entries needed at December 31, 2013 in order to correctly state the 2013 pre-tax income. If no entry is needed, write NONE. 1. Interest on a $39,000, 8%, six-year note payable was last paid on September 1, 2013. 2. On May 31, 2013, Maison entered into a contract to provide services to a customer for eighteen months beginning June 1. The customer paid the $18,000 fee in full on June 1 and Maison credited it to Service Revenue. 3. On August 1, 2013, Maison paid a year’s rent in advance on a warehouse, and debited the $36,000 payment to Prepaid Rent. 4. Depreciation on office equipment for 2013 is $17,000. 5. On December 18, 2013, Maison paid the local newspaper $1,000 for an advertisement to be run in January of 2014, debiting it to Prepaid Advertising. Part II – Show the effect of each adjusting entry in Part I on previously reported pre-tax income, and indicate the correct amount of pre-tax income. Reported 2013 pre-tax income Add (deduct) Item (1) (2) (3) (4) (5) Correct 2013 pre-tax income

$400,000

________ $

Solution 3-71 Part I 1. Interest Expense (39,000 x 8% x 4/12) ..........................................

1,040

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The Accounting Information System

Interest Payable ............................................................ 2.

1,040

Service Revenue (18,000 x 11/18 unearned) ................................ Unearned Service Fees .................................................

11,000

Rent Expense (36,000 x 5/12) ...................................................... Prepaid Rent .................................................................

15,000

Depreciation Expense ................................................................... Accumulated Depreciation.............................................

17,000

11,000

15,000

17,000

NONE.

Part II Reported 2013 pre-tax income Add (deduct) Item (1) (2) (3) (4) (5) Correct 2013 pre-tax income

$400,000 (1,040) (11,000) (15,000) (17,000) $355,960

Pr. 3-72 Adjusting entries and account classification Selected amounts from Elderberry Ltd.’s trial balance at December 31, 2013 appear below: 1. Accounts Payable $ 180,000 2. Accounts Receivable 160,000 3. Accumulated Depreciation —Equipment 230,000 4. Allowance for Doubtful Accounts 21,000 5. Bonds Payable 550,000 6. Cash 155,000 7. Common Shares 63,000 8. Equipment 850,000 9. Insurance Expense 31,000 10. Interest Expense 12,000 11. Merchandise Inventory 290,000 12. Notes Payable (due June 1, 2014) 230,000 13. Prepaid Rent 130,000 14. Retained Earnings 120,000 15. Salaries and Wages Expense 338,000 (All of the above accounts have normal balances.) Instructions Part A Prepare adjusting journal entries at year end, December 31, 2013, based on the following additional information: a) The equipment has a useful life of ten years with no residual (salvage) value. (Straight-line method being used.) Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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b) c) d) e)

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Interest accrued on the bonds payable is $16,000. Unexpired insurance is $9,000. The Prepaid Rent of $130,000 covers the four months from November 30, 2013 through March 31, 2014. Salaries and wages earned but unpaid, $24,000.

Part B Indicate the proper statement of financial position classification of each of the 15 accounts listed, by placing appropriate numbers after each of the following classifications. If the account would appear on the statement of comprehensive income, do not put the number in any of the classifications. a) Current assets b) Non-current assets c) Current liabilities d) Non-current liabilities e) Shareholders' equity Solution 3-72 Part A a) Depreciation Expense—Equipment (850,000/10) ......................... Accumulated Depreciation —Equipment ............................ b)

85,000 85,000

Interest Expense ........................................................................... Interest Payable ..................................................................

16,000

Prepaid Insurance ......................................................................... Insurance Expense .............................................................

9,000

Rent Expense (130,000/4) ............................................................ Prepaid Rent .......................................................................

32,500

Salaries and Wages Expense ........................................................ Salaries and Wages Payable ..............................................

24,000

16,000

9,000

32,500

24,000

Part B a) Current assets—2, 4, 6, 11, 13 b)

Non-current assets—3, 8

Current liabilities—1, 12

Non-current liabilities—5

Shareholders' equity—7, 14

Pr. 3-73 Adjusting entries Data relating to the balances of various accounts affected by adjusting or closing entries appear below. (The entries, which caused the changes in the balances, are not given.) You are asked to supply the missing journal entries, which would logically account for the changes in the account Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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The Accounting Information System

balances. 1. Interest receivable at January 1, 2013 was $1,000. During 2013, cash received from debtors for interest on outstanding notes receivable was $5,800. The 2013 statement of comprehensive income showed Interest Revenue of $4,900. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made. 2. Unearned rent at January 1, 2013 was $5,300, and at December 31, 2013 was $6,000. The records indicate cash receipts from rental sources during 2013 were $45,000, all of which were credited to the Unearned Rent Account. You are to prepare the missing adjusting entry. 3. Accumulated Depreciation—Equipment at January 1, 2013 was $230,000, and at December 31, 2013 was $280,000. During 2013, one piece of equipment was sold. The equipment had an original cost of $40,000 and was 3/4 depreciated when sold. You are to prepare the missing adjusting entry. 4. Allowance for doubtful accounts on January 1, 2013 was $50,000. The balance in the allowance account on December 31, 2013 after making the annual adjusting entry was $65,000. During 2013 bad debts of $30,000 were written off. You are to provide the missing adjusting entry. 5. Prepaid rent at January 1, 2013 was $10,000. During 2013 rent payments of $110,000 were made and debited to Rent Expense. The 2013 statement of comprehensive income shows Rent Expense of $120,000. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made. 6. Retained earnings at January 1, 2013 was $150,000 and at December 31, 2013 it was $210,000. During 2013, cash dividends of $50,000 were paid, which were correctly debited to retained earnings. You are to prepare the missing closing entry to close the Income Summary account. Solution 3-73 1. Interest Receivable ................................................................. Interest Revenue .......................................................... Interest revenue per books $4,900 Interest revenue received related to 2013 ($5,800 – $1,000) 4,800 Interest accrued $ 100 2.

100 100

Unearned Rent Revenue......................................................... Rent Revenue............................................................... Cash receipts $45,000 Beginning balance 5,300 Ending balance (6,000) Rent revenue $44,300

44,300

Depreciation Expense ............................................................. Accumulated Depreciation —Equipment....................... Ending balance $280,000 Beginning balance 230,000 Difference 50,000 Write-off at time of sale 3/4 × $40,000 30,000 $ 80,000

80,000

Bad Debt Expense .................................................................. Allowance for Doubtful Accounts ................................. Ending balance $65,000

45,000

44,300

80,000

45,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Beginning balance Difference Written off

50,000 15,000 30,000 $45,000

Rent Expense .......................................................................... Prepaid Rent ................................................................. Rent expense $120,000 Less cash paid 110,000 Reduction in prepaid rent account $ 10,000

10,000

Income Summary .................................................................... Retained Earnings ........................................................ Ending balance $210,000 Beginning balance 150,000 Difference 60,000 Cash dividends 50,000 Net income must be $110,000

110,000

10,000

110,000

Pr. 3-74 Adjusting and closing entries The following trial balance was taken from the books of Kaslo Corporation at December 31, 2013. Account Debit Credit Cash .......................................................................................... $ 40,000 Accounts Receivable .................................................................. 108,000 Note Receivable ......................................................................... 8,000 Allowance for Doubtful Accounts ................................................ $ 1,800 Merchandise Inventory ............................................................... 54,000 Unexpired Insurance ................................... 4,800 Furniture and Equipment ............................................................ 138,000 Accumulated Depreciation.......................................................... 15,000 Accounts Payable....................................................................... 10,800 Common Stock........................................................................... 44,000 Retained Earnings ...................................................................... 65,000 Sales .......................................................................................... 410,000 Cost of Goods Sold .................................................................... 128,000 Salaries Expense ....................................................................... 53,000 Rent Expense............................................................................. 12,800 Totals ................................................................................ $546,600 $546,600 At year end, the following items have not yet been recorded. 1. Insurance expired during the year, $3,000. 2. Estimated bad debts, 1 percent of gross sales. 3. Depreciation on furniture and equipment, 10% per year. 4. Interest at 9% is receivable on the note for one full year. 5. Rent paid in advance at December 31, $6,800 (originally debited to expense). 6. Accrued salaries at December 31, $6,200. Instructions a) Prepare the necessary adjusting entries. b) Prepare the necessary closing entries. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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The Accounting Information System

Solution 3-74 a) Adjusting Entries 1. Insurance Expense ....................................................................... Unexpired Insurance .............................................................. 2.

3,000 3,000

Bad Debt Expense (410,000 x 1%) ............................................... Allowance for Doubtful Accounts ............................................

4,100

Depreciation Expense (138,000 x 10%) ........................................ Accumulated Depreciation. .....................................................

13,800

Interest Receivable (8,000 x 9%) ................................................. Interest Revenue ....................................................................

720

Prepaid Rent ................................................................................. Rent Expense.........................................................................

6,800

Salaries Expense .......................................................................... Salaries Payable ....................................................................

6,200

b) Closing Entries Sales ............................................................................................... Interest Revenue.................................................................................. Income Summary .......................................................................... Income Summary ................................................................................. Salaries Expense .......................................................................... Rent Expense ............................................................................... Depreciation Expense ................................................................... Bad Debt Expense ........................................................................ Insurance Expense ....................................................................... Cost of Goods Sold ....................................................................... Income Summary ................................................................................. Retained Earnings.........................................................................

4,100

13,800

720

6,800

6,200

410,000 720 410,720 214,100 59,200 6,000 13,800 4,100 3,000 128,000 196,620 196,620

Pr. 3-75 Adjusting and Closing Entries 1. Using the Adjusted Trial Balance of Charles Corporation from Pr 3-78, journalize the adjustments that were made. 2. Using the adjusted Trial Balance of Charles Corporation from Pr 3-78, journalize the closing entries that are required. Solution 3-75 1. Store Supplies Expense ................................................................................................... 4,000 Store Supplies ......................................................................................................... 4,000 Depr. Expense—Store Equipment .................................................................................... 18,000 Accumulated Depreciation— Store Equipment.................................................................................................. 18,000 Depr. Expense—Delivery Equipment................................................................................ 14,000 Accumulated Depreciation— Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Delivery Equipment.............................................................................................. 14,000 Interest Expense ............................................................................................................... 22,000 Interest Payable ....................................................................................................... 22,000

Sales

1,494,400 Income Summary..................................................................................................... 1,494,400

Income Summary .............................................................................................................. 1,527,600 Sales Returns and Allowances ................................................................................ 8,400 Cost of Goods Sold.................................................................................................. 994,800 Salaries Expense ..................................................................................................... 280,000 Advertising Expense ................................................................................................ 52,800 Utilities Expense ...................................................................................................... 28,000 Repair Expense ....................................................................................................... 24,200 Delivery Expense ..................................................................................................... 33,400 Rent Expense .......................................................................................................... 48,000 Store Supplies Expense........................................................................................... 4,000 Depreciation Expense—Store Equipment ........................................................................................................... 18,000 Depreciation Expense—Delivery Equipment ........................................................................................................... 14,000 Interest Expense ...................................................................................................... 22,000 Retained Earnings ............................................................................................................ 33,200 Income Summary..................................................................................................... 33,200

Pr. 3-76 Closing Entries Below is a selection of account balances for Mulcair Ltd. at December 31, 2013: Sales ................................... $856,000 Sales returns .......................... $20,000 Cost of goods sold.................. $456,000 Advertising expense ............... $42,000 Salaries expense .................... $112,000 Depreciation expense............. $29,000 Insurance expense ................. $9,000 Administrative expense .......... $10,000 All accounts have their normal balances. Instructions Prepare all necessary closing entries at December 31, 2013. Solution 3-76 Sales ............................................................................. Sales returns...................................................... Income summary ...............................................

856,000 20,000 836,000

The Accounting Information System

Income summary .......................................................... Administrative expense...................................... Advertising expense ......................................... Depreciation expense ........................................ Cost of goods sold ............................................ Insurance expense ............................................ Salaries expense ...............................................

658,000

Income summary .......................................................... Retained earnings .............................................

178,000

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10,000 42,000 29,000 456,000 9,000 112,000

178,000

Pr. 3-77 Accrual accounting Blackbird Corp.'s records provide the following information concerning certain account balances and changes in these account balances during the current year. Transaction information is missing from each item below. Instructions Prepare the entry to record the missing information for each account. (Consider each independently.) 1. Accounts Receivable: Jan. 1, balance $40,000, Dec. 31, balance $45,000, uncollectible accounts written off during the year, $6,000; accounts receivable collected during the year, $134,000. Prepare the entry to record sales for the year. 2. Allowance for Doubtful Accounts: Jan. 1, balance $2,400, Dec. 31 balance $7,500, uncollectible accounts written off during the year, $30,000. Prepare the entry to record bad debt expense. 3. Accounts Payable: Jan. 1, balance $20,000, Dec. 31, balance $33,000, purchases on account for the year, $110,000. Prepare the entry to record payments on account. 4. Interest Receivable: Jan. 1 accrued, $1,000, Dec. 31 accrued, $2,100, earned for the year, $20,000. Prepare the entry to record cash interest received. Solution 3-77 1. Ending balance $ 45,000 Ending balance Beginning balance 40,000 Plus: Rec. collected Difference 5,000 Write-offs Uncollectible accounts 6,000 OR Receivables collected 134,000 Less: Beginning balance Sales for period $145,000 Sales for period Accounts Receivable ..................................................................... 145,000 Sales .................................................................................. 2.

Ending balance Beginning balance Difference Write-off Adjusting entry

$ 7,500 2,400 5,100 30,000 $35,100

Ending balance Write-off

145,000 $ 7,500 30,000 37,500 2,400 $35,100

OR Beginning balance Adjusting entry

Bad Debts Expense ...................................................................... Allowance for Doubtful Accounts ........................................

$ 45,000 134,000 6,000 185,000 40,000 $145,000

35,100 35,100

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Ending balance Beginning balance Difference Purchases Payments

$ 33,000 20,000 13,000 110,000 $ 97,000

Beginning balance Plus purchases OR Less ending balance Payments

Accounts Payable .......................................................................... Cash ................................................................................... 4.

Revenue Earned Less: Dec. 31 accrual Plus: Jan. 1 accrual Cash received

$20,000 (2,100) 1,000 $18,900

$ 20,000 110,000 130,000 33,000 $ 97,000

Beginning balance Plus revenue earned OR Less ending balance Cash received

Cash .............................................................................................. Interest Receivable ............................................................. (This entry assumes that the $20,000 interest earned was first recorded as a receivable.)

97,000 97,000 $ 1,000 20,000 21,000 2,100 $18,900 18,900 18,900

Pr. 3-78 Eight-column work sheet The work sheet and trial balance of Santos Corporation is reproduced on the following page. The information below is relevant to the preparation of adjusting entries needed to both properly match revenues and expenses for the period and reflect the proper balances in the real and nominal accounts. Instructions As the accountant for Santos, you are to prepare adjusting entries based on the following data, entering the adjustments on the work sheet and completing the additional columns with respect to the income statement and statement of financial position. Carefully key your adjustments and label all items. (Due to time constraints, an adjusted trial balance is not required.) Round all calculations to the nearest dollar. 1. After an aging of accounts receivable, it was determined that three percent of the accounts will become uncollectible. 2. Depreciation is calculated using the straight-line method, with an eight-year life and $1,000 residual (salvage) value. 3. Salesmen are paid commissions of 11% of sales. Commissions on sales for the last week of December have not been paid. 4. The note was issued on October 1, 2013, with interest at 8%, due Feb. 1, 2014. 5. A physical inventory of supplies indicated $280 of supplies currently on hand. 6. Provisions of the company’s lease contract specify rent payments must be made one month in advance, with monthly payments of $900/mo. This provision has been complied with as of Dec. 31, 2013. Santos Corporation Work Sheet Year ended December 31, 2013 Accounts

Trial Balance Dr. Cr.

Adjustments Dr. Cr.

Income Statement Dr. Cr.

State of fin position Dr. Cr.

The Accounting Information System Cash Marketable Securities Accounts Receivable Allow. for D. A. Inventory Supplies Equipment Accum. Depr.–Equip. Accounts Payable Notes Payable Common Shares Retained Earnings Cost of Goods Sold Office Salaries Sales Commissions Rent Expense Misc. Expense Sales Totals

5,400 4,050 40,000

420

16,800 1,040 49,000 9,500 4,400 4,250 40,000 25,340 238,520 20,800 29,000 7,200 2,200 414,010

330,100 414,010

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 3-78 Santos Corporation Work Sheet December 31, 2013 Accounts Cash Marketable Securities Accounts Receivable Allow. for D. A. Mdse. Inventory Supplies Equipment Accum. Depr.–Equip. Accounts Payable Notes Payable Common Stock Retained Earnings Cost of Goods Sold Office Salaries Sales Commissions Rent Expense Misc. Expense Sales Totals Bad Debt Expense Depr. Expense Sales Com. Payable Interest Expense Interest Payable Supplies Expense Prepaid Rent Totals Net Income Totals

Trial Balance Dr. Cr. 5,400 4,050 40,000 420 16,800 1,040 49,000 9,500 4,400 4,250 40,000 25,340 238,520 20,800 29,000 7,200 2,200 330,100 414,010 414,010

Adjustments Dr. Cr.

Income Statement Dr. Cr.

(a)

780

(e)

760

(b) 6,000

900

(a) 780 (b) 6,000

238,520 20,800 36,311 6,300 2,200

330,100

780 6,000 (c) 7,311

(d)

(e) (f)

760 900 15,836

(d)

7,311 85

760 15,836

311,756 18,344 330,100

330,100

900 116,430

330,100

116,430

Adjusting entries and explanations 1. Bad Debt Expense......................................................................... Allowance for Doubtful Accounts ............................................ (3% of accounts receivable is 3% × $40,000, which is $1,200. Since the allowance account has a credit balance of $420 before adjustment, $780 must be added to the allowance account.) 2.

State of fin position Dr. Cr. 5,400 4,050 40,000 1,200 16,800 280 49,000 15,500 4,400 4,250 40,000 25,340

98,086 18,344 116,430

780 780

Depreciation Expense ................................................................... Accumulated Depreciation—Equipment.................................. ($49,000 – $1,000 is $48,000. One-eighth of $48,000 is $6,000.)

6,000

Sales Commissions .......................................................................... Sales Commissions Payable ..................................................... (11% of sales is 11% × $330,100, which is $36,311. The balance in the Sales Commissions account is $29,000

7,311

6,000

7,311

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The Accounting Information System

before adjustment, indicating that $7,311 of commissions are accrued but unpaid.) 4.

Interest Expense .............................................................................. Interest Payable ........................................................................ ($4,250 × .08 × 3/12 = $85)

Supplies Expense ............................................................................ Supplies .................................................................................... (The balance of $1,040 in the Supplies account before adjustment less the correct ending balance of $280 is $760.)

760

Prepaid Rent .................................................................................... Rent Expense............................................................................ (Since the trial balance contains no account for prepaid rent, the $900 lease payment has apparently been debited to Rent Expense. An account must be set up for the Prepaid Rent.)

900

760

900

Pr. 3-79 Preparation of Financial Statements Use the following information to prepare a multi-step Statement of Comprehensive Income, a Statement of Changes in Shareholders Equity, and a classified Statement of Financial Position. Charles Corporation Adjusted Trial Balance December 31, 2013 Debit Cash $ 33,400 Accounts Receivable 87,400 Merchandise Inventory 90,000 Store Supplies 7,000 Store Equipment 170,000 Accumulated Depreciation–Store Equipment Delivery Equipment 96,000 Accumulated Depreciation--Delivery Equipment Notes Payable Accounts Payable Common Shares Retained Earnings Sales Sales Return and Allowances 8,400 Cost of Goods Sold 994,800 Salaries Expense 280,000 Advertising Expense 52,800 Utilities Expense 28,000 Repair Expense 24,200 Delivery Expense 33,400 Rent Expense 48,000 Store Supplies Expense 4,000 Depreciation Expense Store Equipment 18,000 Depreciation Expense Delivery Equipment 14,000 Interest Expense 22,000

Credit

54,000 26,000 82,000 117,000 200,000 16,000 1,494,400

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Interest Payable Totals

2,011,400

22,000 2,011,400

Other Data: 1. Salaries expense is 70% selling and 30% administrative. 2. Rent expense and utilities expense are 80% selling and 20% administrative. 3. $60,000 of notes payable are due for payment next year. 4. Repair expense is 100% administrative. Solution 3-79 CHARLES CORPORATION Statement of Comprehensive Income for year ended December 31, 2013 Sales revenue Sales .............................................................................................. Less: Sales returns and allowances ................................................ Net sales .................................................................................................... Cost of goods sold...................................................................................... Gross profit................................................................................................. Operating expenses Selling expenses $196,000 Salaries expense................................................................. ($280,000 x 70%) 52,800 Advertising expense ............................................................ 38,400 Rent expense ...................................................................... ($48,000 x 80%) 33,400 Delivery expense................................................................. 22,400 Utilities expense .................................................................. ($28,000 x 80%) 18,000 Depr. exp.—store equipment............................................... 14,000 Depr. exp.—delivery equipment .......................................... 4,000 Stores supplies expense ..................................................... $379,000 Total selling expenses ................................................. Administrative expenses 84,000 Salaries expense................................................................. ($280,000 x 30%) 24,200 Repair expense ................................................................... 9,600 Rent expense ...................................................................... ($48,000 x 20%) 5,600 Utilities expense .................................................................. ($28,000 x 20%) 123,400 Total admin. expenses ................................................ Total operating. expenses ........................................ Loss from operations .................................................................................. Other expenses and losses Interest expense ............................................................................. Net loss ......................................................................................................

$1,494,400 8,400 1,486,000 994,800 491,200

502,400 11,200 22,000 $33,200

CHARLES CORPORATION Statement of Changes in Shareholders' Equity for year ended December 31, 2013

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The Accounting Information System

Common Shares

Total Beginning, Jan 1, 2013 Net loss for 2013 Other comprehensive income

216,000

200,000

(33,200)

Retained Earnings $

(33,200)

16,000 (33,200)

Comprehensive income Ending, Dec 31, 2013

Comprehensive Income

(33,200) 182,800

200,000

(17,200)

CHARLES CORPORATION. Statement of Financial Position December 31, 2013 Assets Current assets Cash ....................................................................................................... Accounts receivable .................................................................................... Merchandise inventory ................................................................................ Store supplies ............................................................................................. Total current assets........................................................................ Non-current assets Store equipment .......................................................................................... $170,000 Accumulated depreciation—store equipment ............................................. 54,000 $116,000 Delivery equipment ..................................................................................... 96,000 Accumulated depreciation—delivery 26,000 70,000 equipment ...................................................................................... Total assets .................................................................................... Liabilities and Shareholders’ Equity Current liabilities Current portion of notes payable ................................................................. Accounts payable ........................................................................................ Interest payable ........................................................................................... Total current liabilities .................................................................... Non-current liabilities Notes payable ............................................................................................. Total liabilities ................................................................................. Shareholders’ equity Common Shares ......................................................................................... $200,000 Deficit (17,200) Total liabilities and shareholders’ equity .....................................................

$ 33,400 87,400 90,000 7,000 217,800

186,000 $403,800

$ 60,000 117,000 22,000 199,000 22,000 221,000

182,800 $403,800

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Pr. 3-80 Trial balance correction The Controller of SHD Corporation asks his assistant to correct the company's December 31, 2013 trial balance. The preliminary trial balance, which does not balance, is reproduced below: SHD Corporation Trial Balance December 31, 2013

Cash Accounts Receivable Prepaid Insurance Equipment Inventories Accounts Payable Common Shares Sales Salaries Office Supplies Depreciation Expense

Debit 10,000 15,000 600 40,000 9,000

Credit

11,590 110,000 17,100 64,000 2,150 2,550 ________ 143,300

_______ 138,690

The assistant's review uncovered the following errors: 1. The accounts payable for the purchase of inventories in the amount of $6,560 was recorded as $5,650 in error. 2. Depreciation expense was understated by $450. 3. Office supplies were overstated by $150. 4. A collection from a customer in the amount of $4,000 was not posted to the receivable ledger. Instructions Prepare a corrected trial balance. Solution 3-80 SHD Corporation Trial Balance December 31, 2013 Debit 10,000 11,000 600 40,000 9,000

Cash Accounts Receivable ($15,000 - $4,000) Prepaid Insurance Equipment Inventories Accounts Payable Common Shares ($11,590 + $6,560 - $5,650)

Credit

12,500 110,000

The Accounting Information System

Sales Salaries Office Supplies ($2,150 - $150) Depreciation Expense ($2,550 + $450)

17,100 64,000 2,000 3,000 ________ 139,600

_______ 139,600

3 - 43

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 4 REPORTING FINANCIAL PERFORMANCE SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY

Note:

Item

LOD

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

1 1 1 1 2 3 3 3 3 4

E E E E E E M M M M

40. 41. 42. 43.

4 4 4 5

M H H M

54. 55. 56. 57.

5 6 6 6

M M M M

67. 68. 69. 70.

3 3 4 4

M M H M

81. 82.

5 5,6

H M

E = Easy

Item

LO LOD Item LO LOD Multiple Choice–Conceptual 11. 4 M 21. 6 M 12. 4 E 22. 6 H 13. 4 M 23. 6 M 14. 4 M 24. 6 H 15. 4 M 25. 6 M 16. 5 M 26. 6 M 17. 5 H 27. 6 M 18. 5 H 28. 6 H 19. 5 H 29. 6 M 20. 5,6 H 30. 7 H Multiple Choice–Computational 44. 5 M 48. 7 M 45. 6 M 49. 7 H 46. 7 M 50. 7 M 47. 7 H 51. 7 H Multiple Choice–CPA Adapted 58. 6 M 62. 6 M 59. 6 M 63. 7 M 60. 6 M *64. 10 M 61. 6 M *65. 10 M Exercises 71. 4 E 75. 6 M 72. 4-7,9 H 76. 6 M 73. 5 M 77. 6,7 M 74. 6 M 78. 7 M Problems 83. 6 M 85. 6 M 84. 6 M 86. 6 M

M = Medium

Item

LOD

31. 32. 33. 34. 35. 36. 37. *38. *39.

7 7 7 7 7 8 9 10 10

H H M H H H H H H

52. 53.

7 7

H M

*66.

79. *80.

8 10

M M

87. *88.

6,7 10

H M

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

10. 11. 12.

MC MC MC

13. 14. 15.

MC MC MC

16. 17.

MC MC

18. 19.

MC MC

20. 21. 22. 23. 24.

MC MC MC MC MC

25. 26. 27. 28. 29.

MC MC MC MC MC

30. 31. 32. 33.

MC MC MC MC

34. 35. 46. 47.

MC MC MC MC

36.

79.

37.

72.

*38. *39.

MC MC

*64. *65.

MC MC

Item Type Item Type Learning Objective 1 3. MC 4. MC Learning Objective 2 Learning Objective 3 8. MC 9. MC Learning Objective 4 40. MC 69. Ex 41. MC 70. Ex 42. MC 71. Ex Learning Objective 5 20. MC 44. MC 43. MC 54. MC Learning Objective 6 45. MC 59. MC 55. MC 60. MC 56. MC 61. MC 57. MC 62. MC 58. MC 72. Ex Learning Objective 7 48. MC 52. MC 49. MC 53. MC 50. MC 63. MC 51. MC 72. Ex Learning Objective 8

Item

Type

Item

Type

67.

68.

72.

72. 73.

Ex Ex

81. 82.

Pr Pr

74. 75. 76. 77. 82.

Ex Ex Ex Ex Pr

83. 84. 85. 86. 87.

Pr Pr Pr Pr Pr

77. 78. 87.

Ex Ex Pr

Learning Objective 9

Note:

MC = Multiple Choice

Learning Objective 10 *66. MC *88. Pr *80. Ex Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Reporting Financial Performance

4-3

CHAPTER STUDY OBJECTIVES 1. Appreciate how firms create value and manage performance. A business is based on a basic model of obtaining financing, investing in assets, and using those assets to generate profits. Different industries have different business models. Even within an industry, different businesses may have different strategies for generating revenues. Some businesses and industries are riskier than others. Companies must decide how and whether to manage these risks. Managing risks costs money, which reduces profits. Capital markets demand greater returns for riskier businesses.

2. Understand how users use information about performance to make decisions. Users use information about performance to evaluate past performance and profitability and to provide a basis for predicting future performance. They also use the information to help assess risk and uncertainty regarding future cash flows.

3. Understand the concept of and be able to assess quality of earnings/information. Information quality is not the same. Some information is better than others. The conceptual framework identifies characteristics of useful information. The limitations of an income statement are that (1) the statement does not include many items that contribute to the general growth and well-being of an enterprise; (2) income numbers are often affected by the accounting methods that are used; (3) income measures are often estimates; and (4) information is sometimes biased and GAAP is not always optimal because it is a product of a political process. The concept of quality of earnings is used by analysts and investors to assess how well the reported income reflects the underlying business and future potential. When assessing quality of earnings, consider all information about a company. High-quality earnings have various attributes, as biased, this degrades the quality.

4. Understand the differing perspectives on how to measure income. There are various ways to measure income, including operating income, net income, and comprehensive income. IFRS recognizes the concept of comprehensive income but this is not recognized under ASPE. Other comprehensive income consists of a set list of items identified under IFRS essentially dealing with certain unrealized gains/ losses. Under IFRS, some of these items are recycled (reclassified) to net income and some are not.

5. Measure and report results of discontinued operations. The gain or loss on disposal of a business component involves the sum of: (1) the income or loss from operations to the financial statement date, and (2) the gain or loss on the disposal of the business component. These items are reported net of tax among the irregular items in the income statement. Related assets are identified on the balance sheet where material. Under IFRS, non-current assets are reclassified to current assets.

6. Measure income and prepare the income statement and the statement of comprehensive income using various formats. There are many ways to present the income statement and the statement of comprehensive income. GAAP lays out certain minimum

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

requirements but beyond that, a company has some leeway to present the information as it wishes. The goal is to ensure that the statements present information about performance in a transparent manner, including presenting items such that the users can see which are ordinary versus peripheral activities. IFRS allows the statement of comprehensive income to be presented in a combined statement or two separate statements. By convention, companies use what is known as a single-step method or a multiple-step method (or a variation of the two). In a single-step income statement, there are only two groupings: revenues and expenses. Frequently, income tax is reported separately as the last item before net income to indicate its relationship to income before income tax. A multiple-step income statement shows two additional classifications: (1) a separation of operating results from the results obtained through the subordinate or non-operating activities of the company; and (2) a classification of expenses by functions, such as merchandising or manufacturing, selling, and administration, or by nature (such as salary expense and depreciation). IFRS requires entities to provide information about either the nature or function of expenses. When information is presented using function, additional disclosures should be made regarding the breakdown of the nature of expenses as the latter has good cash flow predictive value. The entity should choose the method that best reflects the nature of the business and industry.

7. Prepare the statement of retained earnings and the statement of changes in equity. The retained earnings statement should disclose net income (loss), dividends, prior period adjustments, and transfers to and from retained earnings (appropriations). This statement is required under ASPE. The statement of changes in equity is a required statement under IFRS and takes the place of the statement of changes in retained earnings. It shows all changes in all equity accounts including accumulated other comprehensive income.

8. Understand how disclosures and analysis help users of financial statements assess performance. Disclosures include notes and supplementary information. They provide background and explanatory information necessary to understand the business. Investors and analysts use quality of earnings analysis to help determine a company’s value.

9. Identify differences in accounting between IFRS and ASPE and potential changes. The chart in Illustration 4-24 outlines the major differences. The IASB is planning to change the way financial statements are presented. The major statements, including balance sheet, income statement, and statement of cash flows, will be classified according to business and financing activities. The IASB is also working to harmonize the definition of “component” for purposes of discontinued operations.

Reporting Financial Performance

4-5

MULTIPLE CHOICE—Conceptual Answer b c b a d b d b d b a c a c a c d b c c b d b a c d b d b c a b d a b c d b c

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. *38. *39.

Description Business model activities Business model activities and the income statement Risk/return tradeoff Representational faithfulness Usefulness of the income statement Concept of soft numbers Earnings management Limitations of the income statement Quality of earnings Net income definition IFRS view of income Other comprehensive income All-inclusive income Comprehensive income inclusions Accumulated other comprehensive income Reporting discontinued operations Determination of a discontinued operation Classification of assets held for sale Assets held for sale EPS disclosures on income statement Unusual gains and losses Separate presentation under IFRS Single step income statement Income statement presentation IFRS requirement for expense presentation Expenses presented by function Intraperiod tax allocation Intraperiod tax allocation Earnings per share data Retained earnings statement Losses excluded from income statement Change in accounting principle Change in accounting principle Correction of an error Statement of shareholders’ equity Notes to financial statements Differences between ASPE and IFRS Accrual basis of accounting Modified cash basis

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Answer d a d c d b c a d a d d b c

No. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53.

Description Calculation of net income using retained earnings Calculation of total purchases Calculation of cost of goods sold Disposal of a major business segment Calculation of loss on discontinued operation Calculation of other income on multiple step income statement Effect of accounting errors Effect of accounting errors Effect of accounting errors Effect of accounting errors Effect of accounting errors on current assets Events affecting income from continuing operations Events affecting retained earnings Calculation of retained earnings balance

MULTIPLE CHOICE—CPA Adapted Answer b d a a b d a a d b b a c

No. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. *64. *65. *66.

Description Calculation of income from discontinued operations Calculation of selling expenses Calculation of general and administrative expenses Calculation of selling expenses Calculation of general and administrative expenses Calculation of income from continuing operations Calculation of net income Determination of infrequent losses Calculation of cost of goods sold Adjustments to retained earnings Accrual vs. cash basis Calculation of cash basis revenue Conversion of cash to accrual basis

*This topic is dealt with in an Appendix to the chapter.

Reporting Financial Performance

4-7

EXERCISES Item E4-67 E4-68 E4-69 E4-70 E4-71 E4-72 E4-73 E4-74 E4-75 E4-76 E4-77 E4-78 E4-79 *E4-80

Description Income statement limitations Characteristics of high quality earnings Calculation of net income from change in shareholders’ equity Calculation of net income from change in shareholders’ equity Comprehensive income Definitions Discontinued operations Income statement classifications Classification of income statement and retained earnings statement items Nature versus function of expense presentation Terminology Statement of changes in equity Analyzing financial health and quality of earnings Cash basis

PROBLEMS Item P4-81 P4-82 P4-83 P4-84 P4-85 P4-86 P4-87 *P4-88

Description Discontinued operations Multiple-step income statement Income statement, including corrections Multiple-step income statement Multiple-step income statement Income statement adjustments Income statement and retained earnings statement Accrual accounting

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. The business model may be broken down into three activities: a) investing, operating, allocating. b) investing, operating, financing. c) financing, operating and comprehensive income. d) balance sheet, income statement, cash flow statement. 2. The income statement captures an entity’s a) financing activities. b) investing activities. c) operating activities. d) interrelationship between activities. 3. The “risk/return tradeoff” means a) using various techniques to manage risks. b) the market demands a greater return when there is greater risk. c) not investing in a risky business. d) monitoring risks.

4. The concept of representational faithfulness requires that the financial statements a) reflect the economic reality of running a business. b) reflect everything no matter how small. c) reflect the biases of management. d) identify all risks that the entity faces.

5. Information in the income statement does NOT help users to a) evaluate the past performance of the enterprise. b) provide a basis for predicting future performance. c) help assess the risk of not achieving future cash flows. d) calculate the exact amount of future dividends. 6. The concept of ‘soft numbers’ reflects the fact that a) financial statement numbers may be manipulated. b) sometimes significant measurement uncertainty exists. c) sometimes significant errors exist. d) earnings numbers may not be sustainable.

7. Earnings management is a) the process of managing a business. b) the process of profit maximization. c) always fraudulent. d) manipulating income to meet a targeted earnings level.

Reporting Financial Performance

4-9

8. Limitations of the income statement include all of the following EXCEPT a) items that cannot be measured reliably are not reported. b) only actual amounts are reported in determining net income. c) income measurement involves the use of estimates. d) income numbers are affected by the accounting methods used. 9. Which of the following is INCORRECT regarding “quality of earnings”? a) Quality of earnings refers to how solid the earnings numbers are. b) Analysts use quality of earnings to assess how well the reported income reflects the underlying business and future potential. c) If earnings quality is high, numbers are accepted as is. d) If earnings quality is low, numbers are accepted as is.

10. Net income represents a) revenues and gains less expenses and losses from continuing operations only. b) revenues and gains less expenses and losses from both continuing and discontinued operations. c) net income plus/minus other comprehensive income. d) ongoing revenues and expenses before gains, losses and discontinued operations.

11. The view of income that IFRS generally supports is referred to as the a) all-inclusive approach. b) current operating performance approach. c) other comprehensive income approach. d) operating income approach.

12. At year end, other comprehensive income is closed out to a) retained earnings. b) share capital. c) accumulated other comprehensive income. d) net income.

13. All-inclusive income includes all of the following EXCEPT a) investments by owners. b) losses on disposal of assets. c) dividend revenue. d) gains on the expropriation of property by the government.

14. Comprehensive income includes all changes in equity during a period EXCEPT a) gains and losses from discontinued operations. b) unrealized gains and losses on available for sale securities. c) those resulting from investments by owners and distributions to owners. d) gains and losses from irregular items.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

15. Accumulated other comprehensive income would be reported in a) shareholders’ equity. b) retained earnings. c) net income. d) net income from continuing operations.

16. When a company disposes of a discontinued operation (segment), the transaction should be included in the income statement as a gain or loss on disposal, and reported as a) a prior period adjustment. b) other comprehensive income. c) an amount after continuing operations. d) a bulk sale of plant assets included in income from continuing operations.

17. For purposes of discontinued operations, the key elements in determining that a separate segment exists are that the component is a) a separate business and a separate legal entity. b) a separate legal entity and generates its own net cash flows. c) in a separate geographic region and can be sold. d) a separate business and generates its own cash flow.

18. If an asset is to be classified as held for sale, which of the following conditions does NOT apply? a) The sale has been authorized by the company's management. b) Changes to the sale plan are likely. c) It is probable that the asset will be sold within one year. d) There is an active program to find a buyer.

19. When an asset is held for sale a) it must relate to a discontinued operation. b) the entity must continue to record depreciation for the asset. c) the asset is remeasured to the lower of carrying (book) value and fair value less costs to sell. d) the asset is remeasured to the lower of fair value and carrying (book) value.

20. Which of the following is a required disclosure in the income statement when reporting the disposal of a segment of the business? a) The gain or loss on disposal should be reported as an unusual item. b) Results of operations of a discontinued segment should be disclosed immediately below other irregular items. c) Earnings per share from both continuing operations and net income should be disclosed on the face of the statement or in the notes. d) The gain or loss on disposal should not be segregated, but should be reported together with the results of continuing operations.

Reporting Financial Performance

4 - 11

21. Unusual gains and losses are items on the income statement that a) are typical of everyday activities but do not occur frequently. b) are not typical of everyday activities or do not occur frequently. c) include writedown of inventories and writeoff of bad debts. d) are not usually disclosed separately.

22. Under IFRS, which of the following is NOT required to be presented separately in the statements of income/comprehensive income? a) Revenues. b) Discontinued operations. c) Cost of goods sold. d) Depreciation/depreciation.

23. The single-step income statement emphasizes a) the gross profit figure. b) total revenues and total expenses. c) discontinued operations and accounting changes. d) the various components of income from continuing operations.

24. Which of the following is NOT a generally practiced method of presenting the income statement? a) including corrections of errors made in a prior period b) the single-step income statement c) the multiple-step income statement d) including gains and losses from discontinued operations

25. IFRS requires that expenses be presented in the income statement a) by amount or in alphabetical order. b) by geographical area or by the single-step method. c) by nature or by function. d) by current or non-current.

26. When expenses are presented by function in the income statement, a) they should be presented by type of expense (e.g., depreciation, purchases, salaries). b) they should be reported as part of other comprehensive income. c) their cash flow predictive value is increased. d) more professional judgment is required to allocate expenses between functions.

27. Intraperiod tax allocation a) allocates tax balances between fiscal years. b) allocates tax balances within a fiscal period. c) is used for income from continuing operations but not for income from discontinued operations. d) is used for other comprehensive income but not for income from discontinued

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

operations.

28. Intraperiod tax allocation a) arises because certain revenue and expense items appear in the income statement either before or after they are included in the tax return. b) is required for the cumulative effect of changes in accounting principles but not for discontinued operations. c) allocates income tax expense evenly over a number of accounting periods. d) relates income tax expense to the items which affect the amount of tax.

29. Regarding earnings per share (EPS) data a) both public and private corporations are required to report EPS on the face of the income statement. b) although public corporations are required to report EPS, private corporations are not. c) EPS related to comprehensive income is required. d) financial analysts do not attach much importance to EPS data.

30. Which of the following items will NOT appear in the retained earnings statement? a) net loss b) correction of an error c) change in accounting estimates d) stock dividends

31. Which one of the following types of losses is excluded from the determination of net income in the income statement? a) material losses resulting from correction of errors related to prior periods b) material losses resulting from sale of assets not originally acquired for resale c) material losses resulting from write-off of intangibles d) material losses resulting from sale of investments

32. Which of the following is a change in accounting principle? a) a change in the estimated service life of machinery b) a change from FIFO to weighted average for inventory costing c) a change in the estimated allowance for bad debts d) a change in estimated future warranty expense

33. When reporting a change in accounting principle, required disclosure(s) on the income statement include a) a per share amount for the cumulative effect of the change. b) the cumulative effect on prior years, net of tax. c) the cumulative effect be disclosed immediately after discontinued operations. d) silly question: a change in accounting principle is not reported on the income statement.

34. Unsure Inc. made a very large arithmetical error in the preparation of its year-end financial

Reporting Financial Performance

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statements by incorrect placement of a decimal point in the calculation of depreciation. The error caused the net income to be reported at almost double the correct amount. When Unsure discovered the error in the following year, correction of the error should be treated as a(n) a) adjustment to beginning retained earnings, net of tax. b) increase in depreciation expense for the year in which the error is discovered. c) gain for the year in which the error was made. d) component of income for the year in which the error is discovered, but separately listed on the income statement and fully explained in a note to the financial statements.

35. The statement of changes in shareholders’ equity a) is a required statement under ASPE. b) is a required statement under IFRS. c) is a required statement under both IFRS and ASPE. d) is an optional statement under both IFRS and ASPE.

36. Which of the following is(are) NOT recommended to be included in notes to the financial statements? a) accounting policies b) information about the capital structure of the company c) individual salaries of top management d) sources of estimation uncertainty

37. Which of the following is INCORRECT regarding differences between IFRS and ASPE? a) Both IFRS and ASPE mandate a list of required items that must be presented. b) IFRS requires that held-for-sale assets be reclassified as current assets. c) Comprehensive income is not recognized under ASPE. d) Both IFRS and ASPE require presentation of both basic and diluted EPS.

*38. The accrual basis of accounting a) must be used by all taxpayers. b) recognizes revenue when earned and expenses when incurred. c) does not record depreciation. d) records depreciation but expenses all inventory purchases.

*39. The modified cash basis a) is frequently used by manufacturing firms. b) does not usually record inventory. c) capitalizes and depreciates property, plant and equipment. d) is derived from the accrual basis of accounting.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

b c b a d b

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

d b d b a c

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

a c a c d b

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

c c b d b a

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

c d b d b c

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

a b d a b c

37. *38. *39.

d b c

Reporting Financial Performance

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MULTIPLE CHOICE—Computational 40. Mango Inc. Has 100,000 common shares outstanding and has a policy of paying a $1.20 annual dividend for each of these shares. Mango has an income tax rate of 40%, and its retained earnings statement for 2014 reported a closing balance of $1,346,000. Assuming an opening retained earnings balance of zero, dividend payments according to its usual policy, and no other adjustments, Mango's 2014 net income was a) $1,394,000. b) $1,418,000. c) $1,451,000. d) $1,466,000.

41. The following information is available for Apple Limited for 2014: Accounts payable, beginning .................................................... $16,000 Cash payments on account during year .................................... 69,000 Purchase discounts taken during year on 2014 purchases ....... 1,400 Accounts payable, ending ......................................................... 9,000 Assuming the company records purchases at gross amounts, the total purchases for 2014 would be a) $63,400. b) $62,000. c) $58,100. d) $57,800.

42. The following information is available for Orange Corp for 2014: Payment for goods during year ................................................. Accounts payable, beginning .................................................... Inventory, beginning ................................................................. Accounts payable, ending ......................................................... Inventory, ending ...................................................................... Cost of goods sold for 2014 is a) $59,800. b) $60,150. c) $64,320. d) $65,300.

$64,000 8,000 11,000 7,400 9,100

43. During 2014, Cantaloupe Corp disposed of Raspberry Division, a major segment of its business. Cantaloupe realized a gain of $1,500,000, net of taxes, on the sale of Raspberry’s assets. During 2014, Raspberry’s operating losses, net of taxes, were $1,800,000. How should these facts be reported in Cantaloupe’s income statement for 2014? Total Amount to be Included in Income from Results of Continuing Operations Discontinued Operations a) $1,800,000 loss $1,500,000 gain b) 300,000 loss 0

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) d)

0 1,500,000 gain

300,000 loss 1,800,000 loss

44. On January 1, 2014, Apricot Ltd. decided to discontinue its plastics making division. The division, considered a reportable segment, was sold on June 1, 2014. Division assets with a carrying value of $650,000 were sold for $500,000. Operating income from January 1, to May 31, 2014 for the division was $50,000. Ignoring taxes, what amount should be reported on Apricot’s income statement for the year ended December 31, 2014, under the caption "discontinued operations"? a) $200,000 gain b) $150,000 loss c) $50,000 gain d) $100,000 loss

45. Blueberry Inc. reported the following information for 2014: Sales revenue........................................................................... $520,000 Cost of goods sold .................................................................... 350,000 Operating expenses.................................................................. 55,000 Gain on the sale of equipment .................................................. 70,000 Cash dividends received on investment securities .................... 3,000 For 2014, on a multiple-step income statement, Blueberry would report other income of a) $185,000. b) $ 73,000. c) $ 70,000. d) $ 3,000.

Use the following information for questions 46 and 47. The 2014 and 2015 financial statements of Banana Inc. contained the following errors:

Ending inventory Insurance expense

______2014______ $10,000 overstated 4,800 understated

2015 __ $16,000 understated 2,600 overstated

46. Assuming that none of the errors were detected or corrected, by what amount will 2014 income before taxes be overstated or understated? a) $5,200 understated b) $5,200 overstated c) $14,800 overstated d) $14,800 understated

47. Assuming that none of the errors were detected or corrected, by what amount will 2015 income before taxes be overstated or understated? a) $28,600 understated b) $23,800 understated

Reporting Financial Performance

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c) $13,400 understated d) $13,400 overstated

Use the following information for questions 48 through 50. Ignore taxes. Peach Inc.’s financial statements for the years 2014 and 2015 contained errors as follows: 2014 2015 Ending Inventory $ 3,000 understated $ 5,000 overstated Depreciation Expense 5,500 overstated 3,500 overstated

48. Assuming that the errors made in 2014 were corrected, but that the errors made in 2015 were not detected, by what amount will 2015 income before taxes be overstated or understated? a) $5,000 overstated b) $8,500 overstated c) $1,500 understated d) $1,500 overstated

49. Assuming that NONE of the errors were detected or corrected, by what amount will retained earnings at December 31, 2015 be overstated or understated? a) $4,000 understated. b) $5,000 overstated. c) $8,500 understated. d) $11,500 understated.

50. Assuming that NONE of the errors were detected or corrected, and that no additional errors were made in 2016, by what amount will current assets at December 31, 2015 be overstated or understated? a) $2,000 overstated b) $10,000 understated c) $10,000 overstated d) $0

Use the following information for questions 51 and 52. For Pear Limited, events and transactions during 2015 included the following. The tax rate for all items is 30%. 1) Depreciation for 2014 was found to be understated by $30,000. 2) A strike by the employees of a supplier resulted in a loss of $20,000. 3) The inventory at December 31, 2013 was overstated by $40,000. 4) A flood destroyed a building that had a book value of $400,000. Floods are very uncommon in that area.

51. The effect of these events and transactions on 2015 income from continuing operations net

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

of tax would be a) $14,000. b) $35,000. c) $63,000. d) $294,000.

52. The effect of these events and transactions on the balance of retained earnings at January 1, 2015 would be a) $14,000. b) $21,000. c) $294,000. d) $343,000.

53. The following information was extracted from the accounts of Cherry Corporation at December 31, 2014: CR(DR) Total reported income since incorporation ................................ $1,500,000 Total cash dividends paid ......................................................... (800,000) Cumulative effect of changes in accounting principle ................ (120,000) Total stock dividends distributed ............................................... (200,000) Correction of an error, recorded January 1, 2014 ..................... 66,000 What should be the balance of retained earnings at December 31, 2014? a) $566,000 b) $500,000 c) $446,000 d) $380,000

Reporting Financial Performance

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

40. 41. 42.

d a d

43. 44. 45.

C D B

46. 47. 48.

c a d

49. 50. 51.

a d d

52. 53.

b c

Item

Ans.

DERIVATIONS—Computational No. Answer

Derivation

$1,346,000 + ($1.20 x 100,000) = $1,466,000.

41.

$69,000 + $1,400 – $16,000 + $9,000 = $63,400.

42.

$64,000 – $8,000 + $7,400 = $63,400 (purchases). $11,000 + $63,400 – $9,100 = $65,300.

43.

$1,800,000 – $1,500,000 = $300,000.

44.

$650,000 – $500,000 – $50,000 = $100,000 loss.

45.

Other income = $70,000 + $3,000 = $73,000.

46.

$10,000 + $4,800 = $14,800.

47.

$10,000 + $16,000 + $2,600 = $28,600.

48.

$5,000 – $3,500 = $1,500.

49.

$5,000 – $3, 000 + $5,500 – 3,500 = $4,000.

50.

$0.

51.

($20,000 + $400,000) x (1-0.3) = $294,000.

52.

$30,000 x (1 – 0.3) = $21,000.

53.

$1,500,000 – $800,000 – $120,000 – $200,000 + $66,000 = $446,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 54. Sesame Corp.'s adjusted trial balance at December 31, 2014 included the following: Debit Credit Sales ........................................................................................ $170,000 Cost of goods sold .................................................................... $ 70,000 Administrative expenses ........................................................... 28,000 Loss on sale of equipment ........................................................ 11,000 Sales commissions ................................................................... 9,000 Interest revenue........................................................................ 6,000 Loss of warehouse due to flood ................................................ 15,000 Loss from operation of discontinued division ............................ 24,000 Bad debt expense ..................................................................... 5,000 _______ Totals ............................................................................ $162,000 $176,000 Sesame uses the perpetual system, and their income tax rate is 30%. On Sesame’s multiplestep income statement for 2014, income from discontinued operations is a) $10,500. b) $16,800. c) $24,000. d) $24,500.

Use the following information for questions 55 and 56. Oskar Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2014, included the following expense accounts: Accounting and legal fees ......................................................... $120,000 Advertising ................................................................................ 150,000 Freight-out ................................................................................ 75,000 Interest ..................................................................................... 60,000 Loss on sale of long-term investments ...................................... 30,000 Officers' salaries ....................................................................... 180,000 Rent for office space ................................................................. 160,000 Sales salaries and commissions ............................................... 110,000 One-half of the rented premises is occupied by the sales department. 55. How much of the expenses listed above should be included in Oskar’s selling expenses for 2014? a) $260,000 b) $335,000 c) $340,000 d) $415,000

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56. How much of the expenses listed above should be included in Oskar’s general and administrative expenses for 2014? a) $380,000 b) $410,000 c) $440,000 d) $470,000

57. Groucho Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2014 included the following accounts: Accounting and legal fees ......................................................... $140,000 Advertising ................................................................................ 160,000 Freight-out ................................................................................ 80,000 Interest ..................................................................................... 70,000 Loss on sale of long-term investment ....................................... 30,000 Officers' salaries ....................................................................... 225,000 Rent for office space ................................................................. 220,000 Sales salaries and commissions ............................................... 170,000 One-half of the rented premises is occupied by the sales department. Groucho’s total selling expenses for 2014 are a) $520,000. b) $440,000. c) $410,000. d) $350,000.

58. The following items were among those reported on Ernie Ltd.'s income statement for the year ended December 31, 2014: Legal and audit fees ................................................................. $100,000 Rent for office space ................................................................. 235,000 Interest on inventory floor plan .................................................. 248,000 Loss on abandoned equipment used in operations ................... 41,000 The office space is used equally by Ernie’s sales and accounting departments. What amount should be classified as general and administrative expenses in Ernie’s multiple-step income statement for 2014? a) $117,500 b) $217,500 c) $335,000 d) $465,500

Use the following information for questions 59 and 60. Sesame Corp.'s adjusted trial balance at December 31, 2014 included the following: Debit Credit Sales ........................................................................................ $170,000 Cost of goods sold .................................................................... $ 70,000

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Administrative expenses ........................................................... 28,000 Loss on sale of equipment ........................................................ 11,000 Sales commissions ................................................................... 9,000 Interest revenue........................................................................ 6,000 Loss of warehouse due to flood ................................................ 15,000 Loss from operation of discontinued division ............................ 24,000 Bad debt expense ..................................................................... 5,000 _______ Totals ............................................................................ $162,000 $176,000 Sesame uses the perpetual system, and their income tax rate is 30%. On Sesame’s multiplestep income statement for 2014:

59. Income from continuing operations is a) $17,500. b) $52,800. c) $24,500. d) $26,600.

60. Net income is a) $9,800. b) $15,000. c) $16,800. d) $24,000.

61. King Inc. incurred the following infrequent losses during 2014: A $90,000 write-down of equipment leased to others (net of tax) A $40,000 adjustment of accruals on long-term contracts (net of tax) A $60,000 write-off of obsolete inventory (net of tax) Of those losses, what amount should be included in King’s 2014 income from continuing operations? a) $190,000 b) $150,000 c) $130,000 d) $100,000

62. The following information is available for Rice Inc. for 2014: Disbursements for purchases ................................................... Increase in trade accounts payable .......................................... Decrease in merchandise inventory .......................................... Cost of goods sold for 2014 was a) $650,000. b) $708,000. c) $700,000. d) $736,000.

$650,000 58,000 28,000

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63. Which of the following should be reported as an adjustment to retained earnings? Change in Estimated Lives Change from Unaccepted of Depreciable Assets Principle to Accepted Principle a) Yes Yes b) No Yes c) Yes No d) No No

*64. Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the accounting period of the Accounts Accrued Receivable Expenses Payable a) No No b) No Yes c) Yes No d) Yes Yes

*65. For the year ended June 30, 2014, Harry Corp. reported revenue of $900,000 in its accrual basis income statement. Additional information was as follows: Accounts receivable June 30, 2013 .......................................... $200,000 Accounts receivable June 30, 2014 .......................................... 490,000 Uncollectible accounts written off during the fiscal year ............ 20,000 Under the cash basis, Harry should report revenue of a) $590,000. b) $610,000. c) $630,000. d) $1,190,000.

*66. Gerald Bone, M.D., keeps his accounting records on the cash basis. During 2014, Dr. Bone collected $150,000 from his patients. At December 31, 2013, Dr. Bone had accounts receivable of $45,000. At December 31, 2014, Dr. Bone had accounts receivable of $35,000 and unearned revenue of $5,000. On the accrual basis, how much was Dr. Bone’s patient service revenue for 2014? a) $145,000 b) $140,000 c) $135,000 d) $105,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

54. 55.

b d

56. 57.

A A

58. 59.

b d

60. 61.

a a

62. 63.

d b

*64. *65.

b a

*66.

DERIVATIONS—CPA Adapted No. Answer 54. b

Derivation $24,000 x (1 – 0.3) = $16,800

55.

$150,000 + $75,000 + $110,000 + ($160,000/2) = $415,000.

56.

$120,000 + $180,000 + $80,000 = $380,000.

57.

$160,000 + $80,000 + ($220,000/2) + $170,000 = $520,000.

58.

$100,000 + ($235,000/2) = $217,500.

59.

$170,000 + $6,000 – $70,000 – $28,000 – $11,000 – $9,000 – $15,000 – $5,000 = $38,000; 38,000 x (1 – 0.3) = $26,600.

60.

($176,000 – $162,000) x (1 – 0.3) = $9,800.

61.

$90,000 + $40,000 + $60,000 = $190,000.

62.

$650,000 + $58,000 + $28,000 = $736,000.

63.

Conceptual

*64.

Conceptual

*65.

$900,000 + $200,000 – $490,000 – $20,000 = $590,000.

*66.

$150,000 – $45,000 + $35,000 – $5,000 = $135,000.

Reporting Financial Performance

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EXERCISES Ex. 4-67 Income statement - limitations Briefly discuss the limitations of the income statement. Solution 4-67 The results disclosed in the income statement are based on the use of estimates and assumptions and may also be affected by the accounting methods used. Furthermore, some important items may, for lack of measurability, not be disclosed at all. Financial recording bias can exist and degrade the quality of the financial statements.

Ex. 4-68 Characteristics of high quality earnings Describe the characteristics of high quality earnings. Solution 4-68 Information content: unbiased/objectively determined; reflect economic reality; sustainable— reflect primary earnings generated from ongoing core business activities, closely correlated with cash flows from operations, based on a sound business strategy/business model. Presentation: transparent and understandable.

Ex. 4-69 Calculation of net income from the change in shareholders' equity Presented below is selected information pertaining to Pullman Enterprises Ltd. for last year: Assets, January 1.......................................................................... $300,000 Assets, December 31 .................................................................... 280,000 Liabilities, January 1...................................................................... 130,000 Common shares, December 31..................................................... 70,000 Retained earnings, December 31 .................................................. 30,000 Common shares issued during the year ........................................ 8,000 Dividends declared during the year ............................................... 13,000 Instructions Calculate the net income for last year. Solution 4-69 January 1 December 31 Assets ........................................................................................... $300,000 $280,000 Liabilities ....................................................................................... 130,000 180,000 Shareholders' equity...................................................................... $ 170,000 $100,000 * Calculation of net income: Shareholders' equity, Dec 31.................................................. $ 100,000 Less shareholders' equity, Jan 1 ............................................ (170,000) Decrease ................................................................................ (70,000) Add back dividend declared ................................................... 13,000 Less common shares issued .................................................. (8,000) Net income (loss)............................................................. $ (65,000)

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*$70,000 + $30,000

Ex. 4-70 Calculation of net income from the change in shareholders' equity Presented below are changes in selected account balances of Briefcase Inc. during last year, except for retained earnings. Increase Increase (Decrease) (Decrease) Cash ........................................... $25,000 Accounts payable .................. $35,000 Accounts receivable (net) ............ (13,000) Bonds payable ...................... (20,000) Inventory ..................................... 52,000 Common shares .................... 88,000 Plant Assets (net)........................ 37,000 The only entries in Retained Earnings were for net income and a dividend declaration of $10,000. Instructions Calculate the net income for last year. Solution 4-70 Calculation of net income: Change in assets ($114,000 – $13,000)..................... Change in liabilities ($35,000 – $20,000) ................... Change in shareholders' equity .................................. Add back dividend declared ....................................... Less common shares ................................................. Net income ..........................................................

$101,000 15,000 86,000 10,000 (88,000) $ 8,000

Increase Increase Increase

Ex. 4-71 Comprehensive Income Valise Corporation completed its first year of operations on December 31, 2014. Results and other information for the year included the following: Sales ............................................................................................. $900,000 Cost of goods sold ........................................................................ 430,000 Operating expenses ...................................................................... 80,000 Unrealized holding gain from investments (accounted for under the fair value through comprehensive income model) ......... 25,000 Instructions Based on the information provided, prepare a combined statement of income and comprehensive income. Ignore income taxes and EPS. Solution 4-71 VALISE CORPORATION Statement of Income and Comprehensive Income For the Year Ended December 31, 2014 Sales .............................................................................................

$900,000

Reporting Financial Performance

Cost of goods sold ........................................................................ Gross profit ................................................................................... Operating expenses ...................................................................... Net income .................................................................................... Other comprehensive income Unrealized holding gain – OCI ................................................ Comprehensive income.................................................................

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430,000 470,000 80,000 390,000 25,000 $415,000

Ex. 4-72 Definitions Provide clear, concise answers for the following: 1. What are revenues? 2. What are expenses? 3. What are gains? 4. What are losses? 5. How should unusual gains and losses be disclosed in the income statement? 6. When does a discontinued segment qualify as discontinued operations? 7. How are earnings per share calculated? 8. State two examples of adjustments to prior year’s retained earnings and indicate how they are reported in the financial statements. 9. The IASB is planning significant changes regarding the presentation of financial statements. How did these changes evolve and how will financial statements likely be impacted? Solution 4-72 1. Revenues are increases in economic resources either by way of inflows or enhancements of assets of an entity or settlements of liabilities, resulting from an entity’s ordinary revenue generating activities. 2.

Expenses are decreases in economic resources, either by outflows or reductions of assets or incurrence of liabilities, resulting from an entity’s ordinary revenue generating activities.

Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues or investment by owners.

Losses are decreases in equity (net assets) from peripheral or incidental transactions, of an entity from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues or investment by owners.

If they are material, they are disclosed separately but must be shown above "income (loss) before discontinued operations” and above the income tax provision. If they are immaterial, they are combined with other gains and losses of the period. Either way, they are included in the company's income from continuing operations.

In order for a segment to be a discontinued operation it must be a distinguishable component of an entity, the activities of which represent a line of business significant to the entity as a whole and/or that are directed to a significant particular class of customer.

The calculation of earnings per share is: net income minus preferred dividends divided by

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the weighted average of common shares outstanding. 8.

Adjustments to a prior year’s retained earnings include correction of an error in the financial statements of a prior period and retroactively applied changes in accounting principles. The adjustment should be charged or credited to the opening balance of retained earnings.

The project was originally started in 2001 and consists of three phases. These phases are currently at various stages of completion. One of the key principles that underlie the proposed changes is a separation of an entity’s financing activities from other activities. Therefore, the changes are expected to result in financial statements that are classified according to financing and business activities.

Ex. 4-73 Discontinued Operations Coreaba Ltd., a private company based in Vancouver, decided to sell its Industrial Design Division. After two years of losses and heavy competition, a plan to dispose of the division was put in place. At the end of 2014, the plan was finalized and approved by the board of directors. The sale is anticipated to be completed by June 30, 2015. Other information: Coreaba's 2014 after-tax net income (excluding the results from the Industrial Design Division) was 230,000. During the year, the division reported an after-tax loss of $140,000 (revenues: $20,000, expenses: $160,000). Management estimates that after-tax legal and audit fees of $40,000 as well as severance payments of $55,000 will be required to finalize the disposal plan. A portion of these costs is expected to be offset by the after-tax proceeds of $50,000 from the sale of the division's assets. Instructions Assuming the Industrial Design Division qualifies for treatment as a discontinued operation, prepare a partial income statement for Coreaba for 2014. The statement should begin with income from continuing operations and include an appropriate footnote pertaining to the disposal of the Industrial Design Division. Solution 4-73 Partial income statement: COREABA LTD Partial Income Statement For the Year Ended December 31, 2014 Net income from continuing operations ................................................ Discontinued operations* Loss from operation of discontinued Industrial Design Division (net of tax) ............................................. Loss from disposal of Industrial Design Division (net of tax) ............................................ Net income...........................................................................................

$230,000

$140,000 45,000

185,000 $45,000

* Footnote:

Reporting Financial Performance

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On December 31, due to continued losses, the board of directors unanimously approved management's plan to dispose of the Industrial Design Division. The sale is anticipated to be completed by June 30, 2015. The after-tax operating results for the current year are as follows: Revenues............................................................................................. $ 20,000 Expenses ............................................................................................. 160,000 Net loss ................................................................................................ $(140,000) The estimated after-tax loss relating to the disposal of the division is comprised of the following items: Proceeds from sale of assets ........................................................ $50,000 Less legal and audit fees............................................................... 40,000 Less severance payments to staff ................................................. 55,000 $45,000

Ex. 4-74 Income statement classifications Indicate the major section or subsection of a multiple-step income statement in which each of the following items would normally appear: a) Advertising b) Depreciation of head office building c) Dividend revenue d) Freight-in e) Loss on disposal of a segment of the business, net of tax f) Income taxes on income g) Major fire loss h) Purchase discounts i) Sales discounts j) Officers' salaries k) Freight-out l) Sinking fund income Solution 4-74 a) Selling expense b)

General and administrative expense

Other revenue

Cost of goods sold, as an addition to purchases

Disclosed separately, but must be shown above “income (loss) before discontinued operations” and before the income tax provision

Income taxes; subtracted from income before income taxes in arriving at net income

Disclosed separately but must be shown above "income (loss) before discontinued

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

operations” and above the income tax provision, i.e., part of income from continuing operations. h)

Cost of goods sold, as a subtraction from purchases

Subtracted from gross revenues

General and administrative expense

Selling expense

Other revenue

Ex. 4-75 Classification of income statement and retained earnings statement items For each of the items listed below, indicate how it should be treated in the financial statements. Use the following letter code for your selections: a) Ordinary item on the income statement b) Discontinued operations c) Unusual item on the income statement d) Adjustment to prior year’s retained earnings _____

The bad debt rate was increased from 1% to 2% of sales, thus increasing bad debt expense.

_____

Obsolete inventory was written off. This was a material amount, and the first loss of this type in the company's history.

_____

An uninsured earthquake loss was incurred. This was the first loss of this type in the company's history.

_____

Recognition of revenue earned last year, inadvertently omitted from last year's income statement.

_____

The company sold one of its warehouses at a loss.

_____

Settlement of a court case involving the federal government, related to income taxes of three years ago. The company is continually involved in various adjustments with the federal government related to its taxes.

_____

A loss incurred from expropriation – the company owned resources in South America which were taken over by a dictator unsympathetic to Canadian business interests.

_____

The company failed to record depreciation in the previous year.

_____

Discontinuance of all production in Canada. The manufacturing operations were relocated to Mexico.

_____ 10.

Loss on sale of investments. The company last sold some of its investments two

Reporting Financial Performance

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years ago. _____ 11.

Loss on the disposal of a segment of the business.

Solution 4-75 1. a 2.

10. a 11. b

Ex. 4-76 Nature versus function of expense presentation IFRS requires a business to present an analysis of expenses based on either “nature” or “function.” Explain what this means. Solution 4-76 Nature refers to the type of expense, such as purchases, depreciation, employee benefits, or distribution costs. Function refers to the business function or activity, such as production or cost of sales, selling and administrative (head office). Thus expenses would be grouped by these activities. Presenting expenses by nature is usually quite straightforward as no allocation of costs is required between functions. On the other hand, presenting expenses by function requires more judgment, as many costs would be allocated between functions, such as payroll, depreciation, and occupancy costs. However, it does give more insight into the various phases of the business.

Ex. 4-77 Terminology In the space provided, write the word or phrase that is defined or indicated. 1. Net income minus preferred dividends divided by the weighted average of common shares outstanding.

1. ________________________________

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2. A correction of an error is reported as a(n)

2. ________________________________

3. An income statement that includes only two groupings (revenues and expenses) is prepared using the

3. ________________________________

4. The income statement category for a disposal of a segment of a business.

4. ________________________________

5. Relating tax expense to specific items on the income statement.

5. ________________________________

Solution 4-77 1. Earnings per share 2.

Adjustment to beginning retained earnings

Single-step method

Discontinued operations

Intraperiod tax allocation

Ex. 4-78 Statement of changes in equity Tote Ltd. reported the following balances at January 1, 2014: Common shares................................................................................... Retained earnings ................................................................................ Accumulated other comprehensive income ..........................................

$420,000 30,000 58,000

During the year Tote earned net income of $200,000 and generated other comprehensive income of $70,000. Instructions Prepare a statement of shareholders’ equity for the year ended December 31, 2014. Solution 4-78 TOTE LTD. Statement of Shareholders’ Equity For the Year Ended December 31, 2014 Accumulated Other

Beginning balance

Common

Comprehensive

Retained

Comprehensive

Total

Income

Earnings

Income

$508,000

$420,000

$ 30,000

Net income

200,000

$200,000

Other comprehensive income

70,000

$58,000

200,000 70,000

Reporting Financial Performance $270,000

Comprehensive income Ending balance

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$778,000

$420,000

$230,000

$128,000

Ex. 4-79 Analyzing financial health and quality of earnings List some items that you should be looking for when analyzing the health and quality of earnings of a company. Solution 4-79 1. Accounting policies 2.

Notes to financial statements

Measurement uncertainty

Financial statements as a whole

Income statement: percentage of net income from continuing operations

Statement of financial position (balance sheet): how is the company financed? revenue generating assets?

Cash flow statement: compare cash from operations to net income

Environmental factors (industry, economy, competition)

*Ex. 4-80 Cash basis Money Inc. reported the following information for their 2014 fiscal year: Revenue on the income statement ................................................ $125,800 Accounts receivable, Jan 1 ........................................................... 4,500 Accounts receivable, Dec 31 ......................................................... 5,540 Unearned revenue, Jan 1 .............................................................. 1,050 Unearned revenue, Dec 31 ........................................................... 1,670 Instructions Calculate the revenue for the year on a cash basis. Solution 4-80 $125,800 + $4,500 – $5,540 – $1,050 + $1,670 = $125,380.

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PROBLEMS Pr. 4-81—Discontinued operations Doberman Corporation operates several stores in British Columbia (Vancouver, Victoria, Kamloops, Penticton and Prince George). The restructuring of its organization on November 20, 2014 has led to the decision to sell its Prince George store. In preparing financial statements at December 31, 2014, the following information was made available: 1. The Prince George operation incurred a loss of $283,500 for the 2014 calendar year, including $225,000 for the period January 1 to November 20, 2014. 2. Estimated costs to sell are $300,000. 3. At December 31, 2014, the fair value of the Prince George assets is estimated at $7 million and the carrying (book) value is $7.3 million. 4. The combined provincial and federal income tax rate is 30%. 5. It is estimated that the operation will lose an additional $250,000 before it is sold. Instructions a) The Prince George operation qualifies for reporting as a discontinued operation. What amount should be reported in the discontinued operations section of Doberman’s 2014 income statement? b) In early 2015, the Prince George operation is sold for $8.5 million, with actual costs to sell of $400,000. Additional income tax expense related to the sale is $500,000. The operation lost an additional $150,000 before it was sold. What amount should be reported in the discontinued operations section of Doberman’s 2015 income statement? Solution 4-81 a) Loss from operations for 2014, before tax .................................... $(283,500) Reduction in carrying value of assets to estimated to be fair value less costs to sell ($7,300,000 – [7,000,000 – 300,000]) ........................................... (600,000) Estimated pre-tax loss ................................................................... (883,500) Recovery of 30% tax of above amount .......................................... (265,050) Loss on discontinued operations ................................................... $(618,450) b) Sale price ...................................................................................... $8,500,000 Minus assets sold at fair value ...................................................... (6,700,000) Additional costs to sell ($400,000-$300,000) ................................. (400,000) Less additional loss from operations ............................................. (150,000) Income tax expenses not previously recorded ............................... (500,000) Estimated pre tax amount ............................................................. 750,000 Applicable income tax at 30% ....................................................... (225,000) Gain on discontinued operations ................................................... $ 525,000

Pr. 4-82 Multiple-step income statement Presented below is information which relates to Labrador Limited for 2014: Collections of credit sales................................................................................ $1,100,000

Reporting Financial Performance

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Retained earnings, January 1, 2014 ................................................................ 800,000 Sales ............................................................................................................... 1,900,000 Selling and administrative expenses ............................................................... 290,000 Casualty loss (pre-tax) .................................................................................... 350,000 Cash dividends declared on common stock .................................................... 34,000 Cost of goods sold .......................................................................................... 1,100,000 Loss resulting from calculation error on depreciation charge in 2012 (pre-tax) 460,000 Other revenues ............................................................................................... 180,000 Other expenses ............................................................................................... 120,000 Loss from early extinguishment of debt (pre-tax) ............................................. 340,000 Gain from transactions in foreign currencies (pre-tax) ..................................... 220,000 Proceeds from sale of Strathroy common shares ............................................ 60,000 Additional information: 1. Early in 2014, Labrador changed depreciation methods for its plant assets from the double declining-balance to the straight-line method. The affected assets were purchased at the beginning of 2012 for $200,000, had no residual value, and had useful lives of 10 years. Depreciation expense of $20,000 is included in the "Selling and Administrative Expenses" of $290,000. 2. On September 1, 2014, Labrador sold one of its segments (product line) to Best Industries for a gain (pre-tax) of $550,000. During the period January 1 to August 31, the discontinued segment incurred an operating loss (pre-tax) of $480,000. This loss is not included in any of the numbers shown above. 3. Included in "Selling and Administrative Expenses" is "Bad Debts Expense" of $19,000. Labrador bases its bad debts expense upon a percentage of sales. In 2012 and 2013, the percentage was 0.5 %. In 2014, the percentage was changed to 1%. Instructions In good form, prepare a multiple-step income statement for 2014. Assume a 20% income tax rate and that 20,000 common shares were outstanding during the year. Solution 4-82 LABRADOR LIMITED Income Statement For the Year Ended December 31, 2014 Sales .................................................................................................... Cost of goods sold ............................................................................... Gross profit .......................................................................................... Selling and administrative expenses .................................................... Operating income................................................................................. Other revenues and gains Other revenues ............................................................................. Gain from transactions in foreign currency .................................... Other expenses and losses Other expenses ............................................................................. Early extinguishment of debt ......................................................... Casualty loss................................................................................. Income from continuing operations before tax ......................................

$1,900,000 1,100,000 800,000 290,000 510,000 180,000 220,000

$120,000 340,000 350,000

400,000 910,000

810,000 100,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Income tax .................................................................................... Income from continuing operations ......................................................

20,000 80,000

Discontinued operations: Loss from operations (net of taxes of $96,000) ............................. (384,000) Gain from sale of assets (net of taxes of $110,000) ...................... 440,000 56,000 Net income........................................................................................... $ 136,000 Earnings per share: Income from continuing operations................................................ Discontinued operations ................................................................ Net income ....................................................................................

$4.00 2.80 $6.80

Pr. 4-83 Income statement, including corrections During calendar 2014, Shepherd Corporation reported income from continuing operations of $800,000 (after taxes). In addition, the following information, which has not yet been considered or included in the above figure, has been revealed: 1. In 2014, Shepherd adopted the average cost method of inventory valuation. Prior to 2014, the company had used the FIFO method. The change decreases income for 2014 by $50,000 (pre-tax) and the cumulative effect of the change on prior years' income was a $200,000 (pre-tax) decrease. 2. A machine was sold for $140,000 cash during the year at a time when its book value was $100,000. (Depreciation has been correctly recorded.) 3. Shepherd decided to discontinue its stereo division in 2014. During the current year, the loss on the disposal of this segment was $150,000 (before applicable taxes). Instructions Present in good form the income statement of Shepherd Corporation for 2014 starting with "income from continuing operations." Assume that Shepherd’s tax rate is 20% and that 100,000 common shares were outstanding during the year. Solution 4-83 SHEPHERD CORPORATION Partial Income Statement For the Year Ended December 31, 2014 Income from continuing operations ...................................................... Discontinued operations Loss on disposal of a segment of a business, $150,000, less applicable income taxes, $30,000 ......................... Net income...........................................................................................

$792,000*

(120,000) $672,000

Earnings per share Income from continuing operations................................................ Discontinued operations, net of tax ............................................... Net income ....................................................................................

$7.92 (1.20) $6.72

*Income from cont. operations (unadjusted) ......................................... Gain on sale of machinery (after tax) ...................................................

$800,000 32,000

Reporting Financial Performance

Current effect of change in accounting principle (after tax) ................... Adjusted income from continuing operations ........................................

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(40,000) $792,000

Pr. 4-84 Multiple-step income statement Presented below is information related to Mastiff Inc. Retained earnings, December 31, 2013 ........................................ $ 650,000 Sales ............................................................................................. 1,400,000 Selling and administrative expenses ............................................. 240,000 Hurricane loss (pre-tax) on plant ................................................... 250,000 Cash dividends declared on common shares ................................ 33,600 Cost of goods sold ........................................................................ 820,000 Gain resulting from calculation error on depreciation charge in 2013 (pre-tax) ................................................................ 520,000 Other revenue ............................................................................... 60,000 Other expenses ............................................................................. 50,000 Instructions In good form, prepare a multiple-step income statement for the year 2014. Assume a 20% tax rate and that 50,000 common shares were outstanding during the year. Mastiff is a private corporation following ASPE. Solution 4-84 MASTIFF INC Income Statement For the Year Ended December 31, 2014 Sales ...................................................................................................................... $1,400,000 Cost of goods sold ................................................................................................. 820,000 Gross profit ............................................................................................................ 580,000 Selling and administrative expenses ...................................................................... 240,000 Income from operations ......................................................................................... 340,000 Other revenue ........................................................................................................ 60,000 Other expenses...................................................................................................... (50,000) Loss from hurricane ............................................................................................... (250,000) Income before taxes .............................................................................................. 100,000 Income taxes ......................................................................................................... (20,000) Net income............................................................................................................. $ 80,000

Pr. 4-85 Multiple-step income statement Shown below is an income statement for 2014 that was prepared by a junior accountant at Poodle Corporation. POODLE CORPORATION Income Statement December 31, 2014 Sales revenue .................................................................................................

$975,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Investment revenue......................................................................................... Cost of merchandise sold ................................................................................ Selling expenses ............................................................................................. Administrative expense ................................................................................... Interest expense.............................................................................................. Income before special items ............................................................................ Special items Loss on disposal of a segment of the business ........................................ Major fire loss ........................................................................................... Net income tax liability..................................................................................... Net income ......................................................................................................

19,500 (408,500) (155,000) (215,000) (13,000) 203,000 (30,000) (80,000) (27,900) $ 65,100

Instructions In good form, prepare a multiple-step income statement for 2014 for Poodle Corporation that is presented in accordance with generally accepted accounting principles (including format and terminology). Poodle Corporation has 50,000 common shares outstanding and has a 20% income tax rate on all tax related items. As a private corporation, Poodle does not disclose earnings per share information. Solution 4-85 POODLE CORPORATION Income Statement For the Year Ended December 31, 2014 Sales .................................................................................................... Cost of goods sold ............................................................................... Gross profit .......................................................................................... Selling expenses .................................................................................. Administrative expenses ...................................................................... Income from operations ....................................................................... Other revenue – Interest revenue.........................................................

$975,000 408,500 566,500 $155,000 215,000

Other expenses – Interest expense...................................................... Fire loss ............................................................................................... Income from continuing operations before taxes .................................. Income taxes ....................................................................................... Income from continuing operations ......................................................

370,000 196,500 19,500 216,000 13,000 80,000 123,000 24,600 98,400

Discontinued operations: Loss from discontinued operations, net of applicable income tax of $6,000 Net income...........................................................................................

24,000 $ 74,400

Pr. 4-86 Income statement adjustments You have been hired by the CFO of Dalmatian Corporation, a public company. As the new senior accountant, you have been asked to help with the preparation of the 2014 income statement. For 2014, Dalmatian reported pre-tax income from continuing operations of $3,150,000. However, you have been advised that the following transactions have not yet been considered. 1. A review of the company's depreciation policies for its computer equipment revealed that

Reporting Financial Performance

2. 3. 4.

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depreciation expense relating to 2013 was overstated by $19,000. During the year, the company wrote off $62,500 in accounts receivable for which no allowance for doubtful accounts had been set up. In 2014, the company sold old equipment for $160,000. The equipment had a net book value of $120,000. During the year, Dalmatian disposed of one its subsidiaries. The CFO tells you that the transaction meets the criteria for discontinued operations. The after-tax losses on the subsidiary’s operations and from disposal were $120,000 and $290,000 respectively. The company made a payment of $400,000 to settle a lawsuit. The lawsuit related to a 2012 event which the company lawyers had been working on since that time. Based on the lawyers’ advice, no contingent liability had been set up.

Instructions In good form, prepare a partial 2014 income statement for Dalmatian, taking into account the effects (if any) of the above items. The statement should start with income from continuing operations before income taxes. Unless otherwise indicated, you may assume an income tax rate of 40% for all items. Earnings per share calculations are not required. Solution 4-86 DALMATIAN CORPORATION Partial Income Statement For the Year Ended December 31, 2014 Income from continuing operations* ..................................................... $2,727,500 Income taxes ....................................................................................... (1,091,000) Income before discontinued operations ......................................... $1,636,500 Discontinued operations Loss from operations (net of tax) ................................................... ($120,000) Loss from disposal (net of tax) ...................................................... (290,000) (410,000) Net Income .......................................................................................... $1,226,500 *Calculations Income from continuing operations (before adjustments) ..................... $3,150,000 1. Would be credited directly to retained earnings ............................. 0 2. Expense ........................................................................................ (62,500) 3. Gain $160,000 – $120,000 ............................................................ 40,000 4. To be shown in discontinued operations section ........................... 0 5. Loss .............................................................................................. _(400,000) Adjusted income from continuing operations ........................................ $2,727,500

Pr. 4-87 Income statement and retained earnings statement Spaniel Corporation's capital structure consists of 20,000 common shares. At December 31, 2014 an analysis of the accounts and discussions with company officials revealed the following information: Sales ............................................................................................. $1,200,000 Purchase discounts ....................................................................... 18,000 Purchases ..................................................................................... 720,000 Earthquake loss (net of $18,000 tax) ............................................ 42,000 Selling expenses ........................................................................... 128,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash ............................................................................................. Accounts receivable ...................................................................... Common shares ............................................................................ Accumulated depreciation ............................................................. Dividend revenue .......................................................................... Inventory, January 1, 2014 ............................................................ Inventory, December 31, 2014 ...................................................... Unearned service revenue ............................................................ Accrued interest payable ............................................................... Land .............................................................................................. Patents.......................................................................................... Retained earnings, January 1, 2014 .............................................. Interest expense............................................................................ Cumulative effect of change from straight-line to accelerated depreciation (net of $15,000 tax) ................................................... General and administrative expenses ........................................... Dividends declared........................................................................ Allowance for doubtful accounts .................................................... Notes payable (maturity July 1, 2017) ........................................... Machinery and equipment ............................................................. Materials and supplies................................................................... Accounts payable ..........................................................................

60,000 90,000 200,000 180,000 18,000 152,000 125,000 4,400 1,000 370,000 100,000 270,000 17,000 35,000 160,000 29,000 5,000 200,000 450,000 40,000 60,000

Unless indicated otherwise, you may assume a 30% income tax rate. Instructions a) Prepare, in good form, a multiple-step income statement. b) Prepare, in good form, a retained earnings statement. Solution 4-87 SPANIEL CORPORATION Income Statement For the Year Ended December 31, 2014 Sales .................................................................................................... Cost of goods sold Merchandise inventory, Jan. 1....................................................... Purchases $720,000 Less purchase discounts 18,000 Net purchases ........................................................................ Merchandise available for sale ...................................................... Less merchandise inventory, Dec. 31............................................ Cost of goods sold.................................................................. Gross profit on sales ............................................................................ Operating expenses Selling expenses ........................................................................... General and administrative expenses ........................................... Total operating expenses ....................................................... Operating income................................................................................. Other revenue and gains

$1,200,000 $152,000

702,000 854,000 125,000 729,000 471,000 128,000 160,000 288,000 183,000

Reporting Financial Performance

Dividend revenue .......................................................................... Other expenses and losses Interest expense............................................................................ Loss from earthquake ................................................................... Income before taxes ............................................................................ Income taxes................................................................................. Net income...........................................................................................

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18,000 (17,000) (60,000)

Earnings per share...............................................................................

(77,000) 124,000 37,200 $ 86,800 $4.34

SPANIEL CORPORATION Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1, 2014..................................................... Cumulative effect of change in depreciation methods, net of applicable taxes of $15,000 .................................................. Adjusted beginning retained earnings .................................................. Add: Net income .................................................................................. Deduct: Dividends declared ................................................................. Retained earnings, December 31, 2014 ...............................................

$270,000 (35,000) 235,000 $86,800 29,000

57,800 $292,800

*Pr. 4-88 Cash to accrual accounting Bloodhound Corporation maintains its records on the cash basis. You have been engaged to convert its cash basis income statement to the accrual basis. The cash basis income statement, along with additional information, follows: BLOODHOUND CORPORATION Income Statement (Cash Basis) For the Year Ended December 31, 2014 Cash receipts from customers.............................................................. Cash payments: Wages........................................................................................... Taxes ............................................................................................ Insurance ...................................................................................... Interest .......................................................................................... Net income...........................................................................................

$380,000 $150,000 65,000 40,000 25,000

280,000 $100,000

Additional information:

Accounts receivable ...................................................................... Wages payable ............................................................................. Taxes payable ............................................................................... Prepaid insurance ......................................................................... Accumulated depreciation ............................................................. Interest payable.............................................................................

_Balances at Dec 31 2014 2013 $50,000 $30,000 15,000 25,000 14,000 19,000 8,000 4,000 95,000 80,000 3,000 9,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

No assets were sold during 2014. Solution 4-88 BLOODHOUND CORPORATION Income Statement (Accrual Basis) For the Year Ended December 31, 2014 Revenue ($380,000 + $50,000 – $30,000) ........................................... Expenses Wages ($150,000 + $15,000 – $25,000) ....................................... Taxes ($65,000 + $14,000 – $19,000) .......................................... Insurance ($40,000 + $4,000 – $8,000)......................................... Depreciation ($95,000 – $80,000) ................................................. Interest ($25,000 + $3,000 – $9,000) ............................................ Total expenses ....................................................................... Net Income ..........................................................................................

$400,000 $140,000 60,000 36,000 15,000 19,000 270,000 $130,000

Reporting Financial Performance

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CHAPTER 5 FINANCIAL POSITION AND CASH FLOWS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

1 2 2 2 2 3 3 3 4 4 4

E E M E M E M M M M M

44. 45. 46.

4 4 4

E M M

55. 56. 57.

2-5,7,9 2-4 4

M E E

67. 68.

3 4

M H

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 12. 4 M 23. 7 13. 4 E 24. 7 14. 4 M 25. 7 15. 4 M 26. 7 16. 4 E 27. 7 17. 4 E 28. 8 18. 4 E 29. 8 19. 4 M 30. 8 20. 4 E 31. 8 21. 4 E 32. 9 22. 6 E 33. 9 Multiple Choice–CPA Adapted 47. 4 M 50. 7 48. 4 M 51. 7 49. 5 M 52. 7 Exercises 58. 4 M 61. 4 59. 4 M 62. 4 60. 4 M 63. 7 Problems 69. 4 M 71. 8 70. 8 H *72. 12

M = Medium

LOD

Item

LOD

E E E E M M M M E M M

34. 35. 36. 37. 38. 39. 40. *41. *42. *43.

9 9 10 10 10 10 11 12 12 12

M M M M M H H M M M

M E E

53. *54.

7 12

E M

M M M

64. *65. *66.

9 12 12

M E E

H H

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

9. 10. 11. 12. 13.

MC MC MC MC MC

14. 15. 16. 17. 18.

MC MC MC MC MC

49.

55.

22.

23. 24.

MC MC

25. 26.

MC MC

28.

29.

32.

33.

36.

37.

40.

*41. *42.

MC MC

*43. *54.

MC MC

Item Type Item Type Learning Objective 1 Learning Objective 2 4. MC 5. MC Learning Objective 3 8. MC 55. Ex Learning Objective 4 19. MC 46. MC 20. MC 47. MC 21. MC 48. MC 44. MC 55. Ex 45. MC 56. Ex Learning Objective 5

Item

Type

Item

Type

55.

56.

67.

57. 58. 59. 60. 61.

Ex Ex Ex Ex Ex

62. 68. 69.

Ex Pr Pr

53. 55.

MC Ex

63.

70.

71.

55.

64.

Learning Objective 6

Note:

MC = Multiple Choice

Learning Objective 7 27. MC 51. MC 50. MC 52. MC Learning Objective 8 30. MC 31. MC Learning Objective 9 34. MC 35. MC Learning Objective 10 38. MC 39. MC Learning Objective 11 Learning Objective 12 *65. Ex *72. Pr *66. Ex Ex = Exercise

Pr = Problem

Financial Position and Cash Flows

5-3

CHAPTER STUDY OBJECTIVES 1. Understand the statement of financial position and statement of cash flows from a business perspective. It is important to understand how users of financial statements use the statement of financial position and the cash flow statement. For example, potential investors in a company may use the statement of financial position to analyze a company’s liquidity and solvency in order to assess risk of investing. In addition, the statement of financial position provides details about the company’s financial structure. Users may use a company’s statement of cash flows to assess its earnings quality and obtain information about its operating, investing, and financing activities.

2. Identify the uses and limitations of a statement of financial position. The statement of financial position provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners’ equity in net resources. The statement of financial position contributes to financial reporting by providing a basis for (1) calculating rates of return, (2) evaluating the enterprise’s capital structure, and (3) assessing the enterprise’s liquidity, solvency, and financial flexibility. The limitations of a statement of financial position are as follows: (1) The statement of financial position often does not reflect current value, because accountants have adopted a historical cost basis in valuing and reporting many assets and liabilities. (2) Judgements and estimates must be used in preparing a statement of financial position. The collectibility of receivables, the saleability of inventory, and the useful life of long-term tangible and intangible assets are difficult to determine. (3) The statement of financial position leaves out many items that are of financial value to the business but cannot be recorded objectively, such as its human resources, customer base, and reputation.

3. Identify the major classifications of a statement of financial position. The statement of financial position’s general elements are assets, liabilities, and equity. The major classifications within the statement of financial position on the asset side are current assets; investments; property, plant, and equipment; intangible assets; and other assets. The major classifications of liabilities are current and long-term liabilities. In a corporation, owners’ equity is generally classified as shares, contributed surplus, retained earnings, and accumulated other comprehensive income.

4. Prepare a classified statement of financial position. The most common format lists liabilities and shareholders’ equity directly below assets on the same page.

5. Identify statement of financial position information that requires supplemental disclosure. Five types of information are normally supplemental to account titles and amounts presented in the statement of financial position. (1) Contingencies: Material events that have an uncertain outcome. (2) Accounting policies: Explanations of the valuation methods that are used or the basic assumptions that are made for inventory valuation, amortization methods, investments in subsidiaries, and so on. (3) Contractual situations: Explanations of certain restrictions or covenants that are attached to specific assets or, more likely, to liabilities. (4) Additional information: Clarification by giving more detail about the composition of statement of

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

financial position items. (5) Subsequent events: Events that happen after the date of the statement of financial position.

6. Identify major disclosure techniques for the statement of financial position. There are four methods of disclosing pertinent information in the statement of financial position: (1) Parenthetical explanations: Additional information or description is often provided by giving explanations in parentheses that follow the item. (2) Notes: Notes are used if additional explanations or descriptions cannot be shown conveniently as parenthetical explanations. (3) Cross-reference and contra items: A direct relationship between an asset and a liability is crossreferenced on the statement of financial position. (4) Supporting schedules: Often a separate schedule is needed to present more detailed information about certain assets or liabilities because the statement of financial position provides just a single summary item.

7. Indicate the purpose and identify the content of the statement of cash flows. The main purpose of a statement of cash flows is to provide relevant information about an enterprise’s cash receipts and cash payments during a period. Reporting the sources, uses, and net increase or decrease in cash lets investors, creditors, and others know what is happening to a company’s most liquid resource. Cash receipts and cash payments during a period are classified in the statement of cash flows into three different activities: (1) Operating activities: Involve the cash effects of transactions that enter into the determination of net income. (2) Investing activities: Include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment. (3) Financing activities: Involve liability and owners’ equity items and include (a) obtaining capital from owners and providing them with a return on their investment and (b) borrowing money from creditors and repaying the amounts borrowed.

8. Prepare a statement of cash flows using the indirect method. This involves determining cash flows from operations by starting with net income and adjusting it for noncash activities, such as changes in accounts receivable (and other current asset/liability) balances, depreciation, and gains/losses. It is important to look carefully at prior years’ operating activities that might affect cash this year, such as cash collected this year from last year’s credit sales and cash spent this year for last year’s accrued expenses. The cash flows from investing and financing activities can then be determined by analyzing changes in statement of financial position accounts and the cash account.

9. Understand the usefulness of the statement of cash flows. Creditors examine the statement of cash flows carefully because they are concerned about being paid. The amount of net cash flow provided by operating activities in relation to the company’s liabilities is helpful in making this assessment. In addition, measures such as a free cash flow analysis provide creditors and shareholders with a better picture of the company’s financial flexibility.

10. Identify differences in accounting between ASPE and IFRS. Illustration 5-24 outlines the major differences in how both sets of standards account for and present items on the statement of financial position and statement of cash flows. Both sets of standards largely require that the same statement of financial position elements be presented. In addition, IFRS requires

Financial Position and Cash Flows

5-5

presentation of biological assets, investment properties, and provisions. The statement of cash flow presentation requirements are similar.

11. Identify the significant changes planned by the IASB regarding financial statement presentation. The IASB has been planning to change the way financial statements are presented by issuing a new standard. However, the project was paused in 2011 “until the IASB concludes its ongoing deliberations about its future work plan.” The major statements, including statement of financial position, income statement, and statement of cash flows, are expected to be classified according to business and financing activities.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer b c d a d d c b c d a d c b c d b b a d c d c a b c a a c d c b c d c a c c d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39.

Description Earnings quality Uses of the statement of financial position Definition of solvency Definition of financial flexibility Limitations of the statement of financial position Monetary assets Monetary assets Financial instruments Basis of classifying assets Definition of operating cycle Identification of current asset Identification of non-current asset Classification of securities Intangible assets Identification of current liabilities Definition of working capital Identification of working capital items Definition of liabilities Identification of long-term liabilities Classification of equity section accounts Classification of shareholders' equity Methods of disclosure Definition of statement of cash flows Disclosure of revenue-producing activities on the statement of cash flows Identify an investing activity Identify a financing activity Identify an investing activity Preparation of statement of cash flows under indirect method Cash flows from operating activities Preparation of statement of cash flows under indirect method Preparation of statement of cash flows under direct method Cash debt coverage ratio Current cash debt coverage ratio Financial flexibility measure Calculation of free cash flow Disclosures under ASPE Disclosures under IFRS Reclassification of current debt Special disclosure under IFRS

Financial Position and Cash Flows

5-7

Answer

No.

Description

c b c d

40. *41. *42. *43.

Upcoming IABS and FASB changes to financial statement presentation Definition of activity ratios Definition of solvency ratios Definition of asset turnover

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

c b d b b c c a d b c

44. 45. 46. 47. 48. 49. 50. 51. 52. 53. *54.

Calculate total current assets Calculate total current assets Calculate total current liabilities Calculate retained earnings balance Calculate current and long-term liabilities Summary of significant accounting policies Classification of investing activity Classification of operating activity Classification of financing activity Classification of investing activity Financial or capital market risks

EXERCISES Item 5-55 5-56 5-57 5-58 5-59 5-60 5-61 5-62 5-63 5-64 *5-65 *5-66

Description Definitions Terminology Current liabilities Account classification Valuation of statement of financial position items Statement of financial position classifications Statement of financial position classifications Statement of financial position classifications Statement of cash flows Statement of cash flows ratios Calculation of ratios Calculation of ratios

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Item 5-67 5-68 5-69 5-70 5-71 *5-72

Description Statement of financial position format Statement of financial position presentation Calculation of ending retained earnings Statement of cash flows – direct method Statement of cash flows – indirect method Calculation of ratios

*This topic is dealt with in an Appendix to the chapter.

Financial Position and Cash Flows

5-9

MULTIPLE CHOICE—Conceptual 1. When assessing earnings quality, financial analysts are concerned that management may attempt to manipulate information to make earnings appear better or worse than they really are. Which of the following would NOT suggest poor earnings quality? a) reduction of the allowance for doubtful accounts b) consistent application of GAAP c) significantly higher net income than cash flows from operations d. reliance on share issuances to offset repeated negative cash flow from operations

2. The statement of financial position is useful for analyzing all of the following EXCEPT a) liquidity. b) solvency. c) profitability. d. financial flexibility. 3. An enterprise’s ability to pay its debts and related interest is called a) liquidity. b) financial flexibility. c) the amount of time expected to pass until an asset is realized. d. solvency. 4. An enterprise’s ability to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities is called a) financial flexibility. b) liquidity. c) the quick ratio. d. solvency.

5. Which of the following is NOT a limitation of the statement of financial position? a) Many assets are reported at historical cost. b) Judgements and estimates are used. c) Only “hard” numbers are reported. d. Disclosure of all pertinent information in the notes.

6. Monetary assets represent a) only cash. b) contractual rights to receive cash. c) equity investments in other companies. d. cash or claims to future cash flows that are fixed and determinable in amounts and timing.

7. Monetary assets include

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a) Cash, accounts receivable and inventory. b) Accounts and notes receivable and inventory. c) Cash, accounts and notes receivable. d. Accounts receivable and property, plant and equipment.

8. Financial instruments do NOT include a) cash. b) inventory. c) derivatives. d. accounts payable.

9. The basis for classifying assets as current or noncurrent is conversion to cash within a) the accounting cycle or one year, whichever is shorter. b) the accounting cycle or one year, whichever is longer. c) the operating cycle or one year, whichever is longer. d. the operating cycle or one year, whichever is shorter.

10. The operating cycle is the time between a) selling products to customers and the realization of cash. b) purchase of inventory and selling to customers. c) manufacture of products and receiving cash from customers. d) acquisition of assets for processing and the realization in cash or cash equivalents.

11. Which of the following is a current asset? a) trade instalment receivables normally collectible in eighteen months b) intangible assets c) investment in associates (significant influence investments) d) cash designated for the purchase of property, plant and equipment

12. Which of the following should NOT be considered current assets in the statement of financial position? a) instalment notes receivable due over eighteen months, in accordance with normal trade practice b) prepaid taxes, which cover assessments for the current year c) equity or debt securities purchased with cash available for current operations d) franchises and copyrights

13. Equity or debt securities held to finance future construction of additional plants should be classified on a statement of financial position as a) current assets. b) property, plant, and equipment. c) non-current investments. d) intangible assets.

Financial Position and Cash Flows

5 - 11

14. Which of the following statements about intangible assets is INCORRECT? a) They are capital assets that have no physical substance. b) Intangibles with finite lives are amortized but not tested for impairment. c) Intangibles with infinite lives are not amortized but are tested for impairment. d) Internally recognized intangibles are never recognized on the statement of financial position.

15. Which of the following is NOT a current liability? a) unearned revenue b) derivatives c) stock dividends distributable d) trade accounts payable

16. Working capital is a) capital which has been reinvested in the business. b) cash invested by owners. c) cash and receivables less current liabilities. d) current assets less current liabilities.

17. An example of an item which is NOT an element of working capital is a) accrued interest on notes receivable. b) goodwill. c) inventory. d) short-term investments.

18. Which of the following statements best describes a liability? a) Any obligation, whether enforceable or not, is a liability. b) A liability is an enforceable economic burden or obligation. c) A liability is a legal economic benefit. d) Deferred income taxes are always shown as liabilities.

19. Which of the following should be EXCLUDED from long-term liabilities? a) derivatives b) employee future benefits obligations c) long-term liabilities maturing within the operating cycle, but will be paid from a sinking fund d) bonds payable maturing in five years

20. Which of the following would NOT appear in the equity section of a statement of financial position? a) preferred shares b) accumulated other comprehensive income c) stock dividend distributable d) investment in affiliate

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

21. The shareholders' equity section is usually divided into which four parts? a) preferred shares, common shares, retained earnings, contributed surplus b) preferred shares, common shares, retained earnings, other comprehensive income c) capital shares, contributed surplus, retained earnings, accumulated other comprehensive income d) capital shares, appropriated retained earnings, unappropriated retained earnings, contributed surplus

22. Which of the following is NOT a method of disclosing additional information in the financial statements? a) supporting schedules b) parenthetical explanations c) cross reference and contra items d) press releases

23. The financial statement which summarizes operating, investing, and financing activities of an entity for a period of time is the a) retained earnings statement. b) income statement. c) statement of cash flows. d) statement of financial position. 24. On a statement of cash flows, the enterprise’s main revenue-producing activities are disclosed in the a) operating activities. b) investing activities. c) financing activities. d) both operating and investing activities.

25. Making and collecting loans and disposing of property, plant, and equipment are a) operating activities. b) investing activities. c) financing activities. d) liquidity activities. 26. In preparing a statement of cash flows, repurchase of a company’s own shares at an amount greater than cost would be classified as a(n) a) operating activity. b) extraordinary activity. c) financing activity. d) investing activity.

27. In preparing a statement of cash flows, which of the following transactions would be considered an investing activity?

Financial Position and Cash Flows

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a) sale of equipment at book value b) sale of merchandise on credit c) declaration of a cash dividend d) issuance of bonds payable at a discount

28. A statement of cash flows prepared under the INDIRECT method adds and subtracts certain items to the base number. Decreases in unearned revenues would be shown as a) a deduction from net income. b) an addition to net income. c) a deduction from sales. d) an addition to sales.

29. In preparing a statement of cash flows under the INDIRECT method, cash flows from operating activities a) are always equal to accrual accounting income. b) are calculated as the difference between revenues and expenses. c) can be calculated by appropriately adding to or deducting from net income those items in the income statement that do not affect cash. d) can be calculated by appropriately adding to or deducting from net income those items in the income statement that do affect cash.

30. Preparing a statement of cash flows under the INDIRECT method involves all of the following EXCEPT determining the a) cash provided by operations. b) cash provided by or used in investing and financing activities. c) change in cash during the period. d) cash collections from customers during the period.

31. A statement of cash flows prepared under the DIRECT method starts with a) net income. b) gross profit. c) cash received from customers. d) income from operations.

32. The cash debt coverage ratio is calculated by dividing net cash provided by operating activities by a) average long-term liabilities. b) average total liabilities. c) ending long-term liabilities. d) ending total liabilities.

33. The current cash debt coverage ratio is often used to assess a) financial flexibility. b) solvency. c) liquidity.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) profitability. 34. A measure of a company’s financial flexibility is the a) cash debt coverage ratio. b) current cash debt coverage ratio. c) free cash flow. d) cash debt coverage ratio and free cash flow.

35. Free cash flow is calculated as net cash provided by operating activities less a) capital expenditures. b) dividends. c) capital expenditures and dividends. d) capital expenditures and depreciation.

36. A company that follows ASPE a) must not disclose cash flow per share. b) may disclose cash flow per share. c) may disclose cash flow per share if it makes a special election to do so. d) must disclose cash flow per share.

37. A company that follows IFRS a) may disclose cash flow per share if it makes a special election to do so. b) must not disclose cash flow per share. c) is generally allowed to disclose cash flow per share. d) only discloses cash flow per share if there are more than two shareholders.

38. When current debt is refinanced by the issue date of financial statements, it may generally be presented as NONCURRENT a) if the company follows IFRS. b) under either ASPE or IFRS. c) if the company follows ASPE. d) only if the company is a subsidiary.

39. Which of the following items would require special disclosure under IFRS? a) investment property only b) biological assets and investment property only c) provisions and biological assets d. biological assets, investment property and provisions

40. Significant changes to the presentation of financial statements are currently being developed by the IASB and FASB. Which of the following best describes the focus of these changes? a) to better highlight the company's assets, liabilities and equity. b) to segregate the company’s operating, financing and investing activities.

Financial Position and Cash Flows

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c) to highlight the company's major business and financing activities. d) to increase the number of notes to be attached to financial statements.

*41. Ratios that measure how effectively an entity is using is assets are called a) liquidity ratios. b) activity ratios. c) solvency ratios. d) profitability ratios.

*42. Ratios that measure the degree of protection for long-term creditors and investors or the ability to meet long-term obligations are called a) liquidity ratios. b) activity ratios. c) solvency ratios. d) profitability ratios.

*43. Net sales divided by average total assets is called a) inventory turnover. b) receivables turnover. c) rate of return on assets. d) asset turnover.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CONCEPTUAL Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

b c d a d d c

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

b c d a d c b

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

c d b b a d c

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

d c a b c a a

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

c d c b c d c

36. 37. 38. 39. 40. *41. *42.

a c c d c b c

*43.

Financial Position and Cash Flows

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MULTIPLE CHOICE—CPA Adapted 44. Pluto Corp.'s trial balance included the following account balances at December 31, 2014: Accounts receivable (net) .............................................................. Trading securities .......................................................................... Accumulated depreciation on equipment and furniture .................. Cash ............................................................................................. Inventory ....................................................................................... Equipment ..................................................................................... Patent ........................................................................................... Prepaid expenses ......................................................................... Land held for future business site..................................................

$41,000 7,000 15,000 10,000 27,000 25,000 4,000 1,500 18,000

In Pluto’s December 31, 2014 statement of financial position, the current assets total is a) $104,500. b) $90,500. c) $86,500. d) $73,500.

Use the following information for questions 45—47. Venus Corp.’s trial balance at December 31, 2014 is properly adjusted except for the income tax expense adjustment. Venus Corp. Trial Balance December 31, 2014 Dr. Cr. Cash $ 675,000 Accounts receivable (net) 2,895,000 Inventory 2,385,000 Property, plant, and equipment (net) 8,366,000 Accounts payable and accrued liabilities $ 1,981,000 Income taxes payable 684,000 Future income tax liability 75,000 Common stock 3,350,000 Contributed surplus 2,680,000 Retained earnings, Jan 1, 2014 4,650,000 Net sales and other revenues 12,360,000 Costs and expenses 10,080,000 Income tax expenses 1,379,000 $25,780,000 $25,780,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Other financial data for the year ended December 31, 2014: • Included in accounts receivable is $720,000 due from a customer and payable in quarterly instalments of $90,000. The last payment is due December 29, 2016. • The balance in the future income tax liability account relates to a temporary difference that arose in a prior year, of which $30,000 is classified as a current liability. • During the year, estimated tax payments of $465,000 were charged to income tax expense. The current and future tax rate on all types of income is 35 percent. 45. In Venus’s December 31, 2014 statement of financial position, the current assets total is a) $5,955,000. b) $5,595,000. c) $3,060,000. d) $4,495,000. 46. In Venus’s December 31, 2014 statement of financial position, the current liabilities total is a) $2,435,000. b) $2,695,000. c) $2,200,000. d) $2,114,000. 47. In Venus’s December 31, 2014 statement of financial position, the final retained earnings balance is a) $5,551,000. b) $6,132,000. c) $5,135,000. d) $6,016,000.

48. On January 1, 2014, Mars Inc. leased a building to Vulcan Corp. for a ten-year term at an annual rental of $160,000. At inception of the lease, Mars received $640,000, which covered the first two years rent of $320,000 and a security deposit of $320,000. This deposit will not be returned to Vulcan upon expiration of the lease, but will be applied to payment of rent for the last two years of the lease. What portion of the $640,000 should be shown as a current and longterm liability in Mars’s December 31, 2014 statement of financial position? Current Liability Long-term Liability a) $0 $640,000 b) $160,000 $320,000 c) $320,000 $320,000 d) $320,000 $160,000

49. Which of the following facts concerning depreciable assets should be included in the summary of significant accounting policies? Depreciation Method Composition a) No Yes b) Yes Yes c) Yes No

Financial Position and Cash Flows

d) No

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50. In a statement of cash flows, receipts from sales of property, plant, and equipment and other productive assets should be classified as cash inflows from a) operating activities. b) financing activities. c) investing activities. d) selling activities.

51. In a statement of cash flows, interest payments to lenders and other creditors should be classified as cash outflows for a) operating activities. b) borrowing activities. c) lending activities. d) financing activities.

52. In a statement of cash flows, proceeds from issuing equity instruments should be classified as cash inflows from a) lending activities. b) operating activities. c) investing activities. d) financing activities.

53. In a statement of cash flows, payments to acquire debt instruments of other entities (other than cash equivalents) should be classified as cash outflows for a) operating activities. b) investing activities. c) financing activities. d) lending activities.

*54. Financial or capital market risks are related to a) financing activities only. b) investing activities only. c) both financing and investing activities. d) operating and financing activities.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA ADAPTED Item

44. 45.

Ans.

c b

Item

Ans.

46. 47.

d b

Item

48. 49.

Ans.

b c

Item

50. 51.

Ans.

c a

Item

52. 53.

Ans.

Item

Ans.

d b

*54.

DERIVATIONS—CPA Adapted No. 44. 45. 46.

Answer c b d

47.

48. 49. 50. 51. 52. 53. *54.

b c c a d b c

Derivation $41,000 + $7,000 + $10,000 + $27,000 + $1,500 = $86,500 $675,000 + [$2,895,000 – ($90,000 x 4)] + $2,385,000 = $5,595,000 Note the adjusted income tax expense will be $798,000 [($12,360,000 – $10,080,000) x 35%] = $798,000. When the expense is reduced by $581,000 ($1,379,000 – $798,000 = $581,000) the liability will also be reduced by the same amount to $103,000 $1,981,000 + $103,000) + $30,000 = $2,114,000 $4,650,000 + $12,360,000 – $10,080,000 – $798,,000 (income tax exp)) = $6,132,000 Conceptual Conceptual Conceptual Conceptual Conceptual Conceptual Conceptual

Financial Position and Cash Flows

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EXERCISES Ex. 5-55 Definitions Provide clear, concise answers for the following: 1. Explain the merits of classified financial statements. 2. What are financial instruments? 3. What are inventories? 4. What are other assets? 5. What statement of financial position information requires supplemental disclosure? 6. Explain the purpose of the statement of cash flows. 7. Explain the concept of free cash flow. Solution 5-55 1. Classification of financial statements increases their information content. This is accomplished through the grouping of items with similar characteristics and separating items with different characteristics. 2.

Financial instruments are contracts between two or more parties that create financial assets for one party and a financial liability or equity instrument for the other and include cash, the right to receive cash or another financial instrument, and investments in other companies.

Inventories are assets that are held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of service.

“Other assets” includes assets that are not included anywhere else. They commonly include items such as noncurrent receivables and assets in special funds and require the disclosure of sufficient detail.

Supplemental disclosure is required for contingencies, accounting policies, contractual situations, and subsequent events. Additional information is also required for many individual statement of financial position items.

The purpose of the statement of cash flows is to allow users to assess an entity's capacity to generate cash and cash equivalents and its needs for cash resources. The statement identifies the sources of cash inflows and uses of cash during the period.

Free cash flow can be defined as a measure of a company's level of financial flexibility and is calculated as cash flow from operating activities less capital expenditures and dividends.

Ex. 5-56 Terminology In the space provided at the right, write the word or phrase that is defined or indicated. 1.

A company's ability to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities.

1. __________________________________

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Claims to future cash flows that are fixed and determinable.

2. __________________________________

Short-term, highly liquid investments that are readily convertible into known amounts of cash.

3. __________________________________

Assets that are held for sale in the ordinary course of business.

4. __________________________________

Expenditures already made for benefits that will be received within one year or the operating cycle.

5. __________________________________

Assets of physical substance that are used in ongoing business operations.

6. __________________________________

Assets that have no physical substance.

7. __________________________________

The excess of total current assets over total current liabilities.

8. __________________________________

Unrealized gains and losses included as part of equity.

9. __________________________________

Solution 5-56 1. Financial flexibility 2. Monetary assets 3. Cash equivalents 4. Inventories 5. Prepaid expenses 6. Property, plant, and equipment 7. Intangible assets 8. Working capital 9. Accumulated other comprehensive income

Ex. 5-57 Current liabilities Define current liabilities without using the word "liability." Solution 5-57 Current liabilities are legally enforceable obligations that are due within one year from the date of the statement of financial position or the operating cycle, whichever is longer.

Ex. 5-58 Account classification ASSETS

LIABILITIES AND CAPITAL

Financial Position and Cash Flows

a) b) c) d) e)

Current assets Investments Property, plant and equipment Intangibles Other assets

f) g) h) i) j) k) l)

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Current liabilities Long-term liabilities Preferred shares Common shares Contributed surplus Retained earnings Items excluded from statement of financial position

Using the letters above, classify the following accounts according to the preferred statement of financial position presentation. ____ 1. Bond sinking fund ____ 2. Common stock dividend distributable ____ 3. Appropriation for plant expansion ____ 4. Bank overdraft ____ 5. Bonds payable (due 2024) ____ 6. Premium on common shares ____ 7. Securities owned by another company which are collateral for that company's note ____ 8. Trading securities ____ 9. Inventory ____ 10. Unamortized discount on bonds payable (due 2024) ____ 11. Patents ____ 12. Unearned revenue Solution 5-58 1. b 2.

10. g 11. d 12. f

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Ex. 5-59 Valuation of statement of financial position items Use the code letters listed below (a – k) to indicate, for each statement of financial position item (1 – 13) listed below, the usual valuation reported on the statement of financial position. ____ 1. Common shares _____ 8. Long-term bonds payable ____ 2. Prepaid expenses _____ 9. Land (in use) ____ 3. Natural resources _____ 10. Land (future plant site) ____ 4. Property, plant, and equipment _____ 11. Patents ____ 5. Trade accounts receivable _____ 12. Trading securities ____ 6. Copyrights _____ 13. Trade accounts payable ____ 7. Merchandise inventory a) b) c) d) e) f) g) h) i) j) k)

No par value Current cost of replacement Amount payable when due, less unamortized discount or plus unamortized premium Amount payable when due Fair value at statement of financial position date Net realizable value Lower of cost or net realizable value Original cost less accumulated depreciation/amortization Original cost less accumulated depletion Historical cost Unexpired or unconsumed cost

Solution 5-59 1. a 2.

10. j 11. h 12. e

Financial Position and Cash Flows

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13. d

Ex. 5-60 Statement of financial position classifications Typical statement of financial position (SFP) classifications are as follows: a) Current Assets g) Long-Term Liabilities b) Investments h) Capital Shares c) Plant Assets i) Contributed Surplus d) Intangible Assets j) Retained Earnings e) Other Assets k) Notes to Financial Statements f) Current Liabilities l) Not Reported on SFP Indicate by use of the above letters how each of the following items would be classified on a statement of financial position prepared at December 31, 2014. If a contra account, or any amount that is negative or opposite the normal balance, place parentheses around the letter selected. A letter may be used more than once or not at all. _____ 1. Accrued salaries and wages _____ 2. Rental revenues for three months collected in advance _____ 3. Land used as plant site _____ 4. Equity securities classified as shortterm _____ 5. Cash

_____16. Natural resources—timberlands _____17. Deficit (no income earned since beginning of company) _____18. Goodwill _____19. Ninety-day notes payable _____20. Investment in bonds in another company; that will be held to 2018 maturity _____21. Land held for speculation

_____ 6. Accrued interest payable due in thirty days _____ 7. Premium on preferred shares issued _____22. Death of company president _____ 8. Dividends in arrears on preferred _____23. Current maturity of bonds payable shares _____ 9. Petty cash fund _____24. Investment in subsidiary; no plans to sell in the near future _____10. Unamortized discount on bonds _____25. Trade accounts payable payable due in 2020 _____11. Common shares at no par value _____26. Preferred shares, no par value _____12. Bond indenture covenants _____27. Prepaid expenses for next twelve months _____13. Unamortized premium on bonds _____28. Copyright payable due in 2020 _____14. Allowance for doubtful accounts _____29. Accumulated depreciation, equipment _____15. Accumulated depletion, oil well _____30. Earnings, not distributed to shareholders

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 5-60 1. f

16. c

17. (j)

18. d

19. f

20. b

21. b

22. l

23. f

24. b

10. (g)

25. f

11. h

26. h

12. k

27. a

13. g

28. d

14. (a)

29. (c)

15. (c)

30. j

Ex. 5-61 Statement of financial position classifications The various classifications listed below have been used in the past by Mercury Ltd. in its statement of financial position. The corporation asks your professional opinion concerning the appropriate classification of each of the items 1–14 below. a) Current Assets f) Current Liabilities b) Investments g) Long-Term Liabilities c) Property, Plant and Equipment h) Capital Shares d) Intangible Assets i) Retained Earnings e) Other Assets Indicate by letter how each of the following items should be classified. If an item need not be reported on the statement of financial position, use the letter "X." A letter may be used more than once or not at all. If an item can be classified in more than one category, choose the category most favoured by the authors of your textbook. ____ 1. Employees' payroll deductions ____ 2. Cash in sinking fund ____ 3. Rent revenue collected in advance

Financial Position and Cash Flows

____ 4. ____ 5. ____ 6. ____ 7. ____ 8. ____ 9. ____ 10. ____ 11. ____ 12. ____ 13. ____ 14.

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Factory building retired from use and held for sale Patents Payroll cash fund Goods held on consignment Accrued revenue on short-term investments Advances to salespersons Premium on bonds payable due two years from date Bank overdraft Salaries which company budget shows will be paid to employees within the next year Work in process Appropriation of retained earnings for bonded indebtedness

Solution 5-61 1. f 2.

a or e

10. g 11. f 12. x 13. a 14. i

Ex. 5-62 Statement of financial position classifications The various classifications listed below have been used in the past by Droid Inc. in its statement of financial position. a) Current Assets e) Current Liabilities b) Investments f) Long-term Liabilities c) Plant and Equipment g) Common Shares

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Intangible Assets

Retained Earnings

Instructions Indicate by letter how each of the items below should be classified at December 31, 2014. If an item is not reported on the December 31, 2014 statement of financial position, use the letter "X" for your answer. If the item is a contra account within the particular classification, place parentheses around the letter. A letter may be used more than once or not at all. Sample question and answer: (a) Allowance for doubtful accounts ____ 1. Customers' accounts with credit balances ____ 2. Bond sinking fund ____ 3. Salaries which the company's cash budget shows will be paid to employees in 2015 ____ 4. Accumulated depreciation ____ 5. Appropriation of retained earnings for plant expansion ____ 6. Impairment of goodwill for 2014 ____ 7. On December 31, 2014, Droid signed a purchase commitment to buy all of its raw materials from Jupiter Inc for the next two years ____ 8. Discount on bonds payable due March 31, 2017 ____ 9. Launching of Droid’s internet retailing division in February, 2014 ____ 10. Cash dividends declared on December 15, 2014, payable on January 15, 2015

Solution 5-62 1. e 2.

(c)

(f)

Financial Position and Cash Flows

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10. e

Ex. 5-63 Statement of cash flows For each event listed below, select the appropriate category, which describes its effect on a statement of cash flows: a) Cash provided/used by operating activities b) Cash provided/used by investing activities c) Cash provided/used by financing activities d. Not a cash flow ____ 1. Payment on long-term debt ____ 2. Issuance of bonds at a premium ____ 3. Collection of accounts receivable ____ 4. Cash dividends declared ____ 5. Issuance of shares to acquire land ____ 6. Sale of marketable securities (long-term) ____ 7. Payment of employees' wages ____ 8. Issuance of common shares for cash ____ 9. Payment of income taxes payable ____ 10. Purchase of equipment ____ 11. Purchase of treasury stock (common) ____ 12. Sale of real estate held as a long-term investment

Solution 5-63 1. c 2.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

10. b 11. c 12. b

Ex. 5-64 Statement of cash flows ratios Financial statements for Asteroid Ltd. are presented below: Asteroid Ltd. Statement of Financial Position December 31, 2014 Assets Liabilities & Shareholders’ Equity Cash ............................................. $ 44,000 Accounts payable ............ $ 28,000 Accounts receivable ...................... 39,000 Bonds payable ................. 54,000 Buildings and equipment ............... 154,000 Accumulated depreciation— buildings and equipment ........ (46,000) Common shares .............. 69,000 Patents ......................................... 24,000 Retained earnings ........... 64,000 $215,000 $215,000 Asteroid Ltd. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable .................................... $(19,000) Increase in accounts payable ........................................ 7,000 Depreciation—buildings and equipment ........................ 12,000 Gain on sale of equipment............................................. (7,000) Amortization of patents .................................................. 3,000 Net cash provided by operating activities .................................... Cash flows from investing activities Sale of equipment ................................................................ Purchase of land .................................................................. Purchase of buildings and equipment................................... Net cash used by investing activities ........................................... Cash flows from financing activities Payment of cash dividend ....................................................

$ 60,000

(4,000) 56,000

14,000 (27,000) (52,000) (65,000)

(25,000)

Financial Position and Cash Flows

Sale of bonds ....................................................................... Net cash provided by financing activities .....................................

5 - 31

45,000

Net increase in cash ................................................................... Cash, January 1, 2014 ................................................................ Cash, December 31, 2014 ..........................................................

20,000 11,000 33,000 $ 44,000

At the beginning of 2014, the accounts payable balance was $21,000, and the bonds payable balance was $9,000. All Asteroid’s bonds have been issued at par. Instructions Calculate the following for Asteroid Ltd.: a) Current cash debt coverage ratio b) Cash debt coverage ratio c) Free cash flow Solution 5-64 a)

Net cash provided by operating activities Current cash debt coverage ratio = —————————————————— Average current liabilities $56,000 $56,000 = ——————————— = ———— = 2.29:1 ($21,000 + $28,000) ÷ 2 $24,500

Net cash provided by operating activities Cash debt coverage ratio = —————————————————— Average total liabilities =

$56,000 = ($30,000 + $82,000) ÷ 2

$56,000 = 1:1 $56,000

Free cash flow = Net cash provided by operating activities – capital expenditures and dividends = $56,000 – *$79,000 – $25,000 = $(48,000) *$27,000 + $52,000

*Ex. 5-65 Calculation of ratios A company reported current assets of $120,000 and current liabilities of $150,000. Instructions Calculate the following: a) Working capital b) Current ratio Solution 5-65 (a) Working capital: $120,000 – $150,000 = $30,000 negative

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

(b) Current ratio: $120,000 / $150,000 = 0.80

*Ex. 5-66—Calculation of ratios A company reported current assets of $450,000, current liabilities of $250,000 and total assets of $1 million. Instructions Calculate the following: a) Working capital b) Current ratio Solution 5-66 (a) Working capital: $450,000 – $250,000 = $200,000 (b) Working capital ratio: $450,000 / $250,000 = 1.80

Financial Position and Cash Flows

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PROBLEMS Pr. 5-67 Statement of financial position format The following statement of financial position has been submitted to you by an inexperienced bookkeeper. List your suggestions for improvements in the format of the statement of financial position. Consider both terminology deficiencies as well as classification inaccuracies. Hathaway Industries Inc. Statement of Financial Position For the Period Ended December 31, 2014 Assets Fixed Assets—Tangible Equipment ......................................................... $110,000 Less: reserve for depreciation ................... (40,000) Factory supplies ................................................ Land and buildings ............................................ 400,000 Less: reserve for depreciation ................... (150,000) Plant site held for future use .............................. Current Assets Accounts receivable .......................................... Cash ................................................................. Inventory ........................................................... Treasury stock (at cost) ..................................... Fixed Assets—Intangible Goodwill ............................................................ Notes receivable ............................................... Patents.............................................................. Deferred Charges Advances to salespersons ................................ Prepaid rent ...................................................... Returnable containers ....................................... TOTAL ASSETS......................................... Liabilities Current Liabilities Accounts payable .............................................. Allowance for doubtful accounts ........................ Common stock dividend distributable ................ Income taxes payable ....................................... Sales taxes payable .......................................... Long-Term Liabilities, 5% debenture bonds, due 2020 Reserve for contingencies ........................................ TOTAL LIABILITIES ...................................

$ 70,000 22,000 250,000 90,000

$ 432,000

175,000 80,000 220,000 20,000

495,000

80,000 40,000 26,000

146,000

60,000 27,000 75,000

$140,000 8,000 35,000 42,000 17,000 500,000 150,000

162,000 $1,235,000

$ 242,000 650,000 892,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Equity Common shares, no par value, issued 12,000 shares with 60 shares held as treasury stock Dividends paid Earned surplus Other accumulated past earnings TOTAL EQUITY TOTAL LIABILITIES AND EQUITY

$240,000 (20,000) 23,000 100,000 343,000 $1,235,000

Note 1. The reserve for contingencies has been created by charges to earned surplus and has been established to provide a cushion for future uncertainties. Note 2. The inventory account includes only items physically present at the main plant and warehouse. Items located at the company's branch sales office, amounting to $30,000, are excluded since the company has consistently followed this procedure for many years. Solution 5-67 1. The heading should be at a specific date rather than for a period of time. 2.

“Fixed Assets – Tangible” and “Reserve for Depreciation” is poor terminology; should be Property, Plant and Equipment and Accumulated Depreciation.

Land and buildings should be segregated into two accounts. The Accumulated Depreciation account should only be reported for the buildings.

Plant site held for future use should be shown in the Investments section.

Popular practice lists current assets first; as well, current assets are usually listed in order of liquidity. Factory supplies should be shown as a current asset.

Treasury stock is not an asset, but a deduction from shareholders’ equity.

Notes receivable should be reported as a current asset or an investment.

The deferred charge items should be reclassified as follows: Advances to salespersons—current asset Prepaid rent—current asset Returnable containers—current asset

Allowance for doubtful accounts should be shown as a contra account to accounts receivable.

10. Common stock dividend distributable should be shown in shareholders’ equity. 11. The debenture bonds should be shown on a separate line. 12. Earned surplus is poor terminology. The term "retained earnings" is more appropriate. 13. Other Accumulated Past Earnings is poor terminology. Accumulated Other Comprehensive Income is the term required by IFRS.

Financial Position and Cash Flows

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14. “Dividends paid” title is a misnomer. It probably is a “dividends declared” item that should be close to retained earnings. 15. No reference in the body of the statement is made to the notes. The order of the notes is wrong. 16. Note 2 indicates that the inventory account is understated by $30,000. 17. Specific identification and description of all significant accounting principles and methods that involve selection from among alternatives and/or those that are peculiar to a given industry should be disclosed in the annual report.

Pr. 5-68 Statement of financial position presentation The following statement of financial position was prepared by the bookkeeper for Badger Corp. at December 31, 2014. Badger Corp. Statement of Financial Position December 31, 2014 Cash .................................... $ 90,000 Accounts payable ..................... $ 75,000 Accounts receivable (net) ..... 52,200 Long-term liabilities ................... 110,000 Inventories ........................... 57,000 Shareholders’ equity ................. 208,500 Investments ......................... 76,300 Equipment (net) ................... 86,000 Patents ................................ 32,000 ________ ............................................ $393,500 $393,500 The following additional information is provided: 1. “Cash” includes prepaid insurance of $9,400; as well, a bank overdraft of $1,500 has been deducted. 2. The net accounts receivable balance includes: (a) accounts receivable—debit balances $62,000; (b) accounts receivable—credit balances $5,000; (c) allowance for doubtful accounts $4,800. 3. Inventories do not include goods costing $5,000 shipped out on consignment. Receivables of $5,000 were recorded on these goods. 4. Investments include investments in common shares, trading $24,000 and long-term $43,300, and franchises $9,000. 5. Equipment costing $8,000 with accumulated depreciation $6,000 is no longer used and is held for sale. Accumulated depreciation on the other equipment is $40,000. Instructions Prepare a statement of financial position in good form (shareholders’ equity details can be omitted.) Solution 5-68 Badger Corp. Statement of Financial Position

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

December 31, 2014 Assets Current assets Cash ............................................................................... Trading securities ............................................................ Accounts receivable ........................................................ Less allowance for doubtful accounts .............................. Inventories ...................................................................... Prepaid insurance ........................................................... *Equipment held for sale ................................................. Total current assets ....................................................

$ 82,100 (1) 24,000 $ 57,000 (2) 4,800

Investments Long-term securities ........................................................ Property, plant, and equipment Equipment ....................................................................... 1 Less accumulated depreciation ....................................... Intangible assets Patents............................................................................ Franchises ...................................................................... Total assets ................................................................

52,200 62,000 (3) 9,400 2,000 (4) 231,700

43,300

124,000 (5) 40,000

32,000 9,000

84,000

41,000 $400,000

Liabilities and Shareholders’ Equity Current liabilities Accounts payable ............................................................ Bank overdraft ................................................................. Total current liabilities .................................................

$ 80,000 (6) 1,500 81,500

Long-term liabilities ................................................................ Total liabilities .................................................................

110,000 191,500

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

208,500 $400,000

(1) ($90,000 – $9,400 + $1,500) (2) ($62,000 – $5,000) (3) ($57,000 + $5,000) (4) ($8,000 – $6,000) (5) ($86,000 + $40,000 – $8,000 + $6,000) (6) ($75,000 + $5,000) *An alternative is to show this as an “other asset.”

Pr. 5-69 Calculation of ending retained earnings The records of Biloxi Corp. for calendar 2014 reflected the following correct pretax amounts: gain from discontinued operations, $50,000; cash dividends declared and paid, $45,000; retained earnings, January 1, 2014, $275,000, correction of accounting error, $35,000 debit; income before income taxes and before discontinued operations, $165,000. The average

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income tax rate of 40 % applies to all items except the dividends. Instructions Calculate the December 31, 2014 ending balance of retained earnings. Solution 5-69 Beginning balance................................... .................................... $275,000 Correction of error ($35,000 x 60%)................. ........................... (21,000) Income ($165,000 x 60%)............................. ............................... 99,000 Gain from discontinued operations ($50,000 x 60%)................... 30,000 Dividends........................................... .......................................... (45,000) Ending balance.............. ....................... ...................................... $338,000

Use the following information for questions 70—71. Pr. 5-70—Statement of Cash Flows – direct method The controller of Nebula Corporation has provided you with the following information: Nebula Corporation Income Statement For the Year Ended December 31, 2014 Net sales .............................................................................................. Operating expenses ............................................................................. Income from operations ....................................................................... Other revenues and expenses Gain on sale of equipment ............................................................ 30,000 Interest expense............................................................................ 8,000 Income before income taxes ................................................................ Income taxes ....................................................................................... Net income...........................................................................................

620,000 410,000 210,000

22,000 232,000 92,800 139,200

Nebula Corporation Comparative Account Information Relating to Operations For the Year Ended December 31, 2014

Accounts receivable Prepaid insurance Accounts payable Interest payable Income taxes payable Unearned revenue

2014 56,000 5,000 59,000 600 4,200 20,000

2013 40,000 6,000 47,000 1,500 6,000 14,000

Instructions Prepare a Statement of Cash Flows (for operating activities only) for the year ended December 31, 2014, using the direct method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 5-70 Nebula Corporation Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash received from customers........................................................ Cash paid For operating expenses............................................................ For interest ............................................................................... For income taxes...................................................................... Net cash provided by operating activities ........................................

$610,000 $397,000 $8,900 $94,600

$500,500 $109,500

Calculations: Cash received from customers: Net sales ................................................ $ 620,000 – Increase in accounts receivable ......... (16,000) + Increase in unearned revenue............. 6,000 $ 610,000 Cash paid for operating expenses: Operating expenses ............................... $ 410,000 – Decrease in prepaid insurance ............ (1,000) – Increase in accounts payable .............. (12,000) $ 397,000 Cash paid for interest: Interest expense .................................... $ 8,000 + Decrease in interest payable ............... 900 $ 8,900 Cash paid for income tax: Income tax expense ............................... $ 92,800 + Decrease in income tax payable ......... 1,800 $ 94,600 Pr. 5-71 Statement of Cash Flows – indirect method Use the information provided in Pr. 5-70. Prepare a Statement of Cash Flows (for operating activities only) for the year ended December 31, 2014 using the indirect method. Solution 5-71 Nebula Corporation Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income........................................................................ Adjustments: Gain on sale of equipment ................................................ Increase in accounts receivable ........................................ Decrease in prepaid insurance.......................................... Increase in accounts payable ............................................

$139,200 (30,000) (16,000) 1,000 12,000

Financial Position and Cash Flows

Decrease in interest payable ............................................. Decrease in income taxes payable.................................... Increase in unearned revenue........................................... Net cash provided by operating activities ..........................

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(900) (1,800) 6,000 $109,500

*Pr. 5-72 Calculation of ratios Brandon Systems Inc. has provided you with the following information: 2014 Cash ............................................................... $ 21,000 Short-term (trading) investments ..................... 28,000 Accounts receivable ........................................ 102,000 Inventory ......................................................... 86,000 Prepaid expenses ........................................... 11,000 Total assets .................................................... 1,503,000 Total current liabilities ..................................... 205,000 Net sales, all on credit ..................................... 877,000 Cost of goods sold .......................................... 570,000 Operating income............................................ 165,000 Income tax expense ........................................ 20,000 Net income...................................................... 109,000 Interest expense ............................................. 36,000 Common shares (no preferred) ....................... 420,000 Retained earnings ........................................... 153,000

2013 $ 47,000 – 116,000 64,000 9,000 1,489,000 241,000 850,000 555,000 158,000 18,000 100,000 40,000 420,000 74,000

Instructions Calculate the following ratios for 2014. Round all values to two decimals, including percentages, e.g. 12.34, 34.56%. Show all calculations for full marks. a) Profit margin on sales b) Quick (acid-test) ratio c) Receivables turnover d) Debt to total assets e) Times interest earned f) Rate of return on assets g) Rate of return on common share equity Solution 5-72 a) Profit margin on sales = Net income/net sales x 100 = 109,000 x 100 = 12.43% 877,000 b)

Quick (acid-test) ratio = Quick assets/current liabilities = 21,000 + 28,000 + 102,000 = .74 to 1 205,000

Receivables turnover = Net sales/average A/R = _ 877,000 _ = 8.05 (times) (102,000 + 116,000)/2

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Debt to total assets = Total liabilities/total assets x 100 = 930,000 x 100 = 61.88% 1,503,000

Total liabilities = 1,503,000 – 420,000 – 153,000 = 930,000 e)

Times-interest-earned = Net income before interest and income taxes/interest exp = 109,000 + 36,000 + 20,000 (i.e. operating income) = 4.58 (times) 36,000

Rate of return on assets = Net income/average total assets = 109,000 x 100 = 7.29% 1,496,000

average total assets = (1,503,000 + 1,489,000)/2 = 1,496,000 g)

Rate of return on common share equity = NI/average comm S/H equity x 100 = 109,000 x 100 = 20.43% 533,500

average equity = (420,000 + 420,000 + 153,000 + 74,000)/2 = 533,500

Financial Position and Cash Flows

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CHAPTER 6 REVENUE RECOGNITION SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

1 1 1 1 1 1 1 1 1 1

E E E M E M M E M M

39. 40. 41. 42. 43. 44.

3 3 3 3 5 5

E E M E M M

62. 63.

1 5

E H

67. 68. 69.

1 1-5,7 1-3,5

M M M

79. 80. 81.

2 2 5

M M H

Note:

E = Easy

Item LO LOD Item LO LOD Multiple Choice–Conceptual 11. 1 E 21. 3 E 12. 2 M 22. 3 M 13. 2 M 23. 3 M 14. 2 M 24. 5 E 15. 2 M 25. 5 M 16. 2 M 26. 5 M 17. 2 E 27. 5 E 18. 2 M 28. 5 M 19. 3 H 29. 5 M 20. 3 M 30. 5 H Multiple Choice–Computational 45. 5 M 52. 5 M 46. 5 H 52. 5 M 47. 5 M 53. 5 M 48. 5 M 54. 5 H 49. 5 M 55. 5 H 50. 5 M 56. 5 E Multiple Choice–CPA Adapted 64. 5 M 66. 5 M 65. 5 M Exercises 70. 2 M 73. 5 M 71. 3 M 74. 5 M 72. 5 E 75. 5 M Problems 82. 5 M 85. 5 M 83. 5 H 86. 5 E 84. 5 M 87. 7 H

M = Medium

Item

LOD

31. 32. 33. 34. 35. 36. 37. 38.

5 5 5 5 5,7 7 7 8

E E M H E E H H

57. 58. 59. 60. 61.

5 5 5 5 7

M E H H E

76. 77. 78.

5 6 7

M M H

H = Hard

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6-2

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

1. 2. 3.

MC MC MC

4. 5. 6.

MC MC MC

12. 13.

MC MC

14. 15.

MC MC

19. 20.

MC MC

21. 22.

MC MC

68.

Note:

24. 25. 26. 27. 28. 29. 30. 31.

MC MC MC MC MC MC MC MC

77.

35. 36.

MC MC

38.

32. 33. 34. 35. 43. 44. 45. 46.

37. 61.

Item Type Item Type Learning Objective 1 7. MC 10. MC 8. MC 11. MC 9. MC 62. MC Learning Objective 2 16. MC 18. MC 17. MC 68. Ex Learning Objective 3 23. MC 40. MC 39. MC 41. MC Learning Objective 4

MC MC MC MC MC MC MC MC

Learning Objective 5 47. MC 55. MC 48. MC 56. MC 49. MC 57. MC 50. MC 58. MC 51. MC 59. MC 52. MC 60. MC 53. MC 63. MC 54. MC 64. MC Learning Objective 6

MC MC

Learning Objective 7 68. Ex 87. Pr 78. Ex Learning Objective 8

MC = Multiple Choice

Ex = Exercise

Item

Type

Item

Type

67. 68. 69.

Ex Ex Ex

69. 70.

Ex Ex

79. 80.

Pr Pr

42. 68.

MC Ex

69. 71.

Ex Ex

65. 66. 68. 69. 72. 73. 74. 75.

MC MC Ex Ex Ex Ex Ex Ex

76. 81. 82. 83. 84. 85. 86.

Ex Pr Pr Pr Pr Pr Pr

Pr = Problem

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CHAPTER STUDY OBJECTIVES 1. Understand the economics and legalities of selling transactions from a business perspective. It is critical to understand a transaction from a business perspective before attempting to account for it. The analysis should begin with what is being sold to the customer (goods or services) and note also the nature and amount of the consideration. When one party is in a better bargaining position than the other, it may be able to negotiate concessions such as more lenient payment terms. These concessions often complicate the accounting as they introduce measurement uncertainty in many cases. Selling transactions are based on contractual arrangements between a buyer and a seller. Contracts create rights and obligations under law that must be considered when accounting for the transactions. In addition to contractual law, rights and obligations may exist under other forms of the law, such as common law or contract law. These should also be considered.

2. Analyze and determine whether a company has earned revenues. Under current accounting standards, the revenues are earned when the risks and rewards of ownership are passed or when the company has done what it said it would do to be entitled to the revenues. Where sale of goods are involved, legal title and possession provide evidence of this. The accounting is more complex when the contract is a long-term contract and when it involves both goods and services. The percentage-of-completion method is commonly used for long-term contracts. The completed contract method is used under ASPE and although IFRS does not mention this method, it is acceptable to recognize revenues at the end of a contract if there is one significant event. IFRS requires the zero-profit method where the outcome is not determinable.

3. Discuss issues relating to measurement and measurement uncertainty. Under accrual accounting, revenue may only be recognized when reliably measurable. There are many reasons that measurement uncertainty exists including inability to reliably measure the revenue itself (for example, barter transactions or price protection clauses) and inability to measure costs or uncertainty relating to the outcome of the contract itself (contingencies). In the latter case, extreme uncertainty may indicate that the contract or business deal has not yet been completed. Where the sale involves more than one element (such as goods and services), then the selling price must be allocated to the respective parts of the sale using an allocation method such as the relative fair value method or residual method.

4. Understand how to account for sales where there is collection uncertainty. Collectibility issues also create measurement uncertainty and must be considered when recognizing and measuring sales transactions. When collectibility cannot be assured and/or the related revenue is not measurable in terms of collection or credit risk, then no sale is booked.

5. Prepare journal entries for consignment sales and long-term contracts. Under consignment sales, the risks and rewards remain with the seller and, therefore, revenues are not recognized until the goods are sold to a third party. Special accounts separate inventory on consignment.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

To apply the percentage-of-completion method to long-term contracts, a basis is needed for measuring the progress toward completion at particular interim dates. One of the most popular input measures that is used to determine the progress toward completion is the cost-to-cost basis. Using this basis, the percentage of completion is measured by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract. The percentage of the total estimated costs that the costs incurred amount to is applied to the total revenue or the estimated total gross profit on the contract to arrive at the revenue or the gross profit amounts to be recognized to date. Under the completed contract method, revenue and gross profit are recognized only when the contract is completed. Costs of long-term contracts in process and current billings are accumulated, but there are no interim charges or credits to income statement accounts for revenues, costs, and gross profit. The annual entries to record costs of construction, progress billings, and collections from customers would be identical to those for the percentage-of-completion method, with one significant exception: revenue and gross profit are not recognized until the end of the contract. The zero profit method (IFRS) is used when the outcome of the contract is not determinable. Recoverable revenues equal to cost are recognized.

6. Understand how to present sales transactions in the income statement and prepare basic disclosures. Transactions where the seller is acting as a principal in the sale should be accounted for on a gross basis. Where the seller is acting as an agent (putting buyers and sellers together), the transaction should be booked on a net basis. Consideration should be given to whether the seller has the risks and rewards of ownership of the product being sold. Transactions are treated as revenues when they relate to the entity’s ordinary activities. They are treated as gains when they deal with ancillary activities. In general, revenues and gains are booked to net income except in very limited circumstances.

7. Discuss current trends in standard setting for revenue recognition including the contract-based approach. IASB and FASB are currently studying a new model for revenue recognition: the contract-based model, which is felt to be conceptually superior.

8. Identify differences in accounting between ASPE and IFRS. The main differences are identified in the chart in Illustration 6-25.

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MULTIPLE CHOICE—Conceptual Answer c a b c d c b b d c b b c a c b b c d b c d c b d a d b a c a b d a c a c d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31 32. 33. 34. 35. 36. 37. 38.

Description Control of an asset Definition of "acquired" Definition of credit risk. Concept of commercial substance Definition of concessionary terms Definition of constructive obligation Allocation of selling price in bundled sales Reasons to recognize revenue Problems with the earnings approach Definition of earnings process Definition of revenue Definition of critical event Definition of discrete earnings process ASPE requirements ASPE requirements Accounting for long-term contracts – principal factors Preferred method under ASPE Classification of progress billings and construction in process Measurement uncertainty Accounting for a volume rebate Definition of onerous contract Recording sales when right of return exists Recording sales when right of return exists Consignment sales—consignor vs. consignee Consignment sales—revenue recognition Disclosure of earned but unbilled revenues Revenue, cost, and gross profit under completed-contract method Disadvantage of using percentage-of-completion method Recognition of loss on long-term contract Recognition of loss on long-term contract Completed-contract method Completed-contract method Recognition of loss on long-term contract Revenue recognition in consignment sales Principal-agent relationship Proposed new model of revenue recognition Proposed new model of revenue recognition ASPE vs IFRS treatment of long-term contracts

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Answer b c b a c b b d c b c b a c d c a c c a d b d

No. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 69. 61.

Description Bundled sales – application of the relative fair value method Bundled sales – application of the residual value method Dealing with collection uncertainty Revenue to be recognized under collection uncertainty Gross profit to be recognized using percentage-of-completion Gross profit to be recognized using percentage-of-completion Calculate cash collected on long-term construction contract Calculate gross profit using percentage-of-completion Gross profit to be recognized using percentage-of-completion Gross profit to be recognized using percentage-of-completion Gross profit to be recognized using completed-contract method Gross profit to be recognized using percentage-of-completion Gross profit to be recognized using completed-contract method Gross profit or loss to be recognized using completed-contract method Gross profit to be recognized using completed-contract method Reporting a current liability with completed-contract-method Reporting assets under completed-contract method Revenue to be recognized from consignment sales Calculate total construction costs Application of the percentage of completion method Sales on consignment Reporting inventory on consignment Calculation of the net contract position – contract based approach

MULTIPLE CHOICE—CPA Adapted Answer a b d a d

No. 62. 63. 64. 65. 66.

Description Definition of "recognition." Calculate contract costs incurred during year. Calculate gross profit using percentage-of-completion method. Calculate gross profit using completed-contract method. Calculate gross profit using completed-contract method.

Revenue Recognition

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EXERCISES Item 6-67 6-68 6-69 6-70 6-71 6-72 6-73 6-74 6-75 6-76 6-77 6-78

Description Concessionary terms Definitions Terminology Comparison of accounting methods for long-term contracts Bundled sales Percentage-of-completion method Percentage-of-completion method Percentage-of-completion method Percentage-of-completion and completed-contract methods Consignment sale Reporting of gross or net revenues Contract-based approach

PROBLEMS Item 6-79 6-80 6-81 6-82 6-83 6-84 6-85 6-86 6-87

Description Revenue recognition Revenue recognition Completed contract method Long-term construction project accounting Accounting for long-term construction contracts Consignment sales Percentage-of-completion and completed-contract methods Percentage-of-completion and completed-contract methods Long-term contract (contract-based approach)

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. Control of an asset normally coincides with a) transfer of possession to the buyer. b) transfer of legal title to the buyer. c) transfer of both possession and legal title to the buyer. d) the receipt of payment from the buyer. 2. When dealing with sales agreements, “acquired” means a) consideration or rights to consideration. b) goods to be delivered in the future. c) dealing at arm’s length. d) measurement of the transaction.

3. If an entity sells on credit, the risk that the customer will not pay is called a) price risk. b) credit risk. c) commercial substance. d) credit policy.

4. The concept of commercial substance in purchase and sales transactions means that a) the transaction is a bona fide purchase and sale. b) the entity's cash flows are expected to change. c) the transaction is a bona fide purchase and sale, and the entity's cash flows are expected to change. d) the transaction must involve tangible assets.

5. Terms negotiated by a party to the contract that are more favourable than normal are called a) credit terms. b) barter transactions. c) arm’s length terms. d) concessionary terms.

6. In many cases, an entity may have an implicit obligation even if it is not explicitly noted in a sales contract. This is called a(n) a) onerous obligation. b) legal obligation. c) constructive obligation. d) earnings obligation.

7. When a sale involves goods and services, the selling price should NOT be a) allocated to each of these parts. b) allocated only to the part with the higher value.

Revenue Recognition

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c) allocated using the relative fair value method. d) allocated using the residual method.

8. Under the earnings approach for the sale of goods, which of the following would NOT be a reason to recognize revenue? a) The risks and rewards are transferred to the buyer. b) The vendor continues to have control over the goods sold. c) Collectibility is reasonably assured. d) Costs and revenues can be reliably measured.

9. Which of the following would NOT normally be considered as a problem associated with the earnings approach to revenue recognition? a) This approach may be subject to a considerable degree of subjective judgement. b) the existence of multiple and sometimes conflicting guidelines c) the difficulties arising from the split of risks and rewards between buyer and seller d) Revenue can be reliably measured and collectability is probable.

10. The actions a company takes to add value are referred to as the a) critical event. b) earnings approach. c) earnings process. d) risks and rewards of ownership.

11. A credit that is realized through an entity's ordinary activities would be treated as a) a gain. b) revenue. c) other income. d) other comprehensive income.

12. When a company sells goods, there is often one main act in the earnings process that signals substantial completion or performance. This is called the a) point of delivery. b) critical event. c) significant event. d) earnings process.

13. If the earnings process has a critical event, it is often referred to as a a) point of delivery. b) constructive obligation. c) discrete earnings process. d) transfer of risks and rewards of ownership.

14. When there is a continuous earnings process, but the progress towards completion is not measurable, ASPE requires the use of the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a) completed-contract method. b) percentage-of-completion method. c) zero-profit method. d) discrete earnings method.

15. Under ASPE, the profession requires that the percentage-of-completion method be used when certain conditions exist. Which of the following is NOT one of those necessary conditions? a) Estimates of progress toward completion, revenues, and costs are reasonably dependable. b) The contractor can be expected to perform the contractual obligation. c) The buyer can be expected to satisfy some of the obligations under the contract. d) The contract clearly specifies the enforceable rights of the parties, the consideration to be exchanged, and the manner and terms of settlement.

16. Under ASPE, when selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a) the terms of payment in the contract. b) the degree to which a reliable estimate of the costs to complete and extent of progress toward completion can be made. c) the method commonly used by the contractor to account for other long-term construction contracts. d) the inherent nature of the contractor's technical facilities used in construction.

17. Under ASPE, when work to be done and costs to be incurred on a long-term contract can be estimated reliably, which of the following methods of revenue recognition is preferable? a) Instalment method b) Percentage-of-completion method c) Completed-contract method d) Zero-profit method

18. Under the percentage-of-completion method, how should the balances of progress billings and construction in process be disclosed in the financial statements prior to the completion of the contract? a) Progress billings as deferred income, construction in progress as a deferred expense. b) Progress billings as income, construction in process as inventory. c) Net, as a current asset if a debit balance, and a current liability if a credit balance. d) Net, as income from construction if a credit balance, and loss from construction if a debit balance.

19. Measurement uncertainty does NOT arise from a) the inability to reasonably estimate related costs of the transaction. b) the inability to reasonably estimate the consideration of the transaction. c) the ability to measure the outcome of the transaction. d) the inability to allocate costs already recorded to the correct account.

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20. Under IFRS, when a vendor gives a volume rebate to a customer, the vendor should account for it as a(n) a) expense. b) reduction of revenue. c) reduction of inventory. d) other gain or loss.

21. When a contract becomes unprofitable to an entity, this is called a(n) a) uncompleted contract. b) zero-profit contract. c) onerous contract. d) unenforceable contract.

22. When a vendor is exposed to continued risks of ownership because of potential return of the product, which of the following accounting procedures should NOT be used? a) Recording the sale, and accounting for returns as they occur in future periods. b) Not recording the sale until all return privileges have expired. c) Recording the sale, but reducing revenue by an estimate of future returns. d) Recording the sale, but ignoring future returns.

23. Under the earnings approach, if a company sells its product but gives the buyer the right to return the product, revenue from the sales transaction should be recognized at the time of sale if a) the market for returnable goods is untested. b) there is a transfer of the risks and rewards of ownership. c) the amount of future returns can be reasonably estimated. d) the amount of goods returned is likely to be high.

24. Under a consignment sales arrangement, a) the consignor receives the merchandise to sell. b) the consignor retains legal title. c) the consignee ships the merchandise to the consignor. d) the consignee retains legal title.

25. Under a consignment sales arrangement, revenue is recognized under the earnings approach a) upon shipment of the merchandise to the consignee. b) upon receipt of the merchandise by the consignee. c) upon sale by the consignee. d) upon receipt by the consignor of notification of the sale.

26. Under the percentage-of-completion method, how should earned but unbilled revenues on a long-term contract be disclosed on the statement of financial position? a) as construction in process in the current asset section b) as construction in process in the noncurrent asset section c) as a receivable in the noncurrent asset section

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) in a note to the financial statements until the customer is formally billed for the portion of work completed

27. Under the completed-contract method, a) revenue, costs, and gross profit are recognized during the contract. b) revenue and costs are recognized during the contract, but gross profit recognition is deferred until the contract is completed. c) costs are recognized during the contract, but revenue and gross profit are not. d) revenue, costs and gross profit are not recognized until the contract is finished.

28. The principal disadvantage of using the percentage-of-completion method of recognizing revenue from long-term contracts is that it a) is unacceptable for income tax purposes. b) gives results based upon estimates which may be subject to considerable uncertainty. c) is likely to assign a small amount of revenue to a period during which a large amount of revenue was actually earned. d) no revenue is recognized during the contract.

29. Cost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be a) recognized in the current period, regardless of whether the percentage-of-completion or completed-contract method is used. b) recognized in the current period under the percentage-of-completion method, but the completed-contract method should defer recognition of the loss to the time when the contract is completed. c) recognized in the current period under the completed-contract method, but the percentage-of-completion method should defer the loss until the contract is completed. d) deferred and recognized when the contract is completed, regardless of whether the percentage-of-completion or completed-contract method is used.

30. Cost estimates at the end of the second year indicate a loss will result on completion of the entire contract. Which of the following statements is correct? a) Under the completed-contract method, the loss is not recognized until the year the construction is completed. b) Under the percentage-of-completion method, the gross profit recognized in the first year must not be changed. c) Under the completed-contract method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability. d) Under the completed-contract method, when the Construction in Process balance exceeds the billings, the estimated loss is added to the accumulated costs.

31. The completed contract method for accounting for long-term construction projects requires that a) no revenue is recognized until the project is completed. b) costs are accumulated and revenue is recognized in proportion to cash collected. c) gross profit is calculated each period, but deferred until the end of the contract.

Revenue Recognition

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d) revenue is calculated each period, but deferred until the end of the contract.

32. Which of the following statements does NOT describe a long-term construction project that is accounted for under the completed contract method? a) Revenues are recognized at the end of the contract. b) Revenues are recognized evenly throughout the contract. c) Gross profit is recognized at the end of the contract. d) Losses are recognized immediately.

33. Losses in long-term construction projects a) are generally deferred until the contract is complete. b) are only recognized immediately under the completed-contract method. c) are only recognized immediately under the percentage-of-completion method. d) are recognized immediately under both the completed-contract method and the percentage-of-completion method.

34. The journal entries to recognize the revenue from a consignment sale would likely be identical under the earnings and the contract-based approaches assuming a) the contract is entered into at the same time as when control over the goods is passed to the customer. b) the underlying goods or services are valued under the residual value method. c) the completed contract method is used. d) the percentage-of-completion method is used.

35. When a realtor sells a house for a client, he/she a) takes temporary title to the property until the client moves in. b) has the risks and rewards of ownership until the client moves in. c) receives a commission on the sale but does not hold title to the property. d) does hold title to the property but has the risks and rewards of ownership until the client moves in.

36. The proposed new revenue recognition model currently being studied by the IASB and FASB is the a) contract-based approach. b) earnings approach. c) percentage of completion method. d) completed contract method.

37. Which of the following is NOT one of the five steps under the proposed new revenue recognition standard currently being studied by the IASB and FASB? a) Identify the contract(s) with the customer. b) Determine the transaction price. c) Determine the collectability of the contract. d) Recognize revenue when a performance obligation is satisfied.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

38. Which of the following statements is correct regarding long-term construction contracts? a) ASPE only allows the use of the completed-contract method. b) ASPE only allows the use of the percentage-of-completion method. c) IFRS only allows the use of the percentage-of-completion and the zero-profit method. d) IFRS allows the use of the percentage-of-completion and the zero-profit method, but does not preclude the use of the completed-contract method.

Revenue Recognition

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MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

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

c a b c d c

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

b b d c b b

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

c a c b b c

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

d b c d c b

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

d a d b a c

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

a b d a c a

37. 38.

c d

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Use the following information for questions 39–40. A product and service are bundled together and sold to customers for $350. The fair values of the product and service are $300 and $100 respectively.

39. Under the relative fair value method, how much would be allocated to the product? a) $300.00 b) $262.50 c) $200.00 d) $175.00

40. Under the residual method, how much would be allocated to the product? a) $300.00 b) $262.50 c) $250.00 d) $200.00

41. Cello Corp. has made a sale to a customer valued at $1,500,000. The associated expenses are $300,000. Some aspects of this sale have created an element of measurement uncertainty. Assuming that this element of uncertainty can be reasonably estimated at $450,000, Cello should a) Increase revenues by $450,000. b) Increase expenses by $450,000. c) Decrease expenses by $450,000. d) Increase expenses by $300,000.

42. On January 1, 2014, Trumpet Ltd. sold land that cost $180,000 for $240,000, receiving a note bearing interest at 10 percent. The note will be paid in three annual instalments of $96,510 starting December 31, 2014. Assuming that collection of the note is very uncertain, how much revenue from this sale should Trumpet recognize in 2014? a) $0 b) $18,000 c) $24,000 d) $96,510

43. Guitar Construction Corp. contracted to construct a building for $1,500,000. Construction began in 2014 and was completed in 2015. Data relating to the contract follow: Year ended December 31, 2014 2015 Costs incurred $600,000 $460,000 Estimated costs to complete 400,000 —

Revenue Recognition

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Guitar uses the percentage-of-completion method. For the calendar years 2014 and 2015, respectively, Guitar should report gross profit of a) $270,000 and $170,000. b) $900,000 and $600,000. c) $300,000 and $140,000. d) $0 and $440,000.

44. In 2014, Banjo Construction Corp. began work on a contract for $3,700,000. Other details follow: 2014 Costs incurred during the year $1,800,000 Estimated costs to complete as of December 31 1,200,000 Billings during the year 1,650,000 Collections during the year 975,000 Banjo uses the percentage-of-completion method. For calendar 2014, Banjo should report gross profit of a) $150,000. b) $420,000. c) $700,000. d) $2,220,000.

Use the following information for questions 45–46. In 2014, Violin Inc. began a three year construction contract for $7,000,000. Violin uses the percentage-of-completion method. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial statement presentation relating to this contract for calendar 2014 follow: Statement of Financial Position Accounts receivable—construction contract billings $300,000 Construction in progress $850,000 Less contract billings 640,000 Costs and recognized profit in excess of billings 210,000 Income Statement Income (before tax) on the contract recognized in 2014 $210,000

45. How much cash was collected in 2014 on this contract? a) $50,000 b) $340,000 c) $400,000 d) $600,000

46. What was the initial estimated gross profit on this contract? a) $762,860 b) $810,462 c) $1,300,408 d) $1,729,412

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

47. Cornet Construction Corp. uses the percentage-of-completion method. In 2014, Cornet began work on a contract for $1,650,000 which was completed in 2015. Data on the costs are: Year Ended December 31 2014 2015 Costs incurred $585,000 $420,000 Estimated costs to complete 390,000 — For the calendar years 2014 and 2015, Cornet should recognize gross profit of 2014 2015 a) $0 $645,000 b) $387,000 $258,000 c) $405,000 $240,000 d) $405,000 $645,000

Use the following information for questions 48–49. Clarinet Ltd. began work in 2014 on a contract for $1,200,000. Other details follow: 2014 2015 Costs incurred during the year $ 200,000 $612,500 Estimated costs to complete as of December 31 600,000 0 Billings during the year 225,000 900,000 Collections during the year 150,000 975,000

48. Assume that Clarinet uses the percentage-of-completion method of accounting. The portion of the total gross profit to be recognized in 2014 is a) $75,000. b) $100,000. c) $300,000. d) $400,000.

49. Assume that Clarinet uses the completed-contract method of accounting. The portion of the total gross profit to be recognized in 2015 is a) $150,000. b) $225,000. c) $387,500. d) $1,200,000.

Use the following information for questions 50–51. Tuba Ltd. began work in 2014 on a contract for $1,250,000. Other data are: 2014 Costs incurred to date $540,000 Estimated costs to complete as of December 31 360,000 Billings to date 420,000 Collections to date 300,000

2015 $335,000 — 1,250,000 1,000,000

Revenue Recognition

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50. If Tuba uses the percentage-of-completion method, the gross profit to be recognized in 2014 is a) $450,000. b) $210,000. c) $200,000. d) $100,000.

51. If Tuba uses the completed-contract method, the gross profit to be recognized in 2015 is a) $375,000. b) $400,000. c) $850,000. d) $1,000,000.

52. Beaver Builders Ltd. is using the completed-contract method for a $2,000,000 contract that will take two years to complete. Data at December 31, 2014, the end of the first year, are: Costs incurred to date $925,000 Estimated costs to complete 1,100,000 Billings to date 850,000 Collections to date 700,000 The gross profit or loss that should be recognized for 2014 is a) $50,000 gross profit. b) $25,000 gross profit. c) $25,000 loss. d) $ 0.

Use the following information for questions 53–55. Piano Construction Corp. began operations in 2014. Construction activity for 2014 is shown below. Piano uses the completed-contract method. Billings Collections Estimated Contract Through Through Costs to Costs to Contract Price 12/31/14 12/31/14 12/31/14 Complete 1 $1,280,000 $1,260,000 $1,040,000 $860,000 — 2 1,440,000 600,000 400,000 328,000 $752,000 3 1,320,000 760,000 700,000 900,000 480,000

53. Which of the following should be shown on the income statement for 2014 related to Contract 1? a) Gross profit, $180,000 b) Gross profit, $240,000 c) Gross profit, $400,000 d) Gross profit, $420,000

54. Which of the following should be shown on the statement of financial position at December 31, 2014 related to Contract 2? a) Inventory, $272,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b) Inventory, $328,000 c) Liability, $272,000 d) Liability, $600,000

55. Which of the following should be shown on the statement of financial position at December 31, 2014 related to Contract 3? a) Unbilled contract costs, $140,000 b) Unbilled contract costs, $60,000 c) Accounts receivable, $760,000 d) Construction in process, $480,000

56. On June 1, Electronics Distribution (ED) shipped 100 TVs to TV World (TVW) on consignment. ED buys these TVs from their supplier for $600 each and sells them to TVW for $800. TVW then retails them for $1,200 each. By the end of June, TV World reported that they had sold 60 of these TVs, and remitted the appropriate amount to ED. How much revenue should be recorded by ED in connection with this transaction? a) $72,000 b) $60,000 c) $48,000 d) $36,000

57. A project was correctly accounted for under the percentage-of-completion method. At the end of the project, the Construction-in-Process account includes total debits and credits of $3,500,000. Assuming that total gross profit of $1,200,000 was recognized throughout the contract, total construction costs were a) $4,600,000. b) $3,500,000. c) $2,300,000. d) $2,100,000.

58. At the end of year 2, the accounting records for a multi-year construction project indicate actual costs incurred to date of $3,200,000, and the most recent estimate of total costs of $9,500,000. Assuming the percentage-of completion method is used, to one decimal, at the end of year 2 the project is a) 33.7% complete. b) 31.2% complete. c) 26.1% complete. d) 25.2% complete.

Use the following information for questions 59–60. On April 1, Harmonica Corp. consigned 50 handcrafted benches to Organ Co. Harmonica’s cost was $350 per bench. Total freight costs were $700, which were paid by Organ. On August 1, Harmonica received a cheque for $14,100 from Organ which included the following information: Number of units sold: 20 Expenses deducted:

Revenue Recognition

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Freight: $700 Commission (20% of sales price) ? Advertising $450 Delivery $290

59. Under the earnings approach, total sales were a) $15,540. b) $18,550. c) $19,060. d) $19,425.

60. The inventory of benches will be reported on whose statement of financial position and at what amount? a) Harmonica's statement of financial position, $10,500 b) Harmonica's statement of financial position, $10,920 c) Organ's statement of financial position $10,500 d) Organ's statement of financial position, $10,920

61. Trombone Inc. entered into a contract with Bassoon Corporation, in which Trombone agreed to provide Bassoon with building supplies. Bassoon agreed to pay a total of $18,000 at delivery. Under the contract-based view, Trombone's net contract position can be assumed to be a) $18,000. b) $9,000. c) $4,500. d) $ 0.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 39. b 43. c 47. c 51. a 55. a 59. d 40. c 44. b 48. b 52. c 56. c 60. b 41. b 45. b 49. c 53. d 57. c 61. d 42. a 46. d 50. b 54. c 58. a

DERIVATIONS—Computational No. Answer

Derivation

39.

$300 x [$350 ÷ ($300 + $100)] = $262.50

40.

$350 – $100 = $250

41.

Conceptual

42.

43.

$600,000 —————————— × ($1,500,000 – $1,000,000) = $300,000 $600,000 + $400,000 ($1,500,000 – $1,060,000) – $300,000 = $140,000

44.

$1,800,000 ——————————–— × ($3,700,000 – $3,000,000) = $420,000 $1,800,000 + $1,200,000

45.

$640,000 - $300,000 = $340,000

46.

$850,000 – $210,000 = $640,000 $640,000 ————————— × ($7,000,000 – Total estimated cost) = $210,000 Total estimated cost Total estimated cost = $5,270,588 $7,000,000 – $5,270,588 = $1,729,412

47.

$585,000 ————- × ($1,650,000 – $975,000) = $405,000 $975,000 ($1,650,000 – $1,005,000) – $405,000 = $240,000

Revenue Recognition

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No.

Answer

Derivation

48.

$200,000 ————— × ($1,200,000 – $800,000) = $100,000 $800,000

49.

$1,200,000 – $812,500 = $387,500

50.

$540,000 ————— × ($1,250,000 – $900,000) = $210,000 $900,000

51.

$1,250,000 – $875,000 = $375,000

52.

$2,000,000 – ($925,000 + $1,100,000) = ($25,000) loss, must be recognized in current year

53.

$1,280,000 – $860,000 = $420,000

54.

$600,000 – $328,000 = $272,000

55.

$900,000 – $760,000 = $140,000

56.

60 x $800 = $48,000

57.

$3,500,000 – $1,200,000 = $2,300,000

58.

$3,200,000 ÷ $9,500,000 = 33.7%

59.

80% Sales – $700 – $450 – $290 = $14,100 (cheque received) 80% Sales = $15,540 Sales = $19,425

60.

($350 x 30) + ($700 x 30 ÷ 50) = $10,920

61.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 62. According to the AcSB guidelines, the process of reporting an item in the financial statements of an entity is a) recognition. b) realization. c) allocation. d) matching.

63. Flute Construction Corp. has consistently used the percentage-of-completion method. During 2014, Flute entered into a fixed-price contract to construct an office building for $6,000,000. Information relating to the contract is as follows: At December 31 2014 2015 Percentage of completion 15% 45% Estimated total cost at completion $4,500,000 $4,800,000 Gross profit recognized (cumulative) 300,000 720,000 Under the earnings approach, contract costs incurred during 2015 were a) $1,440,000. b) $1,485,000. c) $1,575,000. d) $2,160,000.

64. Cymbal Construction Corp. has consistently used the percentage-of-completion method. In 2014, Cymbal started work on a $7,000,000 construction contract that was completed in 2015. The following information was taken from Cymbal’s 2014 accounting records: Billings to date $2,200,000 Costs incurred 2,100,000 Collections to date 1,400,000 Estimated costs to complete 4,200,000 Under the earnings approach, what amount of gross profit should Cymbal recognize in 2014 on this contract? a) $700,000 b) $466,667 c) $350,000 d) $233,333

Use the following information to answers questions 65–66. During 2014, Horn Corp. started a construction job with a total contract price of $700,000. Horn has consistently used the completed contract method. The job was completed on December 15, 2015. Additional data are as follows: 2014 2015 Actual costs incurred $270,000 $305,000 Estimated remaining costs 270,000 — Billings to date 240,000 460,000

Revenue Recognition

Collections to date

200,000

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480,000

65. For 2014, what amount should Horn recognize as gross profit? a) $ 0 b) $80,000 c) $95,000 d) $125,000

66. For 2015, what amount should Horn recognize as gross profit? a) $ 0 b) $80,000 c) $95,000 d) $125,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 62. a 63. b 64. d 65. a 66. d

DERIVATIONS—CPA Adapted No. Answer 62. a

Derivation Conceptual

63.

($4,800,000 × 45%) – ($4,500,000 × 15%) = $1,485,000

64.

$2,100,000 —————– × ($7,000,000 – $6,300,000) = $233,333 $6,300,000

65.

66.

$700,000 – $270,000 – $305,000 = $125,000

Revenue Recognition

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EXERCISES Ex. 6-67 Concessionary terms Explain what concessionary terms are, and give four examples. Solution 6-67 Concessionary terms are terms that are more favourable than normal. This is often seen when supply exceeds demand, and the buyer can negotiate a better deal than usual. Examples include: 1. Deep discounts on selling price 2. Looser credit policy (e.g. giving the customer a longer period to pay) 3. Extended trial periods, with the sale subject to customer acceptance after the trial period 4. Seller provides ongoing or additional services that are beyond normal practice 5. Extended warranties or free warranties 6. More lenient (looser) return policies than normal

Ex. 6-68 Definitions Provide clear, concise answers for the following: 1. Explain the conceptual difference between the earnings approach and the contract-based approach to accounting for revenues. 2. How is revenue recognized under the earnings approach? 3. How is revenue recognized under the contract-based approach? 4. How are sales accounted for in the presence of collection and measurement uncertainty? 5. What are the two main methods to account for long-term construction projects allowed under ASPE? 6. Why is it important to understand the business perspective of selling transactions? 7. Explain the term onerous contracts and its implications. Solution 6-68 1. The earnings approach focuses on the earnings process itself and how value is added. The contract-based approach focuses on the creation of contractual rights and obligations that are created by sales contracts. 2.

Under the earnings approach, revenue is recognized when performance is substantially complete, the transaction can be measured, and collection is reasonably assured.

Under the contract-based approach, the net contract position is initially recognized (through assets and corresponding liabilities) when the contract has been entered into. Revenue is subsequently recognized as the contract obligations are fulfilled.

In the absence of reasonable expectation of collection and/or ability to measure the related revenue, sales should not be booked.

The two main methods allowed under ASPE are the percentage-of-completion and the completed-contract methods.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

The business perspective includes the physical and reciprocal nature as well as any concessionary terms of the transaction. This may impact the timing, measurement and recognition of those sales.

Onerous contracts are contracts that are no longer profitable to the company. These contracts should be re-measured and a loss should be recognized.

Ex. 6-69 Terminology In the space provided at right, write the word or phrase that is defined or indicated. 1.

A contract that is no longer profitable to the company.

1. _________________________________

An entity may have an implicit obligation even if it is not explicitly noted in the sales contract.

2. _________________________________

Sales that are comprised of several individual components.

3. ___________________________________

The party acting as an agent for the seller.

4. _________________________________

The method to allocate sales prices to individual components of a sales bundle where the fair value of the undelivered item is subtracted from the overall purchase price.

5. _________________________________

The method used to account for long-term contracts that do not recognize profits before the completion of the project.

6. _________________________________

The account used in the percentage-of completion and completed contract methods to accumulate costs and recognize profits.

7.__________________________________

Cash or other assets an entity receives in return for the provision of goods or services.

8.__________________________________

The actions a company takes to add value.

9.__________________________________

Solution 6-69 1. Onerous

Revenue Recognition

Constructive obligation

Bundled sales

Consignee

Residual value method

Completed-contract method

Construction in Process account

Consideration

Earnings process

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Ex. 6-70 Comparison of accounting methods for long-term contracts Compare the percentage-of-completion and completed-contract methods. Solution 6-70 The percentage-of-completion method recognizes revenue before completion of the project. A major advantage of this method is that the contractors' revenue stream is not distorted. However, the reliance on estimates, rather than on actual numbers, is a disadvantage. This method conforms to the earnings-based view of revenue recognition. Under the completed contract method, revenue recognition is deferred until the completion of the project. A major advantage of this method is the use of actual numbers, rather than estimates. A major disadvantage is the distortion of income, as no revenue is recognized during the contract. This method does not conform to the earnings-based view of revenue recognition.

Ex. 6-71 Bundled sales Loon Inc., a software company sells new accounting software and user support bundled together. The fair value of the software is $1,500 and the fair value of the user support is $500. The user support is valid for a period of 12 months from the date of software purchase. To be able to compete with a competitor's offering, Loon decided to sell the bundle at a discount for $1,800. During its first month of sales, 100 units of this software bundle were sold at the discounted price, and expenses were $50,000. Instructions a) Calculate the sale price that should be allocated to each component of the bundle using the relative fair value method. b) Calculate the sale price that should be allocated to each component of the bundle using the residual value method. c) Assuming that the relative fair value method is used and income tax rate is 30%, calculate the net income applicable to Loon's first month of sales. Solution 6-71

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a) Relative fair value method: Software: $1,500 x [$1,800 / ($1,500 + $500)] = User Support: $500 x [$1,800 / ($1,500 + $500)] =

b) Residual value method: Software: $1,800 - $500 User Support: $1,800 - $1,300

c) Net income calculation: Sales ($1,800 x 100) ................................................ Less: Expenses........................................................ User Support Unearned Portion ............................... [($450 x 100) x 11÷12] Income before tax .................................................... Less income tax (30%)............................................. Net Income ..............................................................

$1,350 450 $1,800

$1,300 500 $1,800

$180,000 (50,000) (41,250) 88,750 (26,625) $62,125

Ex. 6-72 Percentage-of-completion method Chickadee Construction was awarded a contract to construct an interchange at the junction of two major freeways in a Canadian city at a total contract price of $10,000,000. The estimated total costs to complete the project were $8,000,000, and it is expected to take two years. Instructions Using the percentage-of-completion method and the cost-to-cost basis, a) Prepare the journal entry to record construction costs of $4,400,000 for the first year. b) Prepare the journal entry to record progress billings of $5,000,000 for the first year. c) Prepare the journal entry to recognize the revenue and gross profit for the first year. Solution 6-72 % complete = 4,400,000 ÷ 8,000,000 = 55% a)

Construction in Process ................................................................ 4,400,000 Materials, Cash, A/P, etc. ....................................................... 4,400,000

Accounts Receivable ..................................................................... 5,000,000 Billings on Construction in Process ........................................ 5,000,000

Construction Expenses ................................................................. 4,400,000 Construction in Process (gross profit)............................................ 1,100,000 Revenue from Long-term Contract (55% x $10,000,000)........ 5,500,000

Ex. 6-73 Percentage-of-completion method Finch Construction Corp. contracted to build a bridge for $5,000,000. Construction began in 2014 and was completed in 2015. Data relating to the construction are: 2014 2015 Costs incurred $1,620,000 $1,400,000

Revenue Recognition

Estimated costs to complete

1,380,000

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—

Instructions Using the percentage-of-completion method and the cost-to-cost basis, a) How much revenue should be reported for 2014? Show your calculation. b) Prepare the journal entry to record progress billings of $1,700,000 during 2014. c) Prepare the journal entry to record the revenue and gross profit for 2014. d) How much gross profit should be reported for 2015? Show your calculation. Solution 6-73 a) $1,620,000 ————–— × $5,000,000 = $2,700,000 $3,000,000 b)

Accounts Receivable ..................................................................... 1,700,000 Billings on Construction in Process ........................................ 1,700,000

Construction Expenses ................................................................. 1,620,000 Construction in Process ................................................................ 1,080,000 Revenue from Long-term Contracts........................................ 2,700,000

Revenue ....................................................................................... $5,000,000 Less actual costs........................................................................... (3,020,000) Total gross profit ........................................................................... 1,980,000 Recognized in 2014 ...................................................................... (1,080,000) Recognized in 2015 ...................................................................... $ 900,000 OR Total revenue ................................................................................ $5,000,000 Recognized in 2014 ...................................................................... (2,700,000) Recognized in 2015 ...................................................................... 2,300,000 Actual costs in 2015 ...................................................................... (1,400,000) Gross profit in 2015 ....................................................................... $ 900,000

Ex. 6-74 Percentage-of-completion method Robin Builders Ltd. contracted to build a high-rise for $6,000,000. Construction began in 2014 and is expected to be completed in 2017. Data for 2014 and 2015 are: 2014 2015 Costs incurred $900,000 $1,700,000 Estimated costs to complete 3,600,000 2,400,000 Instructions Using the percentage-of-completion method and the cost-to-cost basis, a) How much gross profit should be reported for 2014? Show your calculation. b) How much gross profit should be reported for 2015? Show your calculation. c) Prepare the journal entry to record the revenue and gross profit for 2015. Solution 6-74 a) $900,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

————— × ($6,000,000 – $4,500,000) = $300,000 $4,500,000 b)

$2,700,000 ————–— × ($6,000,000 – $5,000,000) = $520,000 $5,000,000 Less 2014 gross profit (300,000) Gross profit in 2015 $220,000

Construction in Process (gross profit)........................................... 220,000 Construction Expenses ................................................................. 1,700,000 Revenue from Long-term Contracts........................................ 1,920,000

Ex. 6-75 Percentage-of-completion and completed-contract methods On February 1, 2014, Owl Contractors agreed to construct a building at a total contract price of $3,000,000. Owl estimated total construction costs would be $2,000,000 and the project would be finished in 2016. Information relating to the costs and billings for this contract is as follows: 2014 2015 2016 Total costs incurred to date $ 750,000 $1,320,000 $2,300,000 Estimated costs to complete 1,250,000 880,000 -0Customer billings to date 1,100,000 2,000,000 3,000,000 Collections to date 1,000,000 1,750,000 2,950,000 Instructions Using the percentage-of-completion the completed-contract methods, calculate the gross profit that should be reported for 2014, 2015, and 2016. Fill in the correct amounts on the following schedule:

2014 2015 2016

Percentage-of-Completion Gross Profit __________ __________ __________

2014 2015 2016

Completed-Contract Gross Profit __________ __________ __________

2014 2015 2016

Completed-Contract Gross Profit — — $700,000d

Solution 6-75

2014 2015 2016

Percentage-of-Completion Gross Profit $375,000a $105,000b $220,000c

$750,000 ————— × $1,000,000 = $375,000 $2,000,000

$1,320,000 ————–— × $800,000 = $480,000 $2,200,000

Revenue Recognition

Less 2014 gross profit 2015 gross profit

(375,000) $105,000

Total revenue Total costs Total gross profit Recognized to date 2016 gross profit

$3,000,000 2,300,000 700,000 (480,000) $ 220,000

Total revenue Total costs Total gross profit

$3,000,000 2,300,000 $ 700,000

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Ex. 6-76 Consignment sale In 2014, the following transaction occurred between Seagull Wholesale Corp. (consignor) and Bobolink Stores (consignee): On March 2, 2014 Seagull shipped merchandise costing $52,000 to Bobolink. Seagull paid $4,000 for freight and Bobolink paid $3,000 for advertising (to be reimbursed by Seagull). By the end of the third quarter of 2014 (September 30, 2014), Bobolink advised Seagull that all the merchandise has been sold for $70,000, and forwarded the proceeds (net of a 15% commission and the outlay for advertising) to Seagull. Instructions a) Prepare all entries for Bobolink to account for this transaction. b) Prepare all entries for Seagull to account for this transaction. Solution 6-76 a) Bobolink Receivable from Consignor .................................................................. Cash ........................................................................................... To set up receivable for advertising

3,000

Cash .................................................................................................... Payable to Consignor.................................................................. To record sale

70,000

Payable to Consignor ........................................................................... Receivable from Consignor ......................................................... Commission Revenue*................................................................ *$70,000 x 15% = $10,500 Cash ........................................................................................... Remittance to consignor

70,000

b) Seagull Inventory on Consignment ................................................................... Merchandise Inventory ................................................................ Shipment of consigned merchandise

3,000

70,000

3,000 10,500 56,500

52,000 52,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Inventory on Consignment ................................................................... Cash ........................................................................................... Payment of freight costs

4,000

Cash .................................................................................................... Advertising Expense ............................................................................ Commission Expense .......................................................................... Revenue from Consignment Sales .............................................. Remittance from consignee

56,500 3,000 10,500

Cost of Goods Sold (52,000 + 4,000) ................................................... Inventory on Consignment .......................................................... Cost of sales for consignment sales

56,000

4,000

70,000

56,000

Ex. 6-77 Reporting of gross or net revenues Discuss three factors to consider in determining whether gross or net revenues should be reported on the income statement. Solution 6-77 Factors to consider: 1. Is the company acting as principal or are they acting as agent or broker? If as principal, this would support reporting gross revenue; if as agent/broker, this would support reporting net revenue. 2.

Is the company taking title to the goods being sold? Taking title supports reporting gross revenue.

Who has the risks and rewards of ownership of the goods being sold? Having the risks and rewards supports reporting gross revenue.

Ex. 6-78 Contract-based approach In January 2014, McKay Construction Corp. contracted to construct a building for $6,000,000. Construction started in early 2014 and was completed in 2015. The following additional information is available: 2014 2015 Costs incurred $2,430,000 $2,700,000 Estimated costs to complete 2,600,000 — Collections during the year 2,400,000 3,600,000 McKay uses the percentage-of-completion method. Instructions Under the contract-based approach, a) How much revenue should McKay report for 2014 and 2015? b) Prepare all journal entries for 2014 and 2015 for this contract. Solution 6-78 a)

Revenue Recognition

6 - 35

2014: [$2,430,000 ÷ ($2,430,000 + $2,600,000)] x $6,000,000 = $2,898,608 2015: [($2,430,000 + $2,700,000) ÷ ($2,430,000 + 2,700,000 + $0) x $6,000,000] – $2,898,608 = $3,101,392 b) 2014: Contract asset ...................................................................................... 6,000,000 Contract liability. ......................................................................... 6,000,000 To record contract rights and obligations – January 2014 Contract liability.................................................................................... 2,430,000 Materials, Cash, Payables etc.. ................................................... 2,430,000 To record construction cost – 2014 Cash ................................................................................................... 2,400,000 Contract asset.. ........................................................................... 2,400,000 To record collections – 2014 Construction expenses......................................................................... 2,430,000 Contract liability........................................................................... 2,430,000 To recognize revenue and gross profit – 2014 Contract asset ...................................................................................... 2,898,608 Revenue from long-term contract.. .............................................. 2,898,608 2015: Contract liability.................................................................................... 2,700,000 Materials, Cash, Payables etc.. ................................................... 2,700,000 To record construction cost – 2015 Cash .................................................................................................... 3,600,000 Contract asset.. ........................................................................... 3,600,000 To record collections – 2015 Construction expenses......................................................................... 2,700,000 Contract liability .......................................................................... 2,700,000 To recognize revenue and gross profit – 2015 Contract asset ...................................................................................... 3,101,392 Revenue from long-term contract. ............................................... 3,101,392

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 6-79 Revenue recognition In October 2014, Blackbird Inc. signed a contract for $30,000 with the BH Law office to provide legal services for Blackbird Inc. for the remainder of 2014 and all of 2015. Assume that BH can reliably estimate future direct costs associated with the contract. The following services were performed based on the estimate by BH: Direct Costs Date Completed Research potential lawsuit $2,500 December, 2014 Prepare and file documents 7,500 March, 2015 Serve as Blackbird counsel during legal proceedings 7,500 October 2015 Instructions Under the earnings approach, a) When should BH recognize revenue in this situation? Explain. b) Prepare journal entries to recognize revenues related to this contract on BH’s books. Solution 6-79 a) BH could use a method of proportional revenue recognition, where some revenue is recognized when each service is rendered. This is appropriate because more than one performance act is required. Service revenue should be recognized in proportion to the costs for each act. b) Cash .................................................................................................... Unearned service revenue ............................................................ October 2014, to record the lump sum advance for services

30,000

Unearned service revenue ................................................................... 4,286 Service revenue ............................................................................ December 2014, to recognize earned revenue for research completed *Total estimated direct costs: $2,500 + $7,500 + $7,500 = $17,500 Service revenue recognized: ($2,500  $17,500) × $30,000 = $4,286 (rounded)

30,000

4,286*

Unearned service revenue ................................................................... 12,857 Service revenue ............................................................................ 12,857* March 2015, to recognize earned revenue for preparation and filing of documents *Service revenue recognized: ($7,500  $17,500) × $30,000 = $12,857 Unearned service revenue ................................................................... 12,857 Service revenue ............................................................................ October 2015, to recognize earned revenue for serving as counsel *Service revenue recognized: ($7,500  $17,500) × $30,000 = $12,857

12,857*

In each case above, when revenues are recognized, direct costs associated with revenue recognized are expensed as incurred.

Revenue Recognition

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Pr. 6-80 Revenue recognition Below are several independent situations that occurred during 2014 for Lark Corporation: Situation 1: Lark entered into a consignment arrangement with Sorel Corporation. Sorel will sell the goods and retain a commission. Situation 2: Lark agreed to provide consulting services to Dodo Company, a small company with a questionable credit rating. The term of the contract is 3 years. Situation 3: Lark sold equipment that includes a one-year warranty. The individual fair values of the equipment and warranty components are readily available. Instructions For each situation, explain how revenue should be recognized under the earnings approach. Be sure to include your reasoning. Solution 6-80 Situation 1: As the risks and rewards presumably remain with the seller (Lark), and this appears to be a consignment situation, an actual sale does not occur until the goods are sold to a third party. As a result, revenue should not be recognized before that time. The commission, as well as any other related expenses, would also be recognized at that time. Situation 2: Assuming Lark can ascertain any direct costs relating to the contract, measurement does not appear to be at issue. However, the customer's credit-worthiness is a concern, and may require that revenue recognition be delayed until payment is received. Situation 3: Assuming collectibility and measurement are not an issue, Lark should recognize all revenues that are attributable to the equipment components. The recognition of revenues related to the warranty components would be delayed until earned (as the service is provided).

Pr. 6-81 Completed-contract method Mockingbird Construction Ltd. reported the following construction activity in 2014, their first year of operations. Cash Costs Estimated Total Billings collections Incurred Additional Contract through through through Costs to Contract Price 12/31/14 12/31/14 12/31/14 Complete X $260,000 $170,000 $155,000 $182,000 $ 63,000 Y 325,000 130,000 130,000 100,000 247,000 Z 388,000 388,000 316,000 252,000 -0$973,000 $688,000 $601,000 $534,000 $310,000 Each of the above contracts is with a different customer, and any work remaining at December 31, 2014 is expected to be completed in 2015.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Instructions Prepare a partial income statement and a partial statement of financial position to indicate how the above contract information would be reported. Mockingbird uses the completed-contract method. Solution 6-81 Mockingbird Construction Ltd. Income Statement For the Year ended December 31, 2014 Revenue from long-term contracts (contract Z) .................................... Cost of construction (contract Z) .......................................................... Gross profit .......................................................................................... Provision for loss (contract Y)* ............................................................. *Contract costs through 12/31/10 .................................................. Estimated costs to complete.......................................................... Total estimated costs .................................................................... Total contract price........................................................................ Loss recognized in 2014 ...............................................................

$388,000 252,000 $136,000 22,000 $100,000 247,000 347,000 325,000 $ 22,000

Mockingbird Construction Ltd. Statement of Financial Position December 31, 2014 Current assets: Accounts receivable ($688,000 – $601,000) ................................. Inventories Construction in process (contract X) ....................................... Less: Billings ......................................................................... Unbilled contract costs ........................................................... Current liabilities: Billings ($130,000) in excess of contract costs ($100,000) ............ Estimated loss from long-term contracts .......................................

$ 87,000 $182,000 170,000 12,000

30,000 22,000

Pr. 6-82 Long-term construction project accounting Plover Construction Inc. specializes in the construction of commercial and industrial buildings. The company is experienced in bidding on long-term construction projects of this type, with the typical project lasting from fifteen to twenty-four months. Plover uses the percentage-ofcompletion method. Progress toward completion is measured on a cost to cost basis. Plover began work on a contract at the beginning of 2014. Data for 2014 follow: Contract price ...................................................................................... $2,000,000 Estimated costs Labour ......................................................................................... $425,000 Materials and subcontracts .......................................................... 875,000 Indirect costs ............................................................................... 200,000 1,500,000 Estimated gross profit .......................................................................... $ 500,000 At the end of 2014, the following was the actual status of the contract:

Revenue Recognition

Billings to date...................................................................................... Costs incurred to date Labour ......................................................................................... Materials and subcontracts .......................................................... Indirect costs ............................................................................... Latest forecast of total costs.................................................................

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$1,115,000 $207,000 519,000 75,000

801,000 $1,500,000

It should be noted that included in the above costs incurred to date were standard electrical and mechanical materials stored on the job site, but not yet installed, costing $51,000. These costs should not be considered in the costs incurred to date. Instructions a) Calculate the percentage of completion on the contract at the end of 2014. b) Calculate the gross profit that would be reported on this contract for 2014. c) Prepare the journal entry to record the revenue and gross profit for 2014 on Plover’s books. d) Indicate the account(s) and the amount(s) that would be shown on Plover’s statement of financial position at the end of 2014 related to its construction accounts. Also show how these items would be classified on the statement of financial position. Billings collected during the year were $980,000. e) Assume, instead of $1,500,000, the latest forecast of total costs at the end of 2014 was $2,050,000. How much income (loss) would Plover then report for the year 2014? Solution 6-82 a) Costs to date Less materials on job site

$801,000 (51,000) $750,000

Costs Incurred to Date —————————–— = Percentage of Completion Total Estimated Costs $750,000 ————— = 50% $1,500,000 b)

50% × $2,000,000 = Costs incurred Gross profit

Construction Expense ................................................................... Construction in Process (gross profit)............................................ Revenue from Long-term Project............................................

Current Asset Accounts receivable Current Liability Billings in excess of contract costs and recognized profit

$1,000,000 750,000 $ 250,000 750,000 250,000 1,000,000

$135,000

($1,115,000 – $980,000)

$115,000

($1,115,000 – $1,000,000)

Total loss reported in 2014

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Contract price Estimated cost to complete Amount of loss to be reported

$2,000,000 2,050,000 $ (50,000)

Pr. 6-83 Accounting for long-term construction contracts The board of directors of Snowbird Construction Corp. is meeting to choose between the completed-contract method and the percentage-of-completion method of accounting for longterm contracts in the company's financial statements. You have been engaged to assist Snowbird’s controller in the preparation of a presentation to be given at the board meeting. The controller provides you with the following information: 1. Snowbird commenced doing business on January 1, 2014. 2. Construction activities for the year ended December 31, 2014, were as follows: Total contract Billings through Cash collections Project price 12/31/14 through 12/31/14 A $ 615,000 $ 340,000 $ 310,000 B 450,000 135,000 135,000 C 475,000 475,000 390,000 D 600,000 240,000 160,000 E 480,000 400,000 400,000 $2,620,000 $1,590,000 $1,395,000 Contract costs Estimated incurred through additional costs to Project 12/31/14 complete contracts A $ 510,000 $120,000 B 130,000 260,000 C 350,000 -0D 370,000 290,000 E 320,000 80,000 $1,680,000 $750,000 3. Each contract is with a different customer. 4. Any work remaining to be done on the contracts is expected to be completed in 2015. Instructions a) Prepare a schedule by project, calculating the amount of gross profit (or loss) for the 2014 calendar year, which would be reported under: (1) The completed-contract method. (2) The percentage-of-completion method (based on estimated costs). b) Prepare the general journal entry to record revenue and gross profit on project B for 2014, assuming that the percentage-of-completion method is used. c) Indicate the balances that would appear in the statement of financial position at December 31, 2014 for the following accounts for Project D, assuming that the percentage-ofcompletion method is used. Accounts Receivable Billings on Construction in Process

Revenue Recognition

6 - 41

Construction in Process How would the balances in the accounts discussed in part c) change (if at all) for Project D, if the completed-contract method is used?

Solution 6-83 a) (1) and (2) Projects Contract price Contract costs incurred Additional costs to complete Total cost Total gross profit (loss)

A $615,000 510,000

B $450,000 130,000

C $475,000 350,000

D $600,000 370,000

E $480,000 320,000

120,000 630,000

260,000 390,000

-0350,000

290,000 660,000

80,000 400,000

$ (15,000)

$ 60,000

$125,000

$ (60,000)

$ 80,000

The amount reported as gross profit (loss) under the completed-contract method for 2014 is: Project A $(15,000) B -0C 125,000 D (60,000) E -0$ 50,000 The amount reported as gross profit (loss) under the percentage-of-completion method for 2014 is: Project A $(15,000) B 20,000 $60,000 × ($130,000 ÷ $390,000) C 125,000 D (60,000) E 64,000 $80,000 × ($320,000 ÷ $400,000) $134,000 b)

Construction in Process ................................................................ Construction Expenses ................................................................. Revenue from Long-term Contracts........................................

Billings Cash collections Accounts receivable Billings on Construction in Process Costs incurred Loss reported Construction in process

The account balances would be the same.

20,000 130,000 150,000

$240,000 160,000 $ 80,000 $240,000 $370,000 (60,000) $310,000

Pr. 6-84 Consignment sales On July 2, Hummingbird Corp. ships merchandise costing $460,000 on consignment to Thrush Stores. Hummingbird pays the freight of $10,000. Upon sale, Thrush Stores will receive a 12% commission and a 6% allowance to offset its advertising expenses. At the end of the month,

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Thrush notifies Hummingbird that 50% of the merchandise has been sold for $560,000. Instructions Record the journal entries required by the two companies to account for this consignment. Solution 6-84 Hummingbird

Thrush

a) On shipment Inventory on Consignment 460,000 Merchandise Inventory 460,000 b) Payment of freight Inventory on Consignment Cash

10,000 10,000

c) Sales of consigned merchandise Cash 560,000 Payable to Consignor d) Notification of sales and expenses and remittance of cash Cash 459,200 Payable To Consignor 560,000 Advertising Expense 33,600 Advertising Expense Commission Expense 67,200 Commission Revenue Revenue from Cash Consignment Sales 560,000

560,000

33,600 67,200 459,200

Cost of Goods Sold 235,000 Inventory on Consignment 235,000 0.50 x (460,000 + 10,000) = 235,000 $560,000 x 12% = $67,200 $560,000 x 6% = $33,600 $560,000 – $33,600 – $67,200 = $459,200

Pr. 6-85 Percentage-of-completion and completed-contract methods On January 1, 2014, Auk Construction Ltd. started a construction project for $4,500,000. Relevant data for 2014 and 2015 are as follows: 2014 2015 Current year construction costs $ 3,300,000 $ 620,000 Estimated remaining costs to complete 600,000 -0Current year billings 3,100,000 1,400,000 Current year collections 3,000,000 1,500,000 Instructions Calculate the following amounts for each method: Completed Contract 2014 2015 a) Gross Profit $ $

Percentage-ofCompletion 2014 2015 $ $

Revenue Recognition

b) c)

Construction in progress year-end balance Costs in excess of billings (Billings in excess of costs)

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Solution 6-85

a) b) c)

Gross Profit Construction in progress year-end balance Costs in excess of billings (Billings in excess of costs)

Completed Contract 2014 2015 -0580,000 3,300,000 -0200,000

-0-

Percentage-ofCompletion 2014 2015 507,692 72,308 3,807,692 -0707,692

-0-

Calculations: 4,500,000 – 3,300,000 – 620,000 = 580,000 3,300,000 – 3,100,000 = 200,000 (4,500,000 – 3,300,000 – 600,000) x (3,300,000 ÷ (3,300,000 + 600,000)) = 507,692 3,300,000 + 507,692 = 3,807,692 3,807,692 – 3,100,000 = 707,692 [(4,500,000 – 3,300,000 – 620,000) x [(3,300,000 + 620,000) ÷ (3,300,000 + 620,000)] – 507,692 = 72,308

Pr.6-86 Percentage-of-completion and completed-contract methods On June 15, 2014, Sparrow Construction signed a $360,000 contract to build a small building. Sparrow estimated that the total cost would be $320,000. Construction started immediately because the required completion date was August 31, 2015. Sparrow’s relevant data relating to this construction project were as follows: 2014 2015 Actual costs incurred $ 120,000 $204,000 Estimated costs to complete $ 200,000 -0Progress billings 112,000 248,000 Collections 110,000 250,000 Instructions Calculate how much gross profit that Sparrow should recognize each year, assuming: For 2014

For 2015

Solution 6-86 Method Used a) Completed contract

For 2014 -0-

For 2015 $ 36,000

$15,000*

$21,000**

a) b)

Method Used Completed contract Percentage-of-completion

Percentage-of-completion

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*(360,000 – $320,000) x 120,000 ÷ 320,000 = $15,000 **$36,000 – $15,000 = $21,000

Pr. 6-87 Long-term contract (contract-based approach) On January 1, 2014, Cowbird Corp., a management consulting firm, entered into a contract with Railbird Company to provide advisory services over a four-year period. The contract price was $4,000,000 and was to be paid in four equal annual payments at the end of each year. Cowbird’s expenses relating to this contract were $650,000, $730,000, $780,000 and $710,000 for 2014-2017. Collectibility was reasonably assured throughout the duration of the contract and measurement uncertainties were not an issue. Instructions Using the contract-based revenue recognition model, prepare journal entries for all four years. Solution 6-87 2014 Debit

Credit

To record contract rights and obligations: 4,000,000 Contract asset Contract liability

4,000,000

To record contract expenses: 650,000 Contract liability Materials, Cash, Payables etc.

650,000

To record collections: Cash Contract asset

2015 Debit Credit

730,000

1,000,000

2016 Debit Credit

780,000 730,000

1,000,000 1,000,000

2017 Debit Credit

710,000 780,000

1,000,000 1,000,000

710,000

1,000,000 1,000,000

1,000,000

To recognize revenue and gross profit: Expenses Contract liability

650,000

1,000,000 Contract asset Revenue from long-term contract

780,000

730,000 650,000

730,000 1,000,000

1,000,000

710,000 780,000

1,000,000 1,000,000

710,000 1,000,000

1,000,000

Revenue Recognition

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CHAPTER 7 CASH AND RECEIVABLES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

Note:

LOD

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

1 1 2 2 2 2 3 4 4

E E M E E E E E E

37. 38. 39. 40.

4 4 4 5

M M M H

53. 54.

3 5

M H

60. 61. 62.

1-10 1-8 2

M M M

69. 70.

5 7

M H

E = Easy

Item

LOD

Item

LOD

Multiple Choice–Conceptual 10. 4 M 19. 5 E 11. 4 M 20. 5 E 12. 4 E 21. 5 M 13. 4 E 22. 5 M 14. 4 E 23. 5 M 15. 5 E 24. 6 M 16. 5 E 25. 7 E 17. 5 E 26. 7 E 18. 5 M 27. 7 M Multiple Choice–Computational 41. 5 H 45. 8 M 42. 6 M 46. 8 H 43. 7 M 47. 8 M 44. 7 M 48. 8 M Multiple Choice–CPA Adapted 55. 5 H 57. 5 E 56. 5 M *58. 11 M Exercises 63. 5 E 66. 8 M 64. 7 H 67. 9 M 65. 8 M *68. 11 M Problems 71. 7 M 73. 8 M 72. 8 M 74. 8 M

M = Medium

Item

LOD

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

7 7 8 8 9 9 11 11 11

M M E E E E E M M

*49. *50. *51. *52.

11 11 11 11

E M H M

*59.

75. *76.

8 11

M H

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

3. 4.

MC MC

5. 6.

MC MC

53.

8. 9.

MC MC

10. 11.

MC MC

15. 16. 17. 18.

MC MC MC MC

19. 20. 21. 22.

MC MC MC MC

24.

42.

25. 26.

MC MC

27. 28.

MC MC

30. 31. 45.

MC MC MC

46. 47. 48.

MC MC MC

32.

33.

60.

*34. *35.

MC MC

*36. *49.

MC MC

Note: MC = Multiple Choice

Item

Type

Item

Type

Item

Type

Item

Type

38. 39.

MC MC

60. 61.

Ex Ex

61. 63. 69.

Ex Ex Pr

61. 64.

Ex Ex

70. 71.

Pr Pr

74. 75.

Pr Pr

67.

*59. *68.

MC Ex

*76.

Learning Objective 1 60. Ex 61. Ex Learning Objective 2 60. Ex 62. Ex 61. Ex Learning Objective 3 60. Ex 61. Ex Learning Objective 4 12. MC 14. MC 13. MC 37. MC Learning Objective 5 23. MC 55. MC 40. MC 56. MC 41. MC 57. MC 54. MC 60. Ex Learning Objective 6 60. Ex 61. Ex Learning Objective 7 29. MC 44. MC 43. MC 60. Ex Learning Objective 8 60. Ex 66. Ex 61. Ex 72. Pr 65. Ex 73. Pr Learning Objective 9 60. Ex *60. MC Learning Objective 10 Learning Objective 11 *50. MC *52. MC *51. MC *58. MC Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Cash and Receivables

7-3

CHAPTER STUDY OBJECTIVES 1. Understand cash and accounts receivable from a business perspective. Companies often have a significant amount of accounts receivable, which requires time and effort to manage and control. Companies strive to ensure that their collection policy is restrictive enough to minimize large losses in the form of uncollectible accounts receivable, while not being so restrictive that it interferes with the ability to attract new customers. Typical accounts receivable related categories include trade receivables, loans receivable, and nontrade receivables (including items like interest receivable and amounts due from officers and advances to employees).

2. Define financial assets, and identify items that are considered cash and cash equivalents and how they are reported. Financial assets are a major type of asset defined as cash, a contractual right to receive cash or another financial asset, an equity holding in another company, or a contractual right to exchange financial instruments under potentially favourable conditions. To be reported as cash, an asset must be readily available to pay current obligations and not have any contractual restrictions that would limit how it can be used in satisfying debts. Cash consists of coins, currency, and available funds on deposit at a bank. Negotiable instruments such as money orders, certified cheques, cashier’s cheques, personal cheques, and bank drafts are also viewed as cash. Savings accounts are usually classified as cash. Cash equivalents include highly liquid short-term investments (that is, those maturing three months or less from the date of purchase) that can be exchanged for known amounts of cash and have an insignificant chance of changing in value. Examples include treasury bills, commercial paper, and money-market funds. In certain circumstances, temporary bank overdrafts may be deducted in determining the balance of cash and cash equivalents. Cash is reported as a current asset in the statement of financial position, with foreign currency balances reported at their Canadian dollar equivalent at the date of the statement of financial position. The reporting of other related items is as follows: (1) Restricted cash: Legally restricted deposits that are held as compensating balances against short-term borrowing are stated separately in Current Assets. Restricted deposits held against long-term borrowing arrangements are separately classified in non-current assets either in Investments or Other Assets. (2) Bank overdrafts: These are reported in the Current Liabilities section and may be added to the amount reported as accounts payable. (3) Cash equivalents: This item is often reported together with cash as “cash and cash equivalents”.

3. Define receivables and identify the different types of receivables from an accounting perspective. Receivables are claims held against customers and others for money, goods, or services. Most receivables are financial assets. The receivables are described in the following ways: (1) current or non-current; (2) trade or nontrade; and (3) accounts receivable or notes or loans receivable.

4. Account for and explain the accounting issues related to the recognition and measurement of accounts receivable. The entity becomes a party to the contractual provisions of the accounts receivable financial instrument only when it has a legal claim to receive cash or other financial assets. Therefore the timing of recognition of accounts receivable is intertwined with the timing of recognition of revenue as was discussed in Chapter 6. For most companies when the sale is recognized, either cash is received (realized) or an account receivable is recognized. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Two issues that may complicate the measurement of accounts receivable are (1) the availability of discounts (trade and cash discounts) and (2) the length of time between the sale and the payment due dates (the interest element). Ideally, receivables should be measured initially at their fair value, which is their present value (discounted value of the cash to be received in the future). Receivables that are created by normal business transactions and are due in the short term are excluded from present value considerations.

5. Account for and explain the accounting issues related to the impairment in value of accounts receivable. Short-term receivables are reported at their net realizable value—the net amount that is expected to be received in cash, which is not necessarily the amount that is legally receivable. Determining net realizable value requires estimating uncollectible receivables and any future returns or allowances and discounts that are expected to be taken. The adjustments to the asset account also affect the income statement amounts of bad debt expense, sales returns and allowances, and sales discounts. The assessment of impairment is usually based on an aged accounts receivable report, with higher percentages of uncollectible accounts indicated for older amounts outstanding. Even if a company estimates bad debt expense each period as a percentage of sales, the accounts receivable at the date of the statement of financial position are analyzed to ensure the balance in the allowance account is appropriate.

6. Account for and explain the accounting issues related to the recognition and measurement of short-term notes and loans receivable. The accounting issues related to short-term notes receivable are identical to those of accounts receivable. However, because notes always contain an interest element, interest income must be properly recognized. Notes receivable either bear interest on the face amount (interest-bearing) or have an interest element that is the difference between the amount lent and the maturity value (non–interest-bearing).

7. Account for and explain the accounting issues related to the recognition and measurement of long-term notes and loans receivable. Long-term notes and loans receivable are recognized initially at their fair value (the present value of the future cash flows) and subsequently at their amortized cost. Transaction costs are capitalized. This requires amortizing any discount if the item was issued at less than its face value, or any premium if it was issued for an amount greater than its face value, using the effective interest method. The straight-line method may be used under ASPE. Amortization of the discount (or premium) results in a reduction of (or increase in) interest income below (or above) the cash amount received.

8. Account for and explain the basic accounting issues related to the derecognition of receivables. To accelerate the receipt of cash from receivables, the owner may transfer the receivables to another entity for cash. The transfer of receivables to a third party for cash may be done in one of two ways: (1) Secured borrowing: the creditor requires the debtor to designate or pledge receivables as security for the loan. (2) Sale (factoring or securitization) of receivables: Factors are finance companies or banks that buy receivables from businesses and then collect the remittances directly from the customers. Securitization is the transfer of receivables to a special purpose entity that is mainly financed by highly rated debt instruments. In many cases, transferors have some continuing involvement with the receivables they sell. A financial components approach is used to record this type of transaction: this approach breaks the receivables down into a variety of asset and liability components, and the sold components are derecognized and accounted for separately from the retained ones.

Cash and Receivables

7-5

9. Explain how receivables and loans are reported and analyzed. Disclosure of receivables requires that valuation accounts be appropriately offset against receivables, that the receivables be appropriately classified as current or noncurrent, and that pledged or designated receivables be identified. As financial instruments, specific disclosures are required for receivables so that users can determine their significance to the company’s financial position and performance and can assess the nature and extent of associated risks and how these risks are managed and measured. Private entities require less disclosure than those reporting under IFRS. Receivables are analyzed in terms of their turnover and age (number of days outstanding), and in terms of relative changes in the related sales, receivables, and allowance accounts.

10. Identify differences in accounting between accounting standards for private enterprises (ASPE) and IFRS, and what changes are expected in the near future. The two sets of standards are very similar, with minor differences relating to what is included in cash equivalents. ASPE does not require use of the effective interest method, whereas IFRS does for financial asset investments that are not held for trading purposes. Impairment provisions and derecognition of financial assets are two issues that remain under study by IFRS; the eventual resolution may generate additional differences in the near future.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c b d a d c d b c d a b a c c d b c a b c d a c b c c b a b d d b c c b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. *34. *35. *36.

Description Organizations with significant receivables Management of accounts receivable Definition of financial asset Identification of cash item Classification of bank overdraft Compensating balance Classification of dividends and interest receivable Standards for recognition and measurement of accounts receivable Trade discounts Net method of recording receivables Gross method of recording receivables Classification of Sales Returns and Allowances Non-recognition of interest element Valuation of short-term receivables Definition of credit risk Identification of impaired receivables Classification of allowance for doubtful accounts Write-off of receivables Bad debts and the matching concept Direct write-off method Effect of write-off entry Collection of a previously written off account receivable Relation of bad debts expense to accounts receivable Notes receivable Amortization methods allowed under IFRS Straight-line method of amortization Valuation of notes receivable Note issued at less than face value Note issued above face value Receivables used as collateral Factoring of receivables Accounts receivable turnover ratio Liquidity of accounts receivable Purpose of Cash Over & Short account Bank reconciliation journal entries Treatment of bank error on bank reconciliation

*This topic is dealt with in an Appendix to the chapter.

Cash and Receivables

MULTIPLE CHOICE—Computational Answer b c b d b b c c c c b c d a b c

No. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. *49. *50. *51. *52.

Description Recording of receivables using the net method Recording of receivables using the gross method Use of the net method when discount is taken Calculation of net realizable value of accounts receivable Calculation of bad debt expense using aging of receivables Calculation of implicit interest rate for zero-interest bearing note Recognition of interest income in the first year Recognition of interest income in subsequent year Calculation of cash proceeds from transfer of receivables Entry to record collection of assigned receivables Factoring receivables without recourse Factoring receivables with recourse Entry to replenish petty cash Calculation of correct cash balance Calculation of correct cash balance Calculation of correct cash balance

MULTIPLE CHOICE—CPA Adapted Answer b d c a b c a

No. 53. 54. 55. 56. 57. *58. *59.

Description Calculation of current net receivables Calculation of bad debt expense Calculation of bad debt expense Calculation of actual bad debts written off Calculation of Allowance for Doubtful Accounts balance Calculation of correct cash balance Calculation of correct cash balance

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item 7-60 7-61 7-62 7-63 7-64 7-65 7-66 7-67 *7-68

Description Definitions Terminology Reporting of cash Entries for bad debt expense Note with fair value not equal to cash consideration Accounts receivable assigned Sales of receivables without recourse Accounts receivable analysis and securitization Reconciliation of cash account

PROBLEMS Item 7-69 7-70 7-71 7-72 7-73 7-74 7-75 *7-76

Description Entries for bad debt expense Amortization of discount under the straight-line and effective interest methods Note with fair value not equal to cash consideration Accounts receivable assigned Factoring accounts receivable Reasons for selling receivables Secured borrowings vs factoring of receivables Bank reconciliation

*This topic is dealt with in an Appendix to the chapter.

Cash and Receivables

7-9

MULTIPLE CHOICE—Conceptual 1. Which of the following types of organizations would be most likely to have a significant amount of accounts receivable? a) retailers and wholesalers b) retailers and manufacturers c) manufacturers and wholesalers d) only retailers

2. Which of the following actions would NOT be considered good management of accounts receivable? a) assessing creditworthiness of new or potential customers b) very loose or flexible credit terms to encourage sales c) offering discounts to encourage faster payment d) regular aged receivables analysis

3. Which of the following is NOT a financial asset? a) a contractual right to receive cash or other financial asset from another party b) an equity instrument of another entity c) a contractual right to exchange financial instruments with another party under potentially favourable conditions d) a contractual right to pay cash or another financial asset to another party 4. Which of the following is considered as “cash” for reporting purposes? a) money market chequing accounts b) certificates of deposit (CDs) c) travel advances to employees d) postdated cheques

5. Bank overdrafts are generally reported as a) a current asset. b) a contra account. c) a non-current asset. d) a current liability.

6. The portion of any demand deposit that a customer keeps as support for its existing or maturing obligations is called a(n) a) account receivable. b) bank overdraft. c) compensating balance. d) restricted cash.

7. Dividends and interest receivable would be classified as a) loans receivable. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b) trade receivables. c) notes receivable. d) nontrade receivables.

8. The general accounting standards for recognition and measurement of accounts receivable include a) measuring the receivable initially at amortized cost. b) measuring the receivable initially at fair value. c) after initial recognition, measuring the receivable at fair value. d) not recognizing the receivable until it is paid.

9. Trade discounts are generally NOT used to a) avoid frequent changes in catalogues. b) quote different prices for different quantities purchased. c) encourage faster payment. d) hide the true invoice price from competitors.

10. The net method of recording accounts receivable is rarely used because it a) is less theoretically correct than the gross method. b) requires an “Allowance for Sales Discounts” to be reported on the statement of financial position. c) has a different effect on the statement of financial position and income statement. d) requires more bookkeeping for the additional adjusting entries after the discount period has passed.

11. If a company uses the gross method of recording accounts receivable, then cash discounts taken should be reported as a) a deduction from sales in the income statement. b) an item of "other expense" in the income statement. c) a deduction from accounts receivable in determining the net realizable value of accounts receivable. d) sales discounts forfeited in the cost of goods sold section of the income statement. 12. “Sales Returns and Allowances” are reported as a) an expense. b) a deduction from Sales Revenue. c) a deduction from Accounts Receivable. d) an addition to Accounts Receivable.

13. The interest element for trade receivables a) is usually not recognized because of materiality considerations. b) must always be recognized and be accounted for using the net method. c) is included in the net realizable value of the receivables. d) becomes more significant as the time between the sale and payment shortens.

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14. Assuming that the ideal measure of short-term receivables in the statement of financial position is the discounted value of the cash to be received in the future, failure to follow this practice usually does NOT make the financial statements misleading because a) most short-term receivables are not interest-bearing. b) the allowance for uncollectible accounts includes a discount element. c) the amount of the discount is not material. d) most receivables can be sold to a bank or factor.

15. The likelihood of loss because of the failure of the other party to fully pay the amount owed is called a) accounting risk. b) bad debts. c) credit risk. d) currency risk.

16. The single most important indicator used to identify impaired accounts receivable (potential bad debts) is a) the dollar amount of the receivable. b) current economic conditions. c) geographic location. d) the age of the account. 17. “Allowance for Doubtful Accounts” is a(n) a) expense account. b) contra account. c) liability account. d) current asset.

18. Using the allowance method, when an account receivable is written off, the account to be debited is a) accounts receivable. b) bad debts expense. c) allowance for doubtful accounts. d) cash.

19. Which of the following approaches to determine bad debts expense best achieves the matching concept? a) percentage of sales b) percentage of ending accounts receivable c) percentage of average accounts receivable d) direct write-off

20. The direct write off method of accounting for the impairment of receivables a) is never acceptable. b) is an acceptable method when the effect of not applying the allowance method would be highly immaterial. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) is specifically disallowed under IFRS. d) usually results in the same net income as the allowance method.

21. Under the allowance method of recognizing uncollectible accounts, the entry to write off an uncollectible account a) increases the allowance for doubtful accounts. b) has no effect on the allowance for doubtful accounts. c) has no effect on net income. d) decreases net income.

22. Under the allowance method of recognizing uncollectible accounts, the entry to recognize the collection of a previously written off uncollectible account a) increases net income. b) has no effect on the allowance for doubtful accounts. c) decreases the allowance for doubtful accounts. d) increases the allowance for doubtful accounts.

23. The advantage of relating a company's bad debt expense to its outstanding accounts receivable is that this approach a) gives a reasonably correct valuation of the receivables in the statement of financial position. b) best relates bad debts expense to the period of sale. c) is the only generally accepted method for valuing accounts receivable. d) makes estimates of uncollectible accounts unnecessary.

24. Which of the following statements is correct? a) There is no interest included in a zero-interest-bearing note. b) A long-term note’s fair value and present value are always the same. c) All notes contain an interest element because of the time value of money. d) A note is signed by the payee in favour of the maker.

25. Under IFRS, interest income and the amortization of discounts and premiums for long-term notes must be accounted for using a) the straight-line method. b) the effective interest method only. c) either the straight-line or effective interest method. d) the units-of-production method.

26. The straight-line method of amortization of discounts and premiums for long term notes a) is allowed by both IFRS and ASPE. b) reflects the economic reality of the loan. c) is only allowed by ASPE. d) requires more complicated calculations than the effective interest method.

27. When the stated rate and market rate of a note receivable are the same Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Cash and Receivables

a) the note's face value would be different. b) the note’s face value would be indeterminable. c) the note's face value and fair value would be the same. d) it must be a zero-interest-bearing note.

28. If a note receivable was issued at an amount that is less than its face value, then a) the note was issued at a premium. b) the note was issued at a discount. c) the note's stated rate was the same as the prevailing market rate of interest. d) it must be a zero-interest-bearing note.

29. If a note receivable was issued at an amount that is more than its face value, then a) the note was issued at a premium and the note's stated rate was different from the prevailing market rate of interest. b) the note was issued at a premium and the note's stated rate was the same as the prevailing market rate of interest. c) the note was issued at a discount and the note's stated rate was the same as the prevailing market rate of interest. d) the note was issued at a discount and the note's stated rate was different from the prevailing market rate of interest.

30. If receivables are used as collateral in borrowing transactions a) the receivables generally come under the control of the lender. b) a liability is reported on the borrower’s statement of financial position. c) the receivables will be reported as a liability. d) the transaction would be reported as a sale.

31. Which of the following is INCORRECT regarding factoring of receivables? a) Factoring usually involves a sale to only one company. b) The fees are relatively high. c) The quality of the receivables may be lower. d) The seller usually continues to service the receivables.

32. The accounts receivable turnover ratio is calculated by dividing a) gross sales by ending net trade receivables. b) gross sales by average net trade receivables. c) net sales by ending net trade receivables. d) net sales by average net trade receivables.

33. The ratio that is used to assess the liquidity of accounts receivable is the a) current ratio. b) receivables turnover ratio. c) quick ratio. d) inventory turnover ratio.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*34. A Cash Over and Short account is a) not generally acceptable under Canadian GAAP. b) debited when the sum of the receipts and the cash in the fund is more than the imprest amount. c) debited when the sum of the receipts and the cash in the fund is less than the imprest amount. d) a contra account to Cash.

*35. The journal entries related to a bank reconciliation a) are taken from the "balance per bank" section only. b) may include a credit to Office Expense for bank service charges. c) may include a debit to Accounts Receivable for an NSF cheque. d) may include a debit to Accounts Payable for an NSF cheque.

*36. When preparing a bank reconciliation, a deposit credited to our account by the bank in error is a) added to the bank statement balance. b) deducted from the bank statement balance. c) added to the balance per books. d) deducted from the balance per books.

Cash and Receivables

MULTIPLE CHOICE ANSWERS—Conceptual Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

c b d a d c

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

d b c d a b

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

a c c d b c

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

a b c d a c

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

b c c b a b

31. 32. 33. *34. *35. *36.

d d b c c b

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational

37. Macaroon Corp. has sold goods at terms 1/10, n/30. If the discount is not taken, the amount payable is $8,524. Assuming Macaroon uses the net method, the entry to record the sale is a) a debit and credit of $7,671.60 to both Accounts Receivable and Sales respectively. b) a debit and credit of $8,438.76 to Accounts Receivable and Sales respectively. c) a debit and credit of $8,524 to Accounts Receivable and Sales respectively. d) debits of $8,438.76 and $85.24 to Accounts Receivable and "Forfeited Sales Discounts" respectively, and a credit to Sales for the total.

38. Macaroon Corp. has sold goods at terms 1/10, n/30. If the discount is not taken, the amount payable is $8,524. Assuming Macaroon uses the gross method, the entry to record the sale is a) a debit and credit of $7,671.60 to Accounts Receivable and Sales respectively. b) a debit and credit of $8,438.76 to Accounts Receivable and Sales respectively. c) a debit and credit of $8,524 to Accounts Receivable and Sales respectively. d) debits of $8,438.76 and $85.24 to Accounts Receivable and "Forfeited Sales Discounts" respectively, and a credit to Sales for the total.

39. Macaroon Corp. has sold goods at terms 1/10, n/30. If the discount is not taken, the amount payable is $8,524. Assuming Macaroon has used the net method, and payment was received within the discount period, the entry to record the payment would include a) an additional debit of $85.24 to Accounts Receivable. b) a credit of $8,438.76 to Accounts Receivable. c) a credit of $85.24 to Sales. d) a debit of $85.24 to "Forfeited Sales Discounts."

40. During the year, Brownie Inc, who uses the allowance method, made an entry to write off a $2,000 uncollectible account. Before this entry was posted, the balance in accounts receivable was $40,000 and the balance in the allowance account was $3,500. The net realizable value of accounts receivable after the write-off entry was a) $40,000. b) $38,500. c) $38,000. d) $36,500.

41. The following information is available for Oreo Company: Allowance for Doubtful Accounts at December 31, 2013 ....................... Credit Sales during 2014 ....................................................................... Accounts Receivable deemed worthless and written off during 2014.....

4,000 300,000 4,500

As a result of a review and aging of Accounts Receivable in early January 2015, however, it has been determined that an Allowance For Doubtful Accounts of $5,500 is required at December 31, 2014. What amount should Oreo record as Bad Debt Expense for calendar 2014? a) $5,500 b) $6,000 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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c) $6,500 d) $10,000

42. Fudge Ltd. receives a four-year, $100,000 zero-interest bearing note. The present value of this note is $65,873.10. What is the implicit rate of interest? a) 12% b) 11% c) 10% d) 9%

43. Fudge Ltd. receives a four-year, $100,000 zero-interest bearing note. The present value of this note is $65,873.10. Assuming the note was issued on January 1, 2013, and the effective interest method is used, the interest income to be recognized for calendar 2013 will be a) $11,000.00. b) $ 9,000.46. c) $ 7,246.04. d) $ 6,587.31.

44. Fudge Ltd. receives a four-year, $100,000 zero-interest bearing note. The present value of this note is $65,873.10. Interest income to be recognized for calendar 2014 will be a) $11,797.06. b) $ 8,712.62. c) $ 8,043.11. d) $ 7,246.04.

45. Twinkie Ltd. assigned $500,000 of Accounts Receivable to Friendly Finance as security for a loan of $420,000. Friendly charged a 2% commission on the amount of the loan; the interest rate on the note was 10%. During the first month, Twinkie collected $110,000 of the assigned accounts, after deducting $380 of discounts. As well, Twinkie accepted returns worth $1,350 and wrote off assigned accounts totalling $3,700. The amount of cash Twinkie received from Friendly at the time of the transfer was a) $378,000. b) $410,000. c) $411,600. d) $420,000.

46. Twinkie Ltd. assigned $500,000 of Accounts Receivable to Friendly Finance as security for a loan of $420,000. Friendly charged a 2% commission on the amount of the loan; the interest rate on the note was 10%. During the first month, Twinkie collected $110,000 of the assigned accounts, after deducting $380 of discounts. As well, Twinkie accepted returns worth $1,350 and wrote off assigned accounts totalling $3,700. Entries made by Twinkie during the first month would include a a) debit to Cash of $110,380. b) debit to Bad Debts Expense of $3,700. c) debit to Allowance for Doubtful Accounts of $3,700. d) debit to Accounts Receivable of $115,430.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

47. On February 1, 2013, Chocolate Corp. factored receivables with a carrying amount of $300,000 to Eclair Inc. Eclair assessed a finance charge of 3% of the receivables and retained 5% of the receivables. Relative to this transaction, you are to determine the amount of loss on sale to be reported in the income statement of Chocolate Corp. for February. Assume that Chocolate factors the receivables on a without recourse basis. The loss to be reported is a) $ 0. b) $9,000. c) $15,000. d) $24,000.

48. On February 1, 2013, Chocolate Corp. factored receivables with a carrying amount of $300,000 to Eclair Inc. Eclair assessed a finance charge of 3% of the receivables and retained 5% of the receivables. Relative to this transaction, you are to determine the amount of loss on sale to be reported in the income statement of Chocolate Corp. for February. Assume that Chocolate factors the receivables on a with recourse basis. The recourse obligation has a fair value of $1,000. The loss to be reported is a) $16,000. b) $15,000. c) $10,000. d) $ 9,000.

*49. If a petty cash fund is established in the amount of $350, and contains $300 in cash and $45 in receipts for disbursements when it is replenished, the journal entry to record replenishment should include credits to the following accounts: a) Petty Cash, $45. b) Petty Cash, $50. c) Cash, $45; Cash Over and Short, $5. d) Cash, $50.

*50. If the month-end bank statement shows a balance of $49,000, outstanding cheques are $16,000, a deposit of $7,000 was in transit at month end, and a cheque for $800 was erroneously charged by the bank against the account, the correct balance in the bank account at month end is a) $40,800. b) $40,000. c) $24,800. d) $20,100.

*51. In preparing its bank reconciliation at April 30, 2013, Ritz Inc. has the following information available: Balance per bank statement .................................................................. $65,280 NSF cheque returned with April bank statement .................................... 380 Deposits in transit .................................................................................. 2,300 Outstanding cheques............................................................................. 16,300 Bank service charges for April ............................................................... 25 The correct balance of cash at April 30, 2013 is a) $46,680. b) $51,280. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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c) $51,300. d) $51,685.

*52. In preparing its bank reconciliation at May 31, 2013, Animal Crackers Co. has the following information available: Balance per bank statement ................................................................... $41,000 Deposit in transit .................................................................................... 6,800 Outstanding cheques ............................................................................. 3,100 Note collected by bank in May................................................................ 2,700 The correct balance of cash at May 31, 2013 is a) $47,800. b) $47,400. c) $44,700 d) $42,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

37. 38. 39.

b c b

40. 41. 42.

d b b

43. 44. 45.

c c c

46. 47. 48.

c b c

*49. *50. *51.

d a b

*52.

DERIVATIONS — Computational No. 37. 38. 39. 40. 41.

Answer b c b d b

42. 43. 44. 45. 46. 47. 48. *49. *50. *51. *52.

b c c c c b c d a b c

Derivation $8,524 x (1-0.01) = $8,438.76

($40,000-$2,000) – ($3,500 – $2,000) = $36,500 $4,000 – $4,500 = 500 unadjusted Dr bal $500 + $5,500 desired bal = 6,000 bad debt exp 4 N -65873.1 PV 100000 FV CPT I = 11% $65,873.10 x 11% = $7,246.04 ($65,873.10 + $7,246.04) x 11% = $8,043.11 $420,000 x 98% = $411,600 $300,000 × .03 = $9,000 ($300,000 × .03) + $1,000 = $10,000 $350 - $300 = $50 $49,000 - $16,000 + $7,000 + $800 = $40,800 $65,280 + $2,300 - $16,300 = $51,280 $41,000 + $6,800 - $3,100 = $44,700

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MULTIPLE CHOICE—CPA Adapted 53. On Egypt Corp.’s December 31, 2013 statement of financial position, the current receivables consisted of the following: Trade accounts receivable ................................................................... $ 74,000 Allowance for doubtful accounts .......................................................... (3,500) Claim against shipper for goods lost in transit (November 2013) ......... 4,000 Selling price of unsold goods sent by Egypt on consignment at 130 percent of cost (not included in Egypt’s ending inventory) .. 29,000 Security deposit on lease of warehouse used for storing some inventories........................................................................... 24,000 Total .................................................................................. $127,500 At December 31, 2013, the correct total of Egypt’s current net receivables was a) $78,000. b) $74,500. c) $70,500. d) $66,500.

54. Lebanon Ltd. prepared an aging of its accounts receivable at December 31, 2013 and determined that the net realizable value of the receivables was $290,000. Additional information for calendar 2013 follows: Allowance for doubtful accounts, beginning ......................... $ 34,000 Uncollectible account written off during year ........................ 23,000 Accounts receivable, ending ................................................ 320,000 Uncollectible accounts recovered during year ...................... 5,000 For the year ended December 31, 2013, Lebanon’s bad debt expense should be a) $20,000. b) $23,000. c) $16,000. d) $14,000.

55. For the year ended December 31, 2013, Tunisia Corp. estimated its allowance for doubtful accounts using the year-end aging of accounts receivable. Additional information for calendar 2013 follows: Allowance for doubtful accounts, beginning ......................... $37,000 Estimated uncollectible accounts during 2013 (1% of credit sales of $4,000,000) .......................... 40,000 Uncollectible accounts written off during year ...................... 52,000 Estimated uncollectible accounts per year-end aging .......... 74,000 For the year ended December 31, 2013, Tunisia’s bad debt expense should be a) $37,000. b) $52,000. c) $89,000. d) $126,000.

56. Sudan Ltd.'s allowance for doubtful accounts was $85,000 at the end of 2013 and $105,000 at the end of 2012. For the year ended December 31, 2013, Sudan reported bad debt expense of Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

$18,000 in its income statement. What amount did Sudan debit to allowance for doubtful accounts during 2013 to write off actual bad debts? a) $38,000 b) $34,650 c) $20,000 d) $12,000

57. The following accounts were included on Mali Co.'s unadjusted trial balance at December 31, 2013: ................................................................................. Debit Credit Accounts receivable ............................................................. $850,000 Allowance for doubtful accounts ........................................... 11,000 Net credit sales .................................................................... $2,950,000 Mali estimates that 1.5 % of the gross accounts receivable will become uncollectible. After the proper adjustment at December 31, 2013, the allowance for doubtful accounts should have a credit balance of a) $23,750. b) $12,750. c) $11,000. d) $ 1,750.

*58. In preparing its August 31 bank reconciliation, Ghana Corp. has the following information available: Balance per bank statement................................................. $28,310 Deposit in transit .................................................................. 7,280 Customer’s cheque returned NSF ........................................ 700 Outstanding cheques ........................................................... 3,450 Bank service charges for August .......................................... 50 Ghana’s correct cash balance at August 31 is a) $31,440. b) $32,090 c) $32,140. d) $32,190.

*59. Congo Ltd. prepared the following bank reconciliation at March 31: Balance per bank statement................................................. $37,200 Add: Deposit in transit .......................................................... 10,300 ............................................................................................ 47,500 Less: Outstanding cheques .................................................. 12,600 Correct cash balance per books, March 31 .......................... $34,900 Data per bank statement for the month of April follows: Deposits ............................................................................... $47,700 Disbursements ..................................................................... 49,700 All reconciling items at March 31 cleared the bank in April. Outstanding cheques at April 30 totalled $5,000. There were no deposits in transit at April 30. What is the correct cash balance per books at April 30? a) $30,200 b) $32,900 c) $35,200 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Cash and Receivables

d) $40,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

53. 54.

b d

55. 56.

c a

57. *58.

b c

*59.

DERIVATIONS — CPA Adapted No.

Answer

53. 54.

b d

55. 56. 57.

c a b

*58. *59.

c a

Derivation $74,000 – $3,500 + $4,000 = $74,500. Allowance for Doubtful Acct. balance $34,000 + $5,000 – $23,000 = $16,000 (before bad debt expense) $320,000 – $290,000 – $16,000 = $14,000 (bad debt expense). $74,000 – $37,000 + $52,000 = $89,000. $105,000 + $18,000 – $85,000 = $38,000. $850,000 × 1.5% = $12,750. $28,310 + $7,280 – $3,450 = $32,140 $37,200 + $47,700 – $49,700 = $35,200 (4/30 balance per bank) $35,200 – $5,000 = $30,200.

Cash and Receivables

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EXERCISES Ex. 7-60 Definitions Provide clear, concise answers for the following: 1. What are cash and cash equivalents and how are they reported? 2. What are receivables and how are they reported? 3. How are receivables measured? 4. How are impairments relating to uncollectible receivables accounted for? 5. How can receivables be “converted” to cash prior to their collection from customers? 6. How are receivables analyzed? 7. Identify the main differences between private entity GAAP and IFRS with respect to the accounting for receivables? Solution 7-60 1. Cash and cash equivalents are financial assets. Cash consists of coins, currency and available funds on deposit at a bank, as well as negotiable instruments. Cash equivalents are highly liquid short-term investments that can be exchanged for known amounts of cash. Together they are usually reported as a current asset, “cash and cash equivalents,” in the statement of financial position, unless the funds are restricted or otherwise encumbered. 2.

Receivables are claims against customers and others for cash or other financial assets. They are classified according to their nature as trade, non-trade and accounts receivable (or notes receivable). Current receivables are expected to be collected within one year or during the current operating cycle, whichever is longer.

Receivables are initially measured at their fair value (i.e., their present value rather than their future value) with interest recognized as the future value is reached at collection. This principle however is generally not applied to short term receivables, as the interest element is usually not material when compared with the net income for the period.

The potential impairment is assessed based on management’s estimate of uncollectible accounts. This is commonly accomplished through a review of aged receivables, with special consideration given to older items. Based on that review, the allowance for doubtful accounts is then adjusted to reduce the value of gross receivables accordingly. Companies often use a mix of procedures whereby bad debts are initially estimated based on a percentage of sales and are then adjusted based on the aged receivables report.

This can be accomplished through a secured borrowing arrangement or through the sale of the underlying receivables. In secured borrowing, the receivables are merely used as collateral for a loan. In a sale, the receivables are either sold outright to “factors” or “securitized” whereby the seller usually retains some involvement.

Receivables are analyzed in terms of their turnover, age and change relative to related accounts. A key ratio used by analysts is the receivables turnover ratio. It is calculated by dividing net sales by average net receivables outstanding and is a measurement of the liquidity of a company’s receivables.

The two standards are for the most part very similar. Differences include the disclosure requirements, which are more extensive under IFRS, and the use of the effective interest

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

method for the amortization of discounts and premiums for financial assets (mandated by IFRS, but optional under ASPE).

Ex. 7-61 Terminology In the space provided at right, write the word or phrase that is defined or indicated. 1.

The minimum balances that may have to be kept in chequing or savings accounts.

1. __________________________________

Cash that has been set aside for investment or financing purposes.

2. ___________________________________

Receivables with underlying contractual rights to receive cash.

3. ___________________________________

The reduction from a supplier’s list price.

4. __________________________________

The method used to record receivables that recognizes a deduction from sales when a discount is taken.

5. __________________________________

The method used to amortize discounts and premiums for notes receivable that results in the recognition of equal amounts of interest expense or interest income over the term of the notes.

6. __________________________________

The value at which receivables should be reported.

7. ___________________________________

The method used to account for the estimated impairment of receivables.

8. ___________________________________

The approach that specifically recognizes the assets and liabilities when receivables are sold.

9. ___________________________________

Solution 7-61 1. Compensating balances 2.

Restricted cash

A financial asset

A trade discount

The gross method

The straight-line method

Cash and Receivables

Their net realizable value

The allowance method

The financial components approach

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Ex. 7-62 Reporting of cash At December 31, 2013, Burkina Ltd.’s general ledger Cash balance was $34,600. In addition, Burkina held the following items in its safe on December 31: 1. A cheque for $820 from Zambia Ltd. received December 30, 2013, which was not deposited until January 2, 2014. 2. A cheque from Zanzibar Inc for $1,400 that had been deposited on December 20, but was returned NSF on December 29. The cheque was to be re-deposited on January 3, 2014. The original deposit has been included in the December 31 chequebook balance. 3. Coin and currency on hand: $2,630. Instructions Calculate the proper amount to be reported as cash on Burkina’s statement of financial position at December 31, 2013. Solution 7-62 Cash G/L account ......................................................................... $34,600 Undeposited cheque ..................................................................... 820 Coin & currency ............................................................................ 2,630 Less NSF cheque ......................................................................... (1,400) Cash to be reported ...................................................................... $36,650

Ex. 7-63 Entries for bad debt expense Angola Corp.’s unadjusted trial balance included the following: ............................................................................................ Debit Credit Accounts receivable ................................................................. $140,000 Allowance for doubtful accounts ............................................... $ 890 Sales ........................................................................................ 425,000 Sales returns and allowances................................................... 10,000 Instructions Prepare adjusting journal entries assuming that the estimate of uncollectibles is determined by using a) 4% of gross accounts receivable and b) 1.5% of net sales. Solution 7-63 a) Bad Debts Expense ................................................................. Allowance for Doubtful Accounts ....................................... Gross receivables .............................. Rate ................................................... Total allowance needed ..................... Present allowance ............................. Adjustment needed ............................

4,710 4,710

$140,000 4% 5,600 (890) $ 4,710

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ....................................... Sales .................................................. Less sales returns and allowances..... Net sales ............................................ Rate ................................................... Bad debts expense ............................

6,225 6,225

$425,000 10,000 415,000 1.5% $ 6,225

Ex. 7-64 Note with fair value not equal to cash consideration On January 1, 2013, Cameroon Corp. lent $50,000 to its CEO, interest-free. However, the loan is repayable in full in five years. The market rate for similar loans (with similar credit risk) is 4%. Instructions a) Calculate the present value (fair value) of this loan (round to the nearest dollar). Why is it not the same as the actual cash advanced? b) Prepare the journal entry to record this transaction. Solution 7-64 a) 5 N 4 i 50000 FV CPT PV = $41,096. The fair value is less than the actual cash advanced due to the interest component. The present value actually represents the principal portion of the loan. b)

Loan Receivable ....................................................................... 41,096 Salaries & Wages Expense ...................................................... 8,904 Cash ..................................................................................

50,000

Ex. 7-65 Accounts receivable assigned Moonbeam Ltd. assigned $520,000 of their accounts receivable to the Sunbright Finance Company, as security for a loan of $430,000. Sunbright charged a 3.5% commission on the face amount of the loan, and the note bears interest at 9%. During the first month, Moonbeam collected $260,000 on assigned accounts. This amount was paid to the finance company along with one month's interest on the note. Instructions Prepare the required journal entries on Moonbeam’s books related to the transfer of the accounts receivable, the loan, and the payment to the finance company. Solution 7-65 Cash ............................................................................................... 414,950 Finance Charge $430,000 x 3.5% ................................................. 15,050 Notes Payable ........................................................................

430,000

Cash ............................................................................................... 260,000 Accounts Receivable ..............................................................

260,000

Notes Payable ................................................................................. 260,000 Interest Expense $430,000 x 9% / 12 ............................................ 3,225 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Cash and Receivables

Cash ......................................................................................

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263,225

Ex. 7-66 Sale of receivables without recourse Sparwood Manufacturing factored $250,000 of their accounts receivable to General Factor Corp., on a without recourse basis. The receivables are transferred to General Factor, who takes over the full responsibility of collection. General Factor charged a finance charge of 4% of the dollar value of the receivables, and withheld 5% of the receivable value. Instructions a) Prepare the general journal entry to reflect this transaction on Sparwood’s books. b) Prepare the general journal entry to reflect this transaction on General Factor’s books. Solution 7-66 a) Entry on Sparwood’s books: Cash 500,000 – 12,500 – 10,000 ........................................... 227,500 Due from Factor 250,000 x 5%................................................ 12,500 Loss on Sale of Receivables 250,000 x 4%............................. 10,000 Accounts Receivable ......................................................... b)

250,000

Entry on General Factor’s books: Accounts Receivable ................................................................ 250,000 Due to Sparwood 250,000 x 5% ....................................... Financing Revenue 250,000 x 4% .................................... Cash..................................................................................

12,500 10,000 227,500

Ex. 7-67 Accounts receivable analysis and securitization Discuss why adjustments might have to be made and caution has to be exercised when analysing accounts receivable due to the increased use of securitization transactions. Solution 7-67 Securitization is a financing transaction, so the cash flows are actually from financing, not from operations. When the company has engaged in securitization transactions, adjustments would have to be made to receivables on the statement of financial position for accounts sold but not yet collected. These adjustments would be required before you could assess ratios such as receivables turnover and days sales uncollected. Liquidity ratios would also be affected. The sheer complexity of these transactions requires that the analyst exercise caution and read carefully all disclosures related to securitizations.

Ex. 7-68 Reconciliation of cash account Togo Corp.’s book balance of cash account shows an unadjusted balance of $64,000 before reconciliation. The following data was also available: 1. The bank statement does not include a deposit of $3,100 made on the last day of the month. 2. The bank statement shows a collection of a note receivable by the bank of $1,200 and a customer's cheque for $580 was returned because it was NSF. 3. A customer's cheque for $360 was recorded on the books as $630. 4. A cheque written for $179 was recorded as $791. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Instructions Calculate the correct balance in the cash account. Solution 7-68 Unadjusted Cash G/L account .................................... Note receivable collected ........................................... Less NSF cheque ....................................................... Less error re deposit (630-360) .................................. Add cheque error (791-179) ....................................... Correct cash balance .................................................

$64,000 1,200 (580) (270) 612 $64,962

Cash and Receivables

7 - 31

PROBLEMS Pr. 7-69 Entries for bad debt expense Uganda Corp.’s unadjusted trial balance includes the following balances: Dr. Cr. Accounts receivable ............................................................. $150,000 Allowance for doubtful accounts ........................................... $ 3,500 Sales (all on credit) .............................................................. 680,000 Sales returns and allowances............................................... 30,000 Instructions a) Prepare the entries for estimated bad debts assuming that doubtful accounts are estimated to be (1) 6% of gross accounts receivable and (2) 1% of net sales. b) Assume that all the information above is the same, except that the Allowance for Doubtful Accounts has a debit balance of $3,500 instead of a credit balance. Solution 7-69 a) (1) Bad Debt Expense ............................................................ Allowance for Doubtful Accounts ........................ Gross receivables ......................... Rate .............................................. Total allowance needed ................ Present allowance ........................ Bad debts expense .......................

5,500

$150,000 6% 9,000 (3,500) $ 5,500

(2) Bad Debt Expense ............................................................ Allowance for Doubtful Accounts ................................ Sales ............................................ Sales returns and allowances ....... Net sales ...................................... Rate .............................................. Bad debts expense .......................

5,500

6,500 6,500

$680,000 (30,000) 650,000 1% $ 6,500

The percentage of receivables approach would be affected as follows: Gross receivables ......................... $150,000 Rate .............................................. 6% Total allowance needed ................ 9,000 Present allowance ........................ 3,500 Additional amount required ........... $ 12,500

The journal entry is therefore as follows: Bad Debt Expense ................................................................... .. 12,500 Allowance for Doubtful Accounts ....................................... 12,500 Note that the balance in the Allowance account does not affect calculations for the percentage of sales method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Pr. 7-70 Amortization of discount under the straight-line and effective interest methods On January 1, 2013, Ethiopia Corporation receives a four-year, $50,000 zero-interest bearing note in payment of goods sold. The present value of the note equals the agreed upon sales price of $32,936.55. Ethiopia is a privately held company and follows ASPE. Instructions a) Assuming Ethiopia uses the straight-line method to amortize the note's discount, prepare the journal entry to record the sale on January 1, and the interest accrual on December 31, 2013. b) Assuming Ethiopia uses the effective interest method to amortize the note's discount, prepare the journal entry to record the sale on January 1, and the interest accrual on December 31, 2013. Solution 7-70 a) To record the sale and issue of the note on Jan 1: Note Receivable ....................................................................... 32,936.55 Sales ................................................................................. 32,936.55 To record the interest accrual on Dec 31 (straight line): Note Receivable (50,000 – 32,936.55) / 4 ............................... 4,265.86 Interest Income ..................................................................

4,265.86

b) To record the sale and issue of the note on Jan 1: This entry would be identical to the one prepared under part a) above. To record the interest accrual on Dec 31 (effective interest): Note Receivable 32,936.55 x 11% .................................... Interest Income ............................................................. Implicit rate of interest - 4 N

-32936.55 PV 50000 FV

3,623.02 3,623.02

CPT i = 11%

Pr. 7-71 Note with fair value not equal to cash consideration On January 1, 2013, Senegal Corp. lent $50,000 to its CEO, interest-free. However, the loan is repayable in five instalments, each December 31, until paid. The market rate for similar loans (with similar credit risk) is 4%. Instructions a) Calculate the present value (fair value) of this loan (round to the nearest dollar). b) Prepare the journal entry to record this transaction. Solution 7-71 a) 5 N 4 i 10000 PMT CPT PV = $44,518. b)

Loan Receivable ....................................................................... 44,518 Salaries & Wages Expense ...................................................... 5,482 Cash .................................................................................

50,000

Pr. 7-72 Accounts receivable assigned Prepare journal entries for Tanzania Inc for: Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Cash and Receivables

Accounts receivable of $700,000 that were originally recorded using the gross method were assigned to Chad Finance Co. by Tanzania as security for a loan of $580,000. Chad charged a 4% commission on the value of the accounts receivable; the interest rate on the note is 11%. During the first month, Tanzania collected $300,000 on assigned accounts after deducting $1,500 of sales discounts. As well, Tanzania wrote off a $1,100 assigned account as a bad debt. Tanzania paid Chad the amount collected plus one month's interest on the note.

Solution 7-72 a) Cash ........................................................................................ 552,000 Finance Charge $700,000 x 4% ............................................ 28,000 Notes Payable ................................................................... b)

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580,000

Cash ........................................................................................ 300,000 Sales Discounts ....................................................................... 1,500 Allowance for Doubtful Accounts .............................................. 1,100 Accounts Receivable .........................................................

302,600

Notes Payable .......................................................................... 300,000 Interest Expense $580,000 x 11% / 12 ................................... 5,317 Cash..................................................................................

305,317

Pr. 7-73 Factoring accounts receivable On April 1, Morocco Ltd. factored $500,000 of accounts receivable with Kenya Finance Corp. on a without recourse basis. Under the arrangement, Morocco was to handle disputes concerning service, and Kenya Finance was to make the collections, handle the sales discounts, and absorb the credit losses. Kenya Finance assessed a finance charge of 5% of the total accounts receivable factored and retained an amount equal to 2% of the total receivables to cover sales discounts. Instructions a) Prepare the journal entry required on Morocco's books on April 1. b) Prepare the journal entry required on Kenya Finance’s books on April 1. c) Instead, assume Morocco factors the $500,000 of accounts receivable with Kenya Finance on a with recourse basis. The recourse provision has a fair value of $12,000. Prepare the journal entry required on Morocco’s books on April 1. Solution 7-73 a) Cash ........................................................................................ 465,000 Due from Factor 2% × $500,000 ............................................. 10,000 Loss on Sale of Receivables 5% × $500,000 .......................... 25,000 Accounts Receivable ......................................................... b)

Accounts Receivable ................................................................ 500,000 Due to Morocco ................................................................. Financing Revenue ........................................................... Cash..................................................................................

500,000

10,000 25,000 465,000

Cash ........................................................................................ 465,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Due from Factor ....................................................................... 10,000 Loss on Sale of Receivables ($25,000 + $12,000).................... 37,000 Accounts Receivable ......................................................... Recourse Liability ..............................................................

500,000 12,000

Pr. 7-74 Reasons for selling receivables List three reasons why a business might sell its receivables to another party. Solution 7-74 1. A business may sell its receivables because it needs the cash now and access to normal credit is not available or is too expensive. 2. A business may sell its receivables (instead of borrowing) to avoid violating debt covenant agreements. 3. A business may sell its receivables to avoid billing and collection activities, which are often costly and time-consuming. 4. For competitive reasons, many industries offer sales financing to encourage sales. However, they not be able to finance customers over long periods of time, so will sell or factor the receivables to obtain the cash more quickly.

Pr. 7-75 Secured borrowings vs factoring of receivables Explain the difference between secured borrowings and factoring. Solution 7-75 Secured borrowing is using accounts receivable (or other receivables, such as notes) as collateral to borrow money, usually from a bank. This is common business practice in Canada. The receivables are assigned or pledged as security for the loan. The assignor retains ownership and control of the receivables, thus the receivables remain as an asset on the assignor’s statement of financial position; as well, the liability is recorded as with any other liability. As the assigned receivables are collected, the proceeds are used to pay down on the loan. Any interest or finance charges paid are expensed. Factoring receivables is an outright sale to a factor or lender. The factor buys the receivables and deducts a fee upfront, which is recorded as a “Loss on Sale of Receivables.” The receivables are transferred to the factor, who now has ownership and control of them, and the transferor derecognizes them from the books. Receivables can be sold without recourse where the factor assumes the risk of collection and absorbs any bad debts. The factor may also keep a “holdback” (recorded as “Due from Factor” – a current asset) to cover any sales discounts or returns. On the other hand, receivables are more commonly sold with recourse where the risk of bad debts remains with the transferor. In this case, a recourse liability must be recorded, which will increase the Loss on Sale.

*Pr. 7-76 Bank reconciliation Benin Company deposits all receipts daily and makes all payments by cheque. The following information is available from the cash records:

Cash and Receivables

March 31 Bank Reconciliation Balance per bank ................................................................. Add: Deposits in transit ....................................................... Deduct: Outstanding cheques ............................................. Balance per books ...............................................................

$35,160 4,200 (3,200) $36,160

Month of April Results Balance April 30 ................................................................... April deposits recorded......................................................... April cheques recorded ........................................................ Items on bank statement but not in books: Note collected by bank ........................................................ Bank service charge............................................................. Customer’s NSF cheque returned by the bank .....................

Per Bank Per Books $38,000 $42,140 11,200 17,300 12,010 11,320 5,500 50 1,800

-0-0-0-

Instructions a) Calculate the amount of the April 30: 1. Deposits in transit 2. Outstanding cheques b) What is the April 30 adjusted cash balance? Show all work. *Solution 7-76 a) 1. Deposits in transit: $10,300 ($17,300 + $4,200 -$11,200) 2. Outstanding cheques: $2,510 ($11,320 – $12,010 + $3,200) b)

Adjusted cash balance at April 30: $45,790 (42,140 + $5,500 - $50 - $1,800)

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 8 INVENTORY SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY

Note:

Item

LOD

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

1 1 1 1 3 3 3 3 3 3 3 3 3 3 3 3 3

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

66. 67. 68. 69. 70. 71. 72. 73.

1 1 1 1 1 4 4 4

M H M M E M H H

98. 99. 100.

3 3 3

M M M

E = Easy

Item

LO LOD Item LO LOD Multiple Choice–Conceptual 18. 4 M 35. 6 M 19. 4 M 36. 6 M 20. 4 M 37. 6 E 21. 5 M 38. 6,7 M 22. 5 H 39. 7 E 23. 5 E 40. 7 H 24. 5 H 41. 7 E 25. 5 H 42. 7 M 26. 5 E 43. 7 E 27. 5 H 44. 7 E 28. 5 H 45. 8 M 29. 5 H 46. 8 M 30. 5 M 47. 8 E 31. 5 E 48. 8 E 32. 5 E 49. 8 E 33. 5 E 50. 8 M 34. 5 E 51. 8 E Multiple Choice–Computational 74. 4 M 82. 6,7 H 75. 4 H 83. 6,7 M 76. 5 M 84. 6,7 M 77. 5 M 85. 6,7 M 78. 6 M 86. 7 M 79. 6 E 87. 8 M 80. 6 E 88. 8 H 81. 6,7 M 89. 10 M Multiple Choice–CPA Adapted 101. 3,5 M 104. 7 E 102. 5 M 105. 8 E 103. 6,7 M 106. 10 E

M = Medium

Item

LOD

52. 53. 54. 55. 56. 57. 58. 59. 60. 61. *62. *63. *64. *65.

9 9 10 10 10 10 10 12 12 12 14 14 14 14

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

90. 91. 92. 93. 94. *95. *96. *97.

10 10 10 10 12 14 14 14

H H M M E M H H

107. *108. *109.

12 14 14

H H M

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item

LOD

Item

110. 111. 112. 113.

1,3,6,7 3,5,10 5,6 6

M M M M

114. 115. 116. 117.

124. 125. 126.

3 3 4

M M H

127. 128. 129.

Note:

E = Easy

M = Medium

LOD Item Exercises 6,7 E 118. 6,7 E 119. 6,7 E 120. 6,7 M 121. Problems 4,6 M 130. 5,6 M 131. 6 M *132.

LOD

Item

LOD

8 8 8 10

M E E M

122. *123.

10 14

M M

10 10 14

M H H

*133.

H = Hard

*This topic is dealt with in an Appendix to the chapter.

Inventory

8-3

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

1. 2.

MC MC

3. 4.

MC MC

5. 6. 7. 8.

MC MC MC MC

9. 10. 11. 12.

MC MC MC MC

18. 19.

MC MC

20. 71.

MC MC

21. 22. 23. 24.

MC MC MC MC

25. 26. 27. 28.

MC MC MC MC

35. 36. 37. 38.

MC MC MC MC

78. 79. 80. 81.

MC MC MC MC

38. 39. 40. 41.

MC MC MC MC

42. 43. 44. 81.

MC MC MC MC

45. 46. 47.

MC MC MC

48. 49. 50.

MC MC MC

52.

53.

54. 55. 56.

MC MC MC

57. 58. 89.

MC MC MC

59.

60.

*62. *63.

MC MC

*64. *65.

MC MC

Item Type Item Type Learning Objective 1 66. MC 68. MC 67. MC 69. MC Learning Objective 3 13. MC 17. MC 14. MC 98. MC 15. MC 99. MC 16. MC 100. MC Learning Objective 4 72. MC 74. MC 73. MC 75. MC Learning Objective 5 29. MC 33. MC 30. MC 34. MC 31. MC 76. MC 32. MC 77. MC Learning Objective 6 82. MC 103. MC 83. MC 110. Ex 84. MC 112. Ex 85. MC 113. Ex Learning Objective 7 82. MC 86. MC 83. MC 103. MC 84. MC 104. MC 85. MC 110. Ex Learning Objective 8 51. MC 105. MC 87. MC 118. Ex 88. MC 119. Ex Learning Objective 9 Learning Objective 10 90. MC 93. MC 91. MC 106. MC 92. MC 121. Ex Learning Objective 12 61. MC 94. MC Learning Objective 14 *95. MC *97. MC *96. MC *108. MC

Note: MC = Multiple Choice Ex = Exercise *This topic is dealt with in an Appendix to the chapter.

Item

Type

70. 110.

MC Ex

101. 110. 111. 124.

MC Ex Ex Pr

126. 127.

Pr Pr

126. 127.

Pr Pr

114. 115. 116. 117.

Ex Ex Ex Ex

114. 115. 116. 117.

Ex Ex Ex Ex

120.

122. 130. 131.

Ex Pr Pr

107.

*109. *123.

MC Ex

Item

Type

125.

127. 128. 129.

Pr Pr Pr

*132. *133.

Pr Pr

Pr = Problem

8-4

Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER STUDY OBJECTIVES 1. Understand inventory from a business perspective. It is important to understand the nature of the various types of businesses that have significant inventory as well as the different types of inventory. Retailers, manufacturers, and wholesalers generally carry significant amounts of inventory. However, different companies have different business models. For example, some manufacturers follow a just-in-time strategy and carry very little inventory on hand. Only one inventory account, Merchandise Inventory, appears in the financial statements of a merchandising concern. A manufacturer normally has three inventory accounts: Raw Materials, Work in Process, and Finished Goods. There may also be an inventory account for factory or manufacturing supplies. Management must manage inventory levels in order to ensure sufficient choice and quantities to meet customer needs yet keep costs to a minimum. The financial statements need to provide information about all of this.

2. Define inventory from an accounting perspective. Differing companies have different types of inventories including securities, land for development, work in progress, grain, and other. For accounting purposes, inventory is defined as an asset that is held for sale in the ordinary course of business or for the production of such inventory (including raw materials, work in process, and supplies). Special guidance and/or industry practice exists for inventories of financial instruments, construction in progress, biological assets, agricultural products, mineral products, inventories held by producers of agricultural and forest producers, and inventories held by commodity brokertraders.

3. Identify which inventory items should be included in ending inventory. Inventory is included on the balance sheet of the entity that has substantially all of the risks and rewards of ownership, which is generally the company that has possession and legal title to the goods. Professional judgement must be used to determine whether substantially all of the risks and rewards have passed. For instance, consigned goods remain the property of the consignor. Purchase commitments are generally not recognized unless onerous.

4. Identify the effects of inventory errors on the financial statements and adjust for them. If the ending inventory is misstated, (1) the inventory, retained earnings, working capital, and current ratio in the balance sheet will be incorrect; and (2) the cost of goods sold and net income in the income statement will be incorrect. If purchases and inventory are misstated, (1) the inventory, accounts payable, and current ratio will be incorrect; and (2) purchases and ending inventory will be incorrect.

5. Determine the components of inventory cost. Inventory costs include all costs of purchase, conversion, and other costs incurred in bringing the inventories to the present location and condition necessary for sale. Such charges include freight charges on goods purchased, other direct costs of acquisition, and labour and other direct production costs incurred in processing the goods up to the time of sale. Manufacturing overhead costs are allocated to inventory based on the normal capacity of the production facilities. Interest and asset retirement costs may be included as part of the cost of inventory depending on the circumstances.

Inventory

8-5

6. Distinguish between perpetual and periodic inventory systems and account for them. Under a perpetual inventory system, a continuous record of changes in inventory is maintained in the Inventory account. That is, all purchases into and transfers of goods out of the account are recorded directly in the Inventory account as they occur. No such record is kept under a periodic inventory system. Under the periodic system, year-end inventory is determined by a physical count, and the amount of ending inventory and cost of goods sold is based on this count. Even under the perpetual system, an annual count is needed to test the accuracy of the records.

7. Identify and apply GAAP cost formula options and indicate when each cost formula is appropriate. The specific identification method is used to assign costs for items of inventory that are not ordinarily interchangeable or that are produced for specific projects. The weightedaverage or first-in, first-out cost formula is used to assign costs to other types of inventory. All inventory items that have a similar nature and use to the entity apply the same cost formula.

8. Explain why inventory is measured at the lower of cost and market, and apply the lower of cost and net realizable value standard. Current assets should not be reported on the balance sheet at a higher amount than the net cash that is expected to be generated from their use or sale. When this amount is less than “cost,” inventory is written down and the loss in value is recognized in the same period as the decline. Net realizable value is the estimated selling price in the ordinary course of business reduced by the expected costs to complete and sell the goods. Ordinarily, each item’s cost and NRV are compared and the lower value is chosen. However, items that are related to each other and have similar purposes, that are produced and marketed in the same geographical area, and that cannot be evaluated separately from other items may be grouped and the lower of the group’s cost and net realizable value is chosen.

9. Identify inventories that are or may be valued at amounts other than the lower of cost and net realizable value. Inventories of financial instruments, construction contract work in process, biological assets related to agricultural activity, agricultural produce at the point of harvest and after harvest, inventories held by producers of agricultural and forest producers, mineral products, and inventories of commodity broker-traders all may be accounted for at other than the lower of cost and net realizable value.

10. Apply the gross profit method of estimating inventory. Ending inventory is determined by deducting an estimate of cost of goods sold from the actual cost of goods available for sale. Cost of goods sold is estimated by multiplying net sales by the percentage of cost of goods sold to sales. This percentage is derived from the gross profit percent: 100% – gross profit percentage = cost of goods sold percentage.

11. Identify how inventory should be presented and the type of inventory disclosures required by ASPE and IFRS. ASPE requires disclosure of how cost is determined, inventory that is pledged as security, the amount charged to the income statement as expense in the period, and the inventories’ carrying value by category. Additional information is required by IFRS, including details about inventory impairment writedowns and any recoveries, the circumstances responsible for these, and the carrying amounts and reconciliations of items measured at NRV or fair value. Biological assets must be presented separately on the balance sheet under IFRS. In general, cost of sales is presented on the income statement under both IFRS and ASPE unless expenses are grouped by nature. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

12. Explain how inventory analysis provides useful information and apply ratio analysis to inventory. Common ratios that are used in the management and evaluation of inventory levels are the inventory turnover and a related measure, average days to sell the inventory, often called the average age of inventory. This is useful information as excessive investment in inventory is expensive to carry, yet too little inventory results in lost sales and dissatisfied customers.

13. Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future. ASPE and IFRS are substantially harmonized. IFRS has specific guidance on the measurement of agricultural and construction inventories, the capitalization of borrowing costs on qualifying assets, and on onerous contracts. Asset retirement obligations may be treated differently under IFRS. No major changes are expected in the near future.

14. Apply the retail method of estimating inventory. The retail inventory method is based on converting the retail price of ending inventory by a cost-to-retail percentage, which is derived from information in the accounting and supplementary records. To use this method, records must be kept of the costs and retail prices for beginning inventory, net purchases, and abnormal spoilage, as well as the retail amount of net markups, net markdowns, and net sales. Which items go into the numerator and denominator of the cost-to-retail ratio depends on the type of inventory valuation estimate that is wanted.

15. Identify other primary sources of GAAP for inventory.

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MULTIPLE CHOICE—Conceptual Answer c a d c b a b d b a c d c b a c a a d a d c b d b a c d b a d a c b c a d c b a c a b d c b a a

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48.

Description Inventory categories of a manufacturer Inventory categories of a retailer Monitoring of inventory Calculation of cost of goods available for sale Recognition of ownership Classification of goods in transit Classification of goods in transit Classification of goods in transit Goods on consignment Effect of consignment goods on financial statements Effect of consignment goods on financial statements Accounting for potential sales returns Identify a product financing arrangement Identify ownership under product financing arrangement. Purchase commitments Definition of onerous contract Material purchase commitments Effect of understating inventory on financial statements Effect of understating purchases and ending inventory Effect of inventory errors Use of Purchases Discounts account Effect on income of gross vs. net method Net method and cost/benefit constraint Vendor rebates Identification of product costs Concept of product costs Conversion costs Costs to charge to expense Interest capitalization in manufacturing inventory Classification of factory overhead costs Borrowing costs Concept of standard costs Definition of basket purchase Method to use for basket purchases Perpetual inventory system characteristics Periodic inventory system characteristics Accounts used with a periodic system Perpetual system – moving average cost Specific indentification cost formula characteristics Nature of FIFO valuation of inventory FIFO in periodic vs perpetual system Weighted average cost formula characteristics FIFO cost formula characteristics Objectives underlying inventory standards Departure from accounting for inventory at cost Appropriate use of net realizable value Net realizable value “Replacement cost” definition of “market”

Test Bank for Intermediate Accounting, Tenth Canadian Edition

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MULTIPLE CHOICE—Conceptual (CONTINUED) b c a d c d b c b d a c d c b a d

49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. *62. *63. *64. *65.

Definition of net realizable value Appropriate use of net realizable value Valuation of inventory at net realizable value Valuation of inventory above cost Valuation at fair value less costs to sell Appropriate use of the gross profit method Appropriate use of the gross profit method Calculation of gross profit percentage Appropriate use of the gross profit method Gross profit method Calculation of inventory turnover ratio Calculation of inventory turnover ratio Calculation of average days to sell inventory Conventional retail method Markdowns and the conventional retail method Mark-ups and the conventional retail method Use of the retail method

MULTIPLE CHOICE—Computational Answer c d d c d d a a a d c b b b a a c b a c c a c a c b

No. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91.

Description Calculate cost of goods available for sale Calculate sales given manufacturing cost information Calculate ending inventory Calculate beginning inventory Calculate total sales from cost information Effect of inventory and depreciation errors on income Effect of inventory and depreciation errors on retained earnings Effect of inventory errors on working capital Account for inventory errors Account for inventory errors Accounting for a purchase return (net method) Adjust account payable using the net method Adjusting entry for inventory shortage Journal entries for periodic inventory system Journal entries for perpetual inventory system Calculate ending inventory using weighted-average Calculate ending inventory using moving average Calculate ending inventory using FIFO Calculate ending inventory using average cost Journal entries for perpetual inventory system Calculate cost of goods sold using FIFO Adjusting entry to value inventory at NRV Adjusting entry to value inventory at NRV Mark-up on cost equivalent to mark-up on selling price Estimate ending inventory using gross profit method Estimate ending inventory using gross profit method

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MULTIPLE CHOICE—Computational (CONTINUED) a d d d a c

92. 93. 94. *95. *96. *97.

Estimate ending inventory using gross profit method Estimate cost of inventory destroyed by fire Calculate inventory turnover ratio Basis of cost to retail ratio Calculate ending inventory at retail Calculate ending inventory using conventional retail method

MULTIPLE CHOICE—CPA Adapted Answer c a d a c b d a d c b a

No. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. *108. *109.

Description Calculate accounts payable at year end Calculate accounts payable at year end Calculate accounts payable at year end Calculate cost of sales Calculate inventoriable cost Calculate unit cost using moving-average method Calculate ending inventory using FIFO Recognizing a loss due to application of lower of cost and NRV Estimate cost of inventory lost by theft Calculate average inventory Calculate ending inventory using retail method Calculate ending inventory using retail method

EXERCISES Item E8-110 E8-111 E8-112 E8-113 E8-114 E8-115 E8-116 E8-117 E8-118 E8-119 E8-120 E8-121 E8-122 *E8-123

Description Definitions Terminology Recording purchases at net amounts Year-end entries to update inventory accounts FIFO cost formula Perpetual FIFO Periodic FIFO Journal entries for perpetual inventory system Adjustments to lower of cost and NRV Lower of cost and net realizable value Lower of cost and net realizable value Gross profit method Gross profit method Conventional retail inventory method

*This topic is dealt with in an Appendix to the chapter.

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PROBLEMS Item P8-124 P8-125 P8-126 P8-127 P8-128 P8-129 P8-130 P8-131 *P8-132 *P8-133

Description Theory (executory vs onerous contract) Inventory cut-off Inventory errors Analysis of errors Accounting for purchase discounts Year-end entries to update inventory under periodic system Gross profit method Gross profit method Retail inventory method Conventional retail inventory method

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Conceptual 1. A manufacturing company typically maintains the following inventory account(s): a) Merchandise Inventory. b) Raw Materials and Work in Process only. c) Raw Materials, Work in Process and Finished Goods. d) Work in Process and Merchandise Inventory.

2. A hardware retailer typically maintains the following inventory account(s): a) Merchandise Inventory. b) Raw Materials and Work in Process only. c) Raw Materials, Work in Process and Finished Goods. d) Work in Process and Merchandise Inventory.

3. Companies that carry inventories must carefully monitor inventory in order to a) have the greatest selection available so customers can always find what they want. b) minimize carrying costs and keep inventory levels high so stockouts never occur. c) keep inventory levels high to maximize profits. d) minimize carrying costs and meet customer demands.

4. The cost of goods available for sale is calculated as a) beginning inventory plus ending inventory. b) beginning inventory minus ending inventory. c) beginning inventory plus the cost of goods acquired during the period. d) cost of goods acquired during the period minus ending inventory.

5. When substantially all risks and rewards of ownership have passed to the purchaser, the purchaser then recognizes an asset. For this recognition, which of the following statements is correct? a) The purchaser must have both legal title and possession of the goods. b) Legal title and possession do not always pass to the purchaser at the same time. c) In practice, recording inventory purchases often takes place when they leave the seller’s place of business. d) The purchaser must have possession of goods before it has legal title.

6. Goods in transit which are shipped f.o.b. shipping point should be included a) in the inventory of the buyer. b) in the inventory of the seller. c) in the inventory of the shipping company. d) in no one’s inventory until they arrive at their destination.

7. Goods in transit which are shipped f.o.b. destination should be included a) in the inventory of the buyer. b) in the inventory of the seller. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) in the inventory of the shipping company. d) in no one’s inventory until they arrive at their destination.

8. Which of the following items should be included in inventory at the balance sheet date? a) goods in transit which were purchased f.o.b. destination b) goods received from another company for sale on consignment c) goods sold to a customer, which are being held for the customer to call for at his or her convenience d) goods in transit which were purchased f.o.b. shipping point

9. Which of the following is correct? a) Goods on consignment are included in the consignee's inventory. b) Goods on consignment are included in the consignor’s inventory. c) The consignee essentially has the risks and rewards of ovwnership. d) Inventory on consignment is always shown in a separate account.

10. Fred received merchandise on consignment from Barney. As of March 31, Fred had recorded the transaction as a purchase and included the goods in inventory. The effect of this on Fred’s financial statements for March 31 would be a) net income was correct and current assets and current liabilities were overstated. b) net income, current assets, and current liabilities were overstated. c) net income and current liabilities were overstated. d) no effect.

11. Wilma received merchandise on consignment from Bubbles. As of January 31, Wilma included the goods in inventory, but did not record the transaction. The effect of this on Wilma’s financial statements for January 31 would be a) net income, current assets, and retained earnings were understated. b) net income was correct and current assets were understated. c) net income, current assets, and retained earnings were overstated. d) net income and current assets were overstated and current liabilities were understated.

12. Certain industries allow full or partial refunds for returned inventory. In such cases, which of the following is INCORRECT? a) The vendor retains the risks and rewards for those items expected to be returned. b) If returns can be reasonably predicted, then the goods may be considered sold by the vendor and removed from inventory. c) If returns cannot be predicted, the sale is not recognized and the goods are not removed from inventory. d) If returns cannot be predicted, the sale is still recognized but the goods are not removed from inventory.

Use the following information for questions 13 and 14. During 2014 Ebert Corp. transferred inventory to Siskel Corp., and agreed to repurchase the merchandise early in 2015. Siskel then used the inventory as collateral to borrow from Southern Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Bank, remitting the proceeds to Ebert. In 2015 when Ebert repurchased the inventory, Siskel used the proceeds to repay its bank loan.

13. This transaction is known as a(n) a) consignment. b) instalment sale. c) product financing arrangement. d) sale with delayed payment terms.

14. On whose books should the cost of the inventory appear at the December 31, 2014 statement of financial position date? a) Siskel Corp. b) Ebert Corp. c) Southern Bank. d) Siskel Corp., with Ebert Corp. making appropriate note disclosure of the transaction.

15. Which of the following does NOT correctly describe the implications of an executory contract on the accounting entries and/or disclosures to be made by the purchaser and/or seller? a) Assets and liabilities are usually recorded at inception of the contract. b) Assets and liabilities are usually not recorded at inception of the contract. c) Contract details should be disclosed if the amounts are abnormal in relation to the entity's normal business operations. d) Assets and liabilities are recognized as performance has occurred.

16. If the unavoidable costs of completing a purchase commitment are higher than the expected benefits from receiving the contracted goods or services, IFRS requires a loss provision to be recognized. This is known as a(n) a) executory contract. b) purchase commitment. c) onerous contract. d) impaired contract.

17. If a material amount of inventory has been ordered through a formal purchase contract at the statement of financial position date for future delivery at firm prices, a) this fact must be disclosed. b) disclosure is required only if prices have declined since the date of the order. c) disclosure is required only if prices have since risen substantially. d) an appropriation of retained earnings is necessary.

18. On December 27, Chen Corp. accepted delivery of merchandise which it purchased on account. As of December 31, Chen had recorded the transaction, but did not include the merchandise in its year end inventory. The effect of this on its December 31 financial statements would be a) net income, current assets, and retained earnings were understated. b) net income was correct and current assets were understated. c) net income was understated and current liabilities were overstated. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) net income was overstated and current assets were understated.

19. On June 25, Bold Corp. accepted delivery of merchandise which it purchased on account. As of June 30, Bold had not recorded the transaction nor included the merchandise in its inventory. The effect of this on Bold’s June 30 balance sheet would be a) assets and shareholders’ equity were overstated but liabilities were not affected. b) shareholders’ equity was the only item affected by the omission. c) assets, liabilities, and shareholders’ equity were understated. d) assets and liabilities were understated but shareholders’ equity was not affected.

20. All else being equal, which of the following statements with respect to the impact of inventory errors is NOT correct? a) An overstatement of ending inventory will result in an understatement of income. b) An overstatement of ending inventory will result in an overstatement of income. c) An overstatement of beginning inventory will result in an understatement of income. d) An understatement of beginning inventory will cause cost of goods sold to be understated.

21. The use of a Purchase Discounts account implies that the recorded cost of a purchased inventory item is its a) invoice price plus any purchase discount lost. b) invoice price less the purchase discount taken. c) invoice price less the purchase discount allowable whether taken or not. d) invoice price.

22. During 2014, which was its first year of operations, Landers Company recorded the following: 1. Merchandise purchased for $985,000 before cash discounts taken. 2. All purchases were made on terms of 2/10, n/30. 3. Three-quarters of the items purchased were paid for within ten days of purchase. 4. All of the goods available had been sold at year end. Which of the following recording procedures would result in the highest net income for 2014? a) Recording purchases at net amounts, with the amount of discounts not taken shown under "other expenses" in the income statement. b) Recording purchases at gross amounts. c) Recording purchases at either gross or net will result in the same net income. d) Cannot be determined from the information provided.

23. Not using the net method because of difficulties that may arise is a good example of applying a) relevance. b) the cost/benefit constraint. c) representational faithfulness. d) the fair value principle.

24. Which of the following is correct regarding vendor rebates? a) Vendor rebates are generally recorded as a reduction from sales. b) The rebate is never recognized until it is actually received. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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c) If the rebate meets asset recognition criteria, the receivable is allocated to goods sold. d) Vendor rebates are generally recorded as a reduction in the purchase cost of inventory.

25. Which of the following is correct? a) Selling costs are product costs. b) Manufacturing overhead costs are product costs. c) Interest costs for routine inventories are product costs. d) Direct labour costs are usually period costs.

26. Which of the following best describes the concept of product costs? a) They are costs that are "attached" to inventory. b) They are costs that are usually expenses. c) They usually don't include freight charges. d) They usually don't include conversion costs.

27. Conversion costs include a) all materials plus direct labour. b) all materials plus variable overhead allocated. c) direct labour plus variable and fixed overhead allocated. d) direct labour plus fixed overhead allocated.

28. All of the following costs should be charged to expense in the period in which they are incurred EXCEPT for a) manufacturing overhead costs for a product manufactured and sold in the same accounting period. b) costs which will not benefit any future period. c) costs from idle manufacturing capacity resulting from an unexpected plant shutdown. d) costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory.

29. Which of the following types of interest cost incurred in connection with the purchase or manufacture of inventory should be capitalized as a product cost? a) purchase discounts lost b) interest incurred during the production of discrete projects such as ships or real estate projects c) interest incurred on notes payable to vendors for routine purchases made on a repetitive basis d) interest on a building mortgage

30. An EXCEPTION to the general rule that costs should be charged to expense in the period incurred is a) factory overhead costs incurred on a product manufactured but not sold during the current accounting period. b) interest costs for financing of inventories that are routinely manufactured in large quantities on a repetitive basis. c) general and administrative fixed costs incurred in connection with the purchase of Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

inventory. d) sales commission and salary costs incurred in connection with the sale of inventory.

31. Which of the following statements regarding borrowing costs is correct? a) Neither ASPE nor IFRS usually require disclosure of these items. b) They are usually amortized until the majority of the underlying products have been sold. c) They are usually treated as period costs if they are incurred to bring inventories to a condition ready for sale. d) If interest is capitalized, ASPE requires this policy and the amount capitalized to be disclosed.

32. Which of the following best describes the concept of standard costs? a) They are the costs that should be incurred per unit of finished goods inventory. b) They are the costs that are actually incurred per unit of finished goods inventory. c) When using standard costs, unallocated overhead is capitalized. d) Standard costs are always acceptable for reporting purposes. 33. A “basket purchase” is a purchase of a) a group of units with similar characteristics at a single lump-sum price. b) individual units with similar characteristics priced individually. c) a group of units with different characteristics at a single lump-sum price. d) individual units with different characteristics priced individually. 34. To record a “basket purchase” or to allocate a joint product cost, which method is the most rational? a) average cost b) relative sales value c) fair value d) amortized cost

35. Which of the following does NOT correctly describe a perpetual inventory system? a) Cost of goods sold is calculated every time a sale is made. b) Assuming shrinkage of zero, inventory and cost of goods sold do not have to be updated at the end of the period. c) The use of this system eliminates the requirement for an annual physical inventory count. d) Assuming a FIFO cost flow, cost of goods sold would equal that calculated by the periodic system.

36. Which of the following does NOT correctly describe a periodic inventory system? a) Cost of goods sold is calculated every time a sale is made. b) Cost of goods sold is a residual amount. c) Assuming a FIFO cost flow, cost of goods sold would equal those that calculated by the perpetual system. d) Inventory and cost of goods sold must be updated at the end of the period.

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37. When using a periodic inventory system, a) a Purchases account is not used. b) a Cost of Goods Sold account is used. c) two entries are required to record a sale. d) a Cost of Goods Sold account is not used.

38. When using the moving-average cost formula with a perpetual system, a) a weighted-average cost is calculated at year end. b) a new unit cost is calculated each time a sale is made. c) a new unit cost is calculated each time a purchase is made. d) a new unit cost is calculated both when a sale is made and when a purchase is made.

39. Which of the following does NOT correctly describe the specific identification cost formula? a) This method is most appropriate when goods are not interchangeable. b) This method is most appropriate when goods are interchangeable. c) This method is generally used for expensive, one-of-a-kind merchandise. d) This method is often used for merchandise with serial numbers such as televisions.

40. An inventory cost formula in which the oldest costs incurred rarely have an effect on the ending inventory valuation is a) FIFO. b) moving-average cost. c) LIFO. d) weighted-average.

41. All else being equal, which of the following statements is correct for a company that uses the FIFO costing formula with a perpetual inventory system (compared to a periodic system)? a) The value of the ending inventory would be higher under a periodic system. b) The value of the ending inventory would be lower under a periodic system. c) The value of the ending inventory would be the same under both systems. d) The periodic system would not require any additional entries at the end of the period.

42. Which of the following does NOT correctly describe the weighted average cost formula? a) It prices inventory on the basis of the average cost of beginning inventory. b) It prices inventory on the basis of the average cost of goods available for sale during the period. c) It takes into account that the volume of goods acquired at each price is different. d) It includes the cost of beginning inventory in the calculations.

43. Which of the following does NOT correctly describe the FIFO cost formula? a) This method assumes that the oldest inventory costs are the first costs recorded for cost of goods sold. b) This method assumes that most current inventory costs are the first costs recorded for cost of goods sold. c) This method approximates the physical flow of most types of goods. d) This method is permitted under both ASPE and IFRS. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

44. Which of the following statements is INCORRECT regarding the overriding objectives underlying inventory standards and guide management? a) Report an inventory cost on the statement of financial position that is representative of the inventory’s recent cost. b) Choose an approach that corresponds as closely as possible to the physical flow of goods. c) Use the same method for all inventory assets that have similar economic characteristics. d) It is permissible under ASPE to use any inventory method, including LIFO.

45. The primary basis of accounting for inventories is cost. A departure from the cost basis of pricing inventory is required where there is evidence that when the goods are sold in the ordinary course of business their a) selling price will be less than their replacement cost. b) replacement cost will be more than their net realizable value. c) future utility will be less than their cost. d) cost will be less than their replacement cost.

46. In no case can "net realizable value" (in the lower of cost and net realizable value rule) be more than a) estimated selling price in the ordinary course of business. b) estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. c) estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal and an allowance for a normal profit margin. d) estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal, an allowance for a normal profit margin, and an adequate reserve for possible future losses.

47. When inventory declines in value below original (historical) cost, and this decline is considered other than temporary, what is the maximum amount that the inventory can be valued at? a) net realizable value b) selling price c) historical cost d) net realizable value reduced by a normal profit margin 48. The use of a “replacement cost” definition of “market” is based on the assumption that a) a decline in an item’s replacement cost results in a decline in its selling price. b) prices will fall in the same proportion as input costs fall. c) replacement cost is appropriate for all situations. d) using “net realizable value less a normal profit margin” will arbitrarily shift profits from one period to another.

49. Which of the following does NOT correctly describe the concept of net realizable value (NRV)? Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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a) Estimates of NRV are based on the best evidence available at and shortly after the balance sheet date. b) NRV generally does not change over time. c) NRV generally changes over time. d) A new estimate of NRV is required at each balance sheet date.

50. Lower of cost and net realizable value a) is most conservative if applied to the total inventory. b) is most conservative if applied to major categories of inventory. c) is most conservative if applied to individual items of inventory. d) must be applied to major categories for income tax purposes.

51. If a unit of inventory has declined in value below original cost, but the market value exceeds net realizable value, the amount to be used for purposes of inventory valuation is a) net realizable value. b) original cost. c) market value. d) net realizable value less a normal profit margin.

52. Which of the following criteria does NOT have to be met in order to be able to value inventory ABOVE cost? a) The cost of disposal can be estimated. b) The sale is assured. c) There is an active market for the product. d) The sale must already have occurred.

53. Which of the following inventories may NOT be valued at fair value less costs to sell? a) grain and livestock futures b) biological assets c) farm equipment d) agricultural produce

54. The gross profit method of inventory valuation is NOT suitable when a) a portion of the inventory is destroyed. b) there is a substantial increase in inventory during the year. c) there is no beginning inventory because it is the first year of operation. d) the gross profit percentage applicable to the goods in ending inventory is different from the percentage applicable to the goods sold during the period.

55. Which statement is NOT true about the gross profit method of inventory valuation? a) It may be used to estimate inventories for interim statements. b) It may be used to estimate inventories for annual statements. c) It may be used by auditors. d) It may be used to provide a rough check on the accuracy of the physical inventory count.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

56. The gross profit percentage is calculated by a) dividing cost of goods sold by net sales. b) dividing gross profit on sales by cost of goods sold. c) dividing gross profit on sales by net sales. d) dividing gross profit on sales by goods available for sale.

57. The gross profit method of inventory valuation a) can be used as a substitute for the annual physical count of inventory. b) assumes past percentages are appropriate for the current period. c) uses mark-ups but not markdowns. d) is designed to approximate inventory valuation at the lower of cost and net realizable value.

58. Which of the following statements with respect to the gross profit method of estimating inventory is NOT correct? a) It may be used for interim reporting. b) It may be used to estimate ending inventory when inventory has been destroyed. c) It uses the interrelationship between the accounts used in the cost of goods sold calculation. d) The use of this method eliminates the need for performing an actual inventory count.

59. The inventory turnover ratio is calculated as a) cost of goods sold divided by average inventory. b) average inventory divided by cost of goods sold. c) cost of goods sold times average inventory. d) average assets divided by cost of goods sold.

60. The inventory turnover ratio is calculated by dividing the cost of goods sold by a) beginning inventory. b) ending inventory. c) average inventory. d) number of days in the year.

61. The average days to sell inventory ratio is calculated as a) average inventory divided by inventory turnover. b) inventory turnover divided by cost of goods sold. c) inventory turnover divided by 365 days. d) 365 days divided by inventory turnover.

*62. An inventory method which is designed to approximate inventory valuation at the lower of average cost and market is a) last-in, first-out. b) weighted average. c) conventional retail method. d) specific identification.

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*63. When the conventional retail inventory method is used, markdowns are commonly ignored in the calculation of the cost to retail ratio because a) there may be no markdowns in a given year. b) this tends to give a better approximation of the lower of cost and market. c) mark-ups are also ignored. d) this tends to result in showing a normal profit margin in a period when no markdown goods have been sold.

*64. To produce an inventory valuation which approximates the lower of average cost and market using the conventional retail inventory method, the calculation of the ratio of cost to retail should a) include mark-ups but not markdowns. b) include mark-ups and markdowns. c) ignore both mark-ups and markdowns. d) include markdowns but not mark-ups.

*65. The retail inventory method is NOT used a) as a control measure to determine inventory shortages. b) to allow the calculation of net income without taking a physical inventory count. c) to control quantities of merchandise on hand. d) to calculate the gross profit percentage.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

c a d c b a b d b

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

a c d c b a c a a

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

d a d c b d b a c

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

d b a d a c b c a

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

d c b a c a b d c

46. 47. 48. 49. 50. 51. 52. 53. 54.

b a a b c a d c d

55. 56. 57. 58. 59. 60. 61. *62. *63.

b c b d a c d c b

*64. *65.

a d

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MULTIPLE CHOICE—Computational 66. The following information is available for Hornblow Ltd. for last year: Freight-in ....................................................................................... $ 20,000 Purchase returns ........................................................................... 62,000 Selling expenses ........................................................................... 110,000 Ending inventory ........................................................................... 260,000 The cost of goods sold is equal to 300% of selling expenses. What is the cost of goods available for sale? a) Cannot be determined from information given. b) $370,000 c) $590,000 d) $610,000

67. For calendar 2014, the gross profit of Allan Corp. was $350,000; the cost of goods manufactured was $890,000; the beginning inventories of goods in process and finished goods were $76,000 and $112,000, respectively; and the ending inventories of goods in process and finished goods were $92,000 and $143,000, respectively. Allan Corp.’s sales for 2014 must have been a) $730,000. b) $894,000. c) $1,101,000. d) $1,209,000. 68. Nottingham Inc.’s net sales and gross profit were $1,341,000 and $471,000 respectively. Assuming the cost of goods available were $1,084,000, what was the cost value of the ending inventory? a) $870,000 b) $471,000 c) $247,000 d) $214,000

69. For last month, Perma Corp.'s cost of goods sold and ending inventory were $100,000 and $150,000 respectively. Assuming Perma had neither purchases nor returns during the month, what was the cost of its beginning inventory? a) $50,000 b) $150,000 c) $250,000 d) Cannot be determined from the information given.

70. In its first year of operations as a retailer, Hwang Ltd. reported a gross profit of $135,000, total purchases of $160,000, and an ending inventory of $75,000. Therefore, Hwang’s sales in its first year must have been a) $60,000. b) $80,000. c) $180,000. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d) $220,000.

Use the following information for questions 71 through 73. Giselle Ltd. is a calendar-year corporation. Its financial statements for the years 2015 and 2014 contained errors as follows: 2015 2014 Ending inventory......................... $2,000 overstated $3,000 overstated Depreciation expense ................. $6,000 understated $12,000 overstated

71. Assume that the proper correcting entries were made at December 31, 2014. By how much will 2015 pre-tax income be overstated or understated? a) $2,000 understated b) $2,000 overstated c) $6,000 overstated d) $8,000 overstated

72. Assume that no correcting entries were made at December 31, 2014. Ignoring income taxes, by how much will retained earnings at December 31, 2015 be overstated or understated? a) $4,000 understated b) $6,000 overstated c) $6,000 understated d) $15,000 understated

73. Assume that no correcting entries were made at December 31, 2014, or December 31, 2015 and that no additional errors occurred in 2016. Ignoring income taxes, by how much will working capital, at December 31, 2016 be overstated or understated? a) $0 b) $4,000 overstated c) $4,000 understated d) $6,000 understated

74. For calendar 2014, Gomez Corporation reported pre-tax income of $70,000. A recount of the company's inventory revealed that 2014 ending inventory was overstated by $10,000. What is Gomez's corrected pre-tax income for 2014? a) $60,000 b) $80,000 c) $70,000 d) $75,000

75. For calendar 2014, Halima Corporation reported pre-tax income of $345,000. You have been made aware that the company's beginning inventory was overstated by $12,000 and ending inventory was understated by $11,000. What is Halima's corrected pre-tax income for 2014? a) $322,000 b) $344,000 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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c) $346,000 d) $368,000

Use the following information for questions 76 and 77. Tuck Corp. records purchases at net amounts. On May 5, Tuck purchased merchandise on account costing $8,000 (gross), terms 2/10, n/30. Tuck returned $700 of the May 5 purchase and received credit on account. At May 31 the balance had not been paid.

76. The amount to be recorded as a purchase return is a) $714. b) $700. c) $686. d) $630.

77. By how much should the account payable be adjusted on May 31? a) $0 b) $146 c) $160 d) $540

78. At the end of its accounting year, Guild Corp.'s physical inventory count indicated that 540,000 units of inventory, costing $1.50 each, were on hand. The company's perpetual inventory system reported a balance of $817,200. The year end adjusting entry is a) debit Inventory and credit Loss on Inventory Due to Count, $7,200. b) debit Loss on Inventory Due to Count and credit Inventory, $7,200. c) debit Inventory and credit Loss on Inventory Due to Count, $277,200. d) debit Loss on Inventory Due to Count and credit Inventory, $277,200.

Use the following information for questions 79 and 80. Tehran Ltd. uses FIFO to cost its inventory. The following information is available for Tehran's inventory of product # 101: Beginning inventory: . 120 units @ $3.14 per unit March 1: ................... Purchase of 250 units @ $3.50 per unit April 10: .................... Sale of 100 units @ $5.10 per unit

79. Assuming Tehran uses the periodic inventory system, the entry to account for the March 1 purchase is a) debit Inventory and credit Accounts Payable, $875. b) debit Purchases and credit Accounts Payable, $875. c) debit Accounts Payable and credit Purchases, $875. d) debit Accounts Payable and credit Inventory, $875.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

80. Assuming Tehran uses the perpetual inventory system, the entry to account for the March 1 purchase is a) debit Inventory and credit Accounts Payable, $875. b) debit Purchases and credit Accounts Payable, $875. c) debit Accounts Payable and credit Purchases, $875. d) debit Accounts Payable and credit Inventory, $875.

Use the following information for questions 81 and 82. The following information was available from the inventory records of Lock Company for January: Units Unit Cost Total Cost Balance at January 1....................................... 3,000 $9.77 $29,310 Purchases: January 6 ............................................. 2,000 10.30 20,600 January 26 ........................................... 2,700 10.71 28,917 Sales: January 7 ............................................. (2,500) January 31 ........................................... (4,200) Balance at January 31 ..................................... 1,000

81. Assuming that Lock uses the periodic inventory system, what should the inventory be at January 31, using the weighted-average inventory method, rounded to the nearest dollar? a) $10,237 b) $10,260 c) $10,360 d) $10,505

82. Assuming that Lock uses the perpetual inventory system, what should the inventory be at January 31, using the moving-average inventory method, rounded to the nearest dollar? a) $10,237 b) $10,260 c) $10,360 d) $10,505

Use the following information for questions 83 and 84. Transactions for Littlejohn Ltd. for the month of June were: Purchases June 1 (balance) 400 @ $3.20 3 .................... 1,100 @ 3.10 7 .................... 600 @ 3.30 15 .................... 900 @ 3.40 22 .................... 250 @ 3.50

Sales June 2 ....... .. 300 @ $5.50 6 ....... 800 @ 5.50 9 ....... 500 @ 5.50 10 ....... 200 @ 6.00 18 ....... 700 @ 6.00 25 ....... 150 @ 6.00

Littlejohn uses the periodic inventory system.

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a) $2,100. b) $2,065. c) $1,920. d) $1,900.

84. The ending inventory on a weighted average-cost basis, rounded to the nearest dollar, is a) $1,956. b) $1,970. c) $1,980. d) $1,995.

85. Tehran Ltd. uses FIFO to cost its inventory. The following information is available for Tehran's inventory of product # 101: Beginning inventory: . 120 units @ $3.14 per unit March 1: ................... Purchase of 250 units @ $3.50 per unit April 10: .................... Sale of 100 units @ $5.10 per unit Assuming Tehran uses the perpetual inventory system, the second entry to account for the April 10 sale is a) debit Cost of Goods Sold and credit Inventory, $350. b) debit Cost of Goods Sold and credit Purchases, $350. c) debit Cost of Goods Sold and credit Inventory, $314. d) debit Cost of Goods Sold and credit Purchases, $314.

86. Pate Ltd. has the following data related to an item of inventory: Inventory, March 1 ............. 100 units @ $8.40 Purchase, March 7 ............. 350 units @ $8.80 Purchase, March 16 ........... 70 units @ $9.50 Inventory, March 31 ........... 150 units If Pate Ltd. uses FIFO, the value assigned to cost of goods sold is a) $3,305. b) $3,262. c) $3,216. d) $1,369.

Use the following information for questions 87 and 88. The following information is available for Anselmo Corporation's inventories: December 31, 2014: At cost: $585,000 At lower of cost and net realizable value (NRV): $525,000 December 31, 2015: At cost: $780,000 At lower of cost and net realizable value (NRV): $740,000 Anselmo uses a periodic inventory system and an allowance account to adjust its inventory from cost to the lower of cost and NRV.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

87. Anselmo's 2014 journal entry to adjust its inventory from cost to the lower of cost and net realizable value (NRV) will include a a) debit of $60,000 to Loss on Inventory Due to Decline in NRV. b) credit of $60,000 to Loss on Inventory Due to Decline in NRV. c) debit of $60,000 to Allowance to Reduce Inventory to NRV. d) credit of $60,000 to Inventory.

88. Anselmo's 2015 journal entry to adjust its inventory from cost to the lower of cost and net realizable value (NRV) will include a a) debit of $40,000 to Loss on Inventory Due to Decline in NRV. b) debit of $40,000 to Allowance to Reduce Inventory to NRV. c) debit of $20,000 to Allowance to Reduce Inventory to NRV. d) credit of $40,000 to Recovery of Loss Due to Decline in Inventory.

89. Rounded to the nearest whole percent, a mark-up of 35% on cost is equivalent to what percentage of gross profit on selling price? a) 26% b) 29% c) 40% d) 60%

90. Oregon Ltd. estimates the cost of its physical inventory at March 31 for use in interim financial statements. The rate of mark-up on cost is 25%. The following account balances are available: Inventory, March 1 ...................................................... $220,000 Purchases .................................................................. 172,000 Purchase returns ........................................................ 8,000 Sales during March..................................................... 350,000 What is the estimated dollar value of the inventory at March 31? a) $34,000 b) $78,000 c) $104,000 d) $121,500

91. On January 1, 2014, the merchandise inventory of Morton Corp. was $600,000. During 2014, Morton purchased $1,150,000 of merchandise and recorded sales of $1,350,000. The gross profit rate on these sales was 35%. What is the estimated dollar value of the inventory at December 31? a) $877,500 b) $872,500 c) $562,500 d) $472,500

92. For calendar 2014, cost of goods available for sale for Scarlett Corp. was $870,000. The average gross profit rate was 40%. Sales for the year were $700,000. What is the estimated dollar value of the inventory at December 31? Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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a) $450,000 b) $420,000 c) $170,000 d) $68,000

93. On April 15 of the current year, a fire destroyed the entire inventory of The Corner Shoppe, a retail store. The following data are available: Sales, January 1 through April 15 .............................. $485,000 Inventory, January 1................................................... 80,000 Purchases, January 1 through April 15....................... 391,000 Mark-up on cost ......................................................... 25% The amount of the inventory loss is estimated to be a) $174,000. b) $97,000. c) $94,000. d) $83,000.

94. The 2014 financial statements of Barclay Ltd. reported beginning inventory of $130,000, ending inventory of $140,000, and cost of goods sold of $650,000 for the year. To one decimal, Barclay’s inventory turnover ratio for 2014 is a) 2.9 times. b) 3.4 times. c) 4.0 times. d) 4.8 times.

Use the following information for questions *95 through *97. Tang Inc. uses the retail inventory method. The following information is available for the current year: Cost Retail Beginning inventory........................................... $117,000 $183,000 Purchases ......................................................... 442,000 623,000 Freight-in ........................................................... 8,000 — Employee discounts .......................................... — 3,000 Net mark-ups .................................................... — 22,000 Net markdowns ................................................. — 30,000 Sales ................................................................. — 585,000

*95. If the ending inventory is to be valued at approximately lower of average cost and market, the calculation of the cost ratio should be based on cost and retail of a) $450,000 and $645,000. b) $450,000 and $642,000. c) $559,000 and $825,000. d) $567,000 and $828,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a) $210,000. b) $216,000. c) $225,000. d) $240,000.

*97. The approximate cost of the ending inventory by the conventional retail method is a) $153,720. b) $147,000. c) $143,850. d) $142,380.

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

66. 67. 68. 69. 70. 71.

c d d c d d

72. 73. 74. 75. 76. 77.

a a a d c b

78. 79. 80. 81. 82. 83.

b b a a c b

84. 85. 86. 87. 88. 89.

a c c a c a

90. 91. 92. 93. 94. *95.

c b a d d d

*96. *97.

a c

DERIVATIONS—Computational No. Answer 66. c 67. d 68. 69. 70. 71. 72. 73.

d c d d a a

74. 75. 76. 77. 78. 79.

a d c b b b

80.

82.

83.

84.

Derivation $260,000 + (300% x $110,000) = $590,000 $890,000 + $112,000 – $143,000 = $859,000 (COGS) $859,000 + $350,000 = $1,209,000 $1,084,000 – ($1,341,000 – $471,000) = $214,000. $100,000 + $150,000 = $250,000. $135,000 + ($160,000 – $75,000) = $220,000. $2,000 + $6,000 = $8,000. $12,000 – ($2,000 + $6,000) = $4,000. The effect of the errors in ending inventories reverse themselves in the following year. $70,000 – $10,000 = $60,000. $345,000 + $12,000 + $11,000 = $368,000 $700 x 98% = $686. ($8,000 – $700) × .02 = $146. $817,200 – (540,000 x $1.50) = $7,200 Loss. Under the periodic system, a Purchases account is used. 250 x $3.50 = $875. Under the perpetual system, purchases are debited to Inventory. 250 x $3.50 = $875. ($29,310 + $20,600 + $28,917) ÷ (3,000 + 2,000 + 2,700) = $10.237/unit $10.237 × 1,000 = $10,237. Avg. on Jan 6 $49,910 ÷ 5,000 = $9.982/unit Avg. on Jan 26 $53,872 ÷ 5,200 = $10.36/unit $10.36 × 1,000 = $10,360. Total GAFS 3,250 units; total sold 2,650 units; EI = 600 units EI = (250 × $3.50) + (350 × $3.40) = $2,065. $10,605 ÷ 3,250 units = $3.26;$3.26 × 600 = $1,956.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

DERIVATIONS—Computational (CONTINUED) No. Answer 85. c 86.

87. 88.

a c

89. 90.

a c

91.

92. 93. 94. *95.

a d d d

*96. *97.

a c

Derivation Under FIFO, the unsold units in beginning inventory are considered to be the first units sold. 100 x $3.14 = $314. 100 + 350 + 70 – 150 = 370 units sold (100 × $8.40) + (270 × $8.80) = $3,216. $585,000 – $525,000 = $60,000. Existing balance in allowance account must decrease from $60,000 to $40,000. This is accomplished by debiting the allowance account by $20,000. Then the adjusted inventory will be $780,000 – $40,000 = $740,000. 35% ÷ (1 + 35%) = 26% (rounded). COGS = $350,000 ÷ 1.25 = $280,000 ($220,000 + $172,000 – $8,000) – $280,000 = $104,000. COGS = $1,350,000 x 0.65 = $877,500 $600,000 + $1,150,000 – $877,500 = $872,500. $870,000 - ($700,000 x 0.60) = $450,000. $80,000 + $391,000 – ($485,000 ÷ 1.25) = $83,000. $650,000 ÷ [($130,000 + $140,000) ÷ 2] = 4.8 times. Cost: $117,000 + $442,000 + $8,000 = $567,000. Retail: $183,000 + $623,000 + $22,000 = $828,000. $183,000 + $623,000 – $3,000 + $22,000 – $30,000 – $585,000 = $210,000. Cost: $117,000 + $442,000 + $8,000 = $567,000 Retail: $183,000 + $623,000 +$22,000 = $828,000 Cost-to-retail ratio = $567,000 ÷ $828,000 = 68.5% $210,000 × 68.5% = $143,850.

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MULTIPLE CHOICE—CPA Adapted 98. Delaware Corp.'s accounts payable at December 31, 2014, totalled $450,000 before any necessary year-end adjustments relating to the following: 1. On December 27, 2014, Delaware wrote and recorded cheques to creditors totalling $175,000 causing an overdraft of $100,000 in Delaware’s bank account at December 31, 2014. The cheques were mailed out on January 10, 2015. 2. On December 28, 2014, Delaware purchased and received goods for $100,000, terms 2/10, n/30. Delaware records purchases and accounts payable at net amounts. The invoice was recorded and paid on January 3, 2015. 3. Goods shipped f.o.b. destination on December 20, 2014 from a vendor were received on January 2, 2015. The invoice cost was $65,000. At December 31, 2014, what amount should Delaware report as total accounts payable? a) $550,000 b) $575,000 c) $723,000 d) $755,500

99. The balance in Georgia Corp.'s accounts payable account at December 31, 2014 was $900,000 before any necessary year-end adjustments relating to the following: 1. Goods were in transit to Georgia from a vendor on December 31, 2014. The invoice cost was $75,000. The goods were shipped f.o.b. shipping point on December 29, 2014 and were received on January 4, 2015. 2. Goods shipped f.o.b. destination on December 21, 2014 from a vendor were received on January 6, 2015. The invoice cost was $37,500. 3. On December 27, 2014, Georgia wrote and recorded cheques to creditors totalling $45,000 that were mailed on January 10, 2015. At December 31, 2014, what amount should Georgia report as total accounts payable? a) $1,020,000 b) $1,012,500 c) $975,000 d) $945,000

100. Florida Ltd.'s accounts payable balance at December 31, 2014 was $600,000 before any necessary year-end adjustments relating to the following: 1. Goods were in transit from a vendor to Florida on December 31, 2014. The invoice price was $40,000, and the goods were shipped f.o.b. shipping point on December 29, 2014. The goods were received on January 4, 2015. 2. Goods shipped to Florida, f.o.b. shipping point on December 20, 2014, from a vendor were lost in transit. The invoice price was $25,000. On January 5, 2015, Florida filed a $25,000 claim against the common carrier. At December 31, 2014, what amount should Florida report as total accounts payable? a) $600,000 b) $625,000 c) $640,000 d) $665,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

101. The following information was derived from the 2014 accounting records of Jersey Co.: Jersey’s Goods Jersey’s Central Warehouse held by consignees Beginning inventory $260,000 $28,000 Purchases 475,000 90,000 Freight-in 15,000 Transportation to consignees 5,000 Freight-out 25,000 8,000 Ending inventory 290,000 20,000 Jersey’s 2014 cost of sales was a) $563,000. b) $558,000. c) $488,000. d) $460,000.

102. The following information was reported by Montana Inc. for 2014: Merchandise purchased for resale.............................. $100,000 Freight-in .................................................................... 7,000 Freight-out .................................................................. 4,000 Purchase returns ........................................................ 2,000 Based on this data, Montana’s 2014 inventoriable cost was a) $113,000. b) $111,000. c) $105,000. d) $100,000.

103. Arizona Inc. uses the perpetual inventory system, and recorded the following data pertaining to raw material X during January 2014: Units Date Received Cost Issued On Hand Jan 1 Inventory $4.00 3,200 Jan 11 Issue (sold) 1,600 1,600 Jan 22 Purchase 4,000 $4.70 5,600 The moving-average unit cost of raw material X inventory at January 31, 2014 is a) $4.70. b) $4.50. c) $4.43. d) $4.35.

104. At January 1, 2014, Nevada Ltd. had 150 units of product A on hand, costing $32 each. Purchases of product A during January were as follows: Date Units Unit Cost Jan 10 200 $33.00 18 250 34.50 28 100 36.00 A physical count on January 31, 2014 shows 200 units of product A on hand. The cost of the Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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inventory at January 31, 2014 under the FIFO cost formula is a) $6,150. b) $6,375. c) $6,600. d) $7,050.

105. Washington Distribution Co. has determined its December 31, 2014 inventory on a FIFO basis at $240,000. Information pertaining to that inventory follows: Estimated selling price ............................................... $255,000 Estimated cost of disposal .......................................... 10,000 Normal profit margin ................................................... 30,000 Washington records losses that result from applying the lower of cost and net realizable value rule. At December 31, 2014, the loss that Washington should recognize is a) $0. b) $5,000. c) $15,000. d) $25,000.

106. Tennessee Ltd.'s accounting records reported the following information: Inventory, Jan 1, 2014 ................................................ $ 300,000 Purchases during 2014 .............................................. 1,500,000 Sales during 2014 ...................................................... 2,000,000 A physical inventory taken on December 31, 2014 resulted in an ending inventory of $350,000. Tennessee’s gross profit on sales has remained constant at 30% in recent years. Tennessee suspects some inventory may have been taken by a new employee. At December 31, 2014, what is the estimated cost of the missing inventory? a) $400,000 b) $100,000 c) $ 75,000 d) $ 50,000

107. For 2014, Colorado Corp.’s cost of goods sold was $562,500 and their sales were $1,200,000. Assuming an inventory turnover of 3.5 for the year, what was the company’s average inventory? (Round to the nearest dollar.) a) $251,786 b) $170,682 c) $160,714 d) Cannot be determined from the information given.

*108. Maine Co. uses the retail inventory method to estimate its inventory for interim statement purposes. Data relating to the calculation of the inventory at July 31, 2014, are as follows: Cost Retail Inventory, July 1/14 ........................................... $ 200,000 $ 250,000 Purchases ......................................................... 1,200,000 1,575,000 Mark-ups, net .................................................... 175,000 Sales ................................................................. 1,700,000 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Estimated normal shoplifting losses................... 20,000 Markdowns, net ................................................. 110,000 Under the lower of average cost and market method, Maine's estimated inventory at July 31, 2014, is a) $85,000. b) $119,000. c) $133,000. d) $136,000.

*109. At December 31, 2014, the following information was available from Hampshire Corp.'s accounting records: Cost Retail Inventory, Jan 1 ...................................................... $147,000 $ 205,000 Purchases .............................................................. 763,000 1,155,000 Additional mark-ups ................................................ 40,000 Available for sale .................................................... $910,000 $1,400,000 Sales for the year totalled $1.1 million. Markdowns amounted to $10,000. Under the lower of average cost and market method, Hampshire’s estimated inventory at December 31, 2014 was a) $188,500. b) $195,000. c) $201,500. d) $318,500.

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MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

98. 99. 100.

c a d

101. 102. 103.

a c b

104. 105. 106.

d a d

107. *108. *109.

c b a

DERIVATIONS—CPA Adapted No. 98. 99. 100. 101.

Answer c a d a

102. 103. 104. 105. 106.

c b d a d

107. *108.

c b

*109.

Derivation $450,000 + $175,000 + $98,000 = $723,000. $900,000 + $75,000 + $45,000 = $1,020,000. $600,000 + $40,000 + $25,000 = $665,000. $260,000 + $28,000 + $475,000 + $90,000 + $15,000 + $5,000 – $290,000 – $20,000 = $563,000. $100,000 + $7,000 – $2,000 = $105,000. [(3,200 x $4) – (1,600 × $4) + (4,000 × $4.70)] ÷ 5,600 = $4.50. (100 × $36) + (100 × $34.50) = $7,050. NRV = $255,000 – $10,000 = $245,000; Cost = $240,000; Therefore no loss. $2,000,000 × .70 = $1,400,000 (COGS) $300,000 + $1,500,000 – $1,400,000 – $350,000 = $50,000. $562,500 ÷ 3.5 = $160,714. ($200,000 + $1,200,000) ÷ ($250,000 + $1,575,000 + $175,000) = 0.7 ($250,000 + $1,575,000 + $175,000 – $20,000 – $110,000 – $1,700,000) × 0.7 = $119,000. $910,000 ÷ $1,400,000 = 65.0% ($1,400,000 – $10,000 – $1,100,000) × 65.0% = $188,500.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 8-110 Definitions Provide clear, concise answers for the following: 1. Identify the inventory categories of a manufacturing company and describe how they are related. 2. What is a perpetual inventory system? 3. What is a periodic inventory system? 4. What is the specific identification cost flow method? 5. What is the average cost inventory cost flow method? 6. What is the FIFO cost flow method? Solution 8-110 1. Manufacturing companies typically have three inventory categories: raw materials, work-inprocess and finished goods. Their relationship can be seen in that both the raw materials and the finished goods are included in the finished goods inventory. Specifically, the raw materials can be traced directly to the end product. 2.

In a perpetual inventory system, all purchases and sales are recorded directly in the inventory general ledger account as they occur. Cost of goods sold is calculated every time goods are sold. As a result, up-to-date information as to the number of units on hand and cost of goods sold is always available.

In a periodic inventory system, detailed records of purchases and sales are not kept in the inventory accounts. Cost of goods sold is a residual amount and is only available after a physical inventory count has been performed.

This method is used to assign costs to individual inventory items that are not interchangeable and are identifiable. Examples include special orders and serialized products such as automobiles and major appliances.

This method prices items in inventory on the basis of average cost of goods available for sale during the period. The weighted average cost formula takes into account that the volume of goods purchased at each price is different.

This method assumes that the oldest inventory costs are the first costs recorded for goods sold. As a result, it matches the physical flow of goods for most types of inventory.

Ex. 8-111 Terminology In the space provided at right, write the word or phrase that is defined or indicated. 1. An approach whereby a company 1. __________________________________ finances its inventory without reporting either the liability or the inventory asset on its statement of financial position. 2.

The method of initially recording purchases at the full invoice amount.

2. __________________________________

Inventory

The method of initially recording purchases at an amount that assumes that discounts will be taken.

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3. __________________________________

A contract in which neither party has fulfilled its part of the contract.

4. __________________________________

The costs that are “attached” to Inventory.

5. __________________________________

Direct costs and allocated overhead that are incurred to process raw materials into finished goods.

6. __________________________________

The predetermined costs to produce one unit of a given item of inventory.

7. __________________________________

The purchase of a group of units with different characteristics at a single lump sum price.

8. __________________________________

An inventory estimation method that uses the interrelationships between the accounts used in the calculation of cost of goods sold.

9. __________________________________

Solution 8-111 1. A product financing arrangement 2.

The gross method

The net method

Executory contract

Product costs

Conversion costs

Standard costs

Basket purchase

The gross profit method

Ex. 8-112 Recording purchases at net amounts Mexico Inc. records purchases at net amounts and uses the periodic inventory system. Prepare entries for the following: May 11 Purchased merchandise on account, $16,000, terms 2/10, n/30. 15 Returned part of May 11 purchase, $2,000, and received credit on account. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Test Bank for Intermediate Accounting, Tenth Canadian Edition

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Prepared the adjusting entry required for financial statements.

Solution 8-112 May 11 Purchases (.98 × $16,000) .............................................. Accounts Payable .................................................. 15

15,680 15,680

Accounts Payable (.98 × $2,000) .................................... Purchase Returns and Allowances ........................

1,960

Purchase Discounts Lost [0.02 x ($15,680 – 1,960)] ....... Accounts Payable ..................................................

274.40

1,960

274.40

Ex. 8-113 Year-end entries to update inventory accounts Omaha Corporation uses FIFO and a periodic inventory system. You have been provided with the following information relating to the company's inventory for the year ended December 2014: Beginning inventory Jan 1 ................................................. $24,500 Ending inventory Dec 31 ................................................... 109,080 Total purchases recorded during 2014 .............................. 130,000 Instructions Record the journal entry (entries) that are required to bring Omaha's inventory accounts and cost of goods sold up to date for 2014. Solution 8-113 Ending inventory (Note 1)................ .................................. Cost of goods sold (Note 2)............. .................................. Beginning inventory (Note 3)........................ ............ Purchases (Note 4).................................... ...............

109,080 45,420 24,500 130,000

Note 1: To record ending inventory Note 2: To record cost of goods sold ($24,500 + $130,000 - $109,080) Note 3: To remove beginning inventory Note 4: To clear purchases account

Ex. 8-114 FIFO cost formula The Malibu Shop shows the following data related to item Y27: Inventory, February 1 ................. 100 units @ $7.00 Purchase, February 9 ................. 200 units @ $7.60 Purchase, February 19 ............... 150 units @ $7.90 Inventory, February 28 ............... 200 units Instructions Using the FIFO cost formula, what value should be assigned to the ending inventory of item Y27? Solution 8-114 150 @ $7.90 = $1,185 50 @ $7.60 = 380 $1,565

Inventory

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Ex. 8-115 Perpetual FIFO A record of transactions for the month of May is as follows: Purchases Sales May 1 (balance) 400 @ $4.00 May 3 ........ 300 @ $7.00 4 ................. 1,300 @ $4.10 6 ........ 1,000 @ 7.00 8 ................. 800 @ $4.30 12 ........ 900 @ 7.50 14 ................. 700 @ $4.40 18 ........ 400 @ 7.50 22 ................. 1,200 @ $4.50 25 ........ 1,400 @ 8.00 29 ................. 500 @ $4.75 Assuming that perpetual inventory records are kept in dollars, calculate the ending inventory using FIFO. Solution 8-115 500 @ $4.75 = $2,375 400 @ $4.50 = 1,800 $4,175

Ex. 8-116 Periodic FIFO Maine Corporation sells item A as part of its product line, using the periodic system. Information as to balances on hand, purchases, and sales of item A are given in the following table for the first six months of 2014: Quantities Unit Price Date Purchased Sold Balance of Purchase January 11 — — 300 $5.00 January 24 1,300 — 1,600 5.20 February 8 — 300 1,300 — March 16 — 560 740 — June 11 600 — 1,340 5.60 Instructions Calculate the cost of goods sold for the first six months of 2014 using the FIFO cost formula. Solution 8-116 300@ $5.00 = 560@ $5.20 = 860

$1,500 2,912 $4,412

Ex. 8-117 Journal entries for perpetual inventory system Idaho Inc. is a wholesale company selling special parts for the automotive industry. The company uses FIFO and a perpetual inventory system. Its inventory records for part SA-123 show the following transactions for the month of May 2014:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Date

May 1 May 10 May 15 May 21 May 23

Transaction

Balance Purchase Sale Sale Purchase

Units Purchased 120 500

Unit Cost

Units Sold

Unit Selling Price

$7.00 $7.20 (100) (150)

250

$12.40 $12.50

$7.30

Instructions Assuming Idaho makes all sales and purchases of inventory on account, prepare the journal entries for each of the above listed transactions. Solution 8-117 May 10 Inventory........................................ ...................................................... . Accounts Payable ...................................................................... To record purchase (500 x $7.20 = $3,600) May 15 Accounts Receivable......................... .................................................. Sales............................................................... ............................ To record sale (100 x $12.40 = $1,240) Cost of goods sold............................ ................................................... Inventory........................................................... .......................... To update inventory and cost of goods sold (100 x $7.00 (from BI) = $700) May 21 Accounts Receivable...................... ..................................................... Sales............................................................. .............................. To record sale (150 x $12.50 = $1,875) Cost of goods sold............................ ................................................... Inventory.......................................................... ........................... To update inventory and cost of goods sold (20 x $7.00 – from BI) + (130 x $7.20 - from May 10 purch) = $1,076 May 23 Inventory.......................................... .................................................... Accounts Payable........................................ ............................... To record purchase (250 x $7.30 = $1,825)

3,600 3,600

1,240 1,240

700 700

1,875 1,875

1,076 1,076

1,825 1,825

Ex. 8-118 Adjustments to lower of cost and NRV The controller of Utah Corp. has provided you with the following information relating to its inventory: Date Cost Lower of cost and NRV Dec 31/14 $457,000 $410,000 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Inventory

Dec 31/15

$615,000

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$555,000

Utah uses the periodic inventory system, and records its inventory at cost. An allowance account is adjusted at the end of each year to adjust the value of the inventory to the lower of cost and NRV. Instructions Prepare the journal entries that Utah would have prepared for its 2014 and 2015 year ends, assuming that 2014 was its first year of operations. Solution 8-118 December 2014: Loss on Inventory Due to Decline in NRV........................ ..................... Allowance to Reduce Inventory to NRV................................. ...... To set up allowance to decrease inventory from cost to the lower of cost and NRV ($457,000 – $410,000 = $47,000)

47,000

December 2015: Loss on Inventory Due to Decline in NRV.......................... ................... 13,000 Allowance to Reduce Inventory to NRV................................. ...... To increase the balance in the allowance account by $13,000 ($615,000 – $47,000) – $555,000 = $13,000. Allowance account now at $60,000 Cr = difference between cost and NRV

47,000

13,000

Ex. 8-119 Lower of cost and net realizable value (NRV) Determine the unit value that should be used for inventory costing, using the "lower of cost and NRV" rule. A B C D E F Cost $2.40 $2.40 $2.30 $2.54 $2.44 $2.65 Replacement cost 2.20 2.60 2.20 2.50 2.42 2.36 Net realizable value 2.50 2.50 2.25 2.45 2.50 2.50 Solution 8-119 Case A $2.40 Case B

$2.40

Case C

$2.25

Case D

$2.45

Case E

$2.44

Case F

$2.50

Ex. 8-120 Lower of cost and net realizable value (NRV) The December 31, 2014 inventory of Rhode Inc. consisted of four products, for which certain information is provided below: Replacement Estimated Expected

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Product A B C D

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Original Cost $29.00 $44.00 $145.00 $21.00

Cost $22.00 $40.00 $125.00 $15.80

Disposal Cost $6.50 $8.00 $25.00 $3.00

Selling Price $40.00 $48.00 $190.00 $28.00

Instructions Using the lower of cost and NRV approach applied on an individual-item basis, calculate the inventory valuation that should be reported for each product on December 31, 2014. Solution 8-120 Product A B C D

Net Realizable Value $40.00 – $6.50 = $33.50 $48.00 – $8.00 = $40.00 $190.00 – $25.00 = $165.00 $28.00 – $3.00 = $25.00

Cost $29.00 $44.00 $145.00 $21.00

Lower of Cost And NRV $29.00 $40.00 $145.00 $21.00

Ex. 8-121 Gross profit method An inventory taken the morning after a large theft (March 12) discloses $27,500 of goods on hand. The following additional data is available from the books: Inventory on hand, March 1 ........................................ $ 42,000 Purchases received, March 1 – 11 ............................. 36,000 Sales (goods delivered to customers) ......................... 67,500 Past records indicate that sales are made at 50% above cost. Instructions Estimate the inventory of goods on hand at the close of business on March 11 by the gross profit method and determine the amount of the theft loss. Show appropriate titles for all amounts in your presentation. Solution 8-121 Beginning inventory ........................................................... Purchases ......................................................................... Goods available for sale .................................................... Less COGS ($67,500 ÷ 150%) .......................................... Estimated ending inventory ............................................... Physical inventory still on hand.......................................... Theft loss ..........................................................................

$ 42,000 36,000 78,000 (45,000) 33,000 (27,500) $ 5,500

Ex. 8-122 Gross profit method On January 1, Jasper Store had inventory valued at $124,000. January purchases were $78,000 and January sales were $220,000. On February 1, a fire destroyed most of the inventory. The rate of gross profit was 25% of cost. Merchandise with a selling price of $10,000 remained undamaged after the fire. Instructions Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Inventory

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Calculate the amount of the fire loss. Show appropriate titles for all amounts in your presentation. Solution 8-122 Beginning inventory .......................................................... $ 124,000 Purchases ......................................................................... 78,000 Goods available for sale.................................................... 202,000 Less COGS ($220,000 ÷ 125%) ........................................ (176,000) Estimated ending inventory ............................................... 26,000 Cost of undamaged inventory ($10,000 ÷ 125%) .............. (8,000) Estimated fire loss............................................................. $ 18,000

*Ex. 8-123 Conventional retail inventory method Karel’s General Store uses the conventional retail inventory method. Information relating to the calculation of the inventory at December 31, 2014, follows: Cost Retail Inventory, January 1 ......................................................... $140,000 $220,000 Purchases ......................................................................... 480,000 720,000 Freight-in........................................................................... 80,000 Sales ................................................................................. 750,000 Net mark-ups .................................................................... 160,000 Net markdowns ................................................................. 60,000 Instructions Calculate the inventory at December 31, 2014, using the conventional retail inventory method. (Carry the cost ratio to two decimal places, e.g. 12.34%. Show your calculations in good form and label all amounts.) *Solution 8-123 Inventory, January 1 ......................................................... Purchases ......................................................................... Freight-in........................................................................... Net mark-ups .................................................................... .................................................................................... Net markdowns ................................................................. Totals ................................................................................ Less sales ......................................................................... Inventory, Dec. 31, at retail ............................................... Estimated inventory, Dec. 31 ($290,000 × 63.64%) ..........

At Cost $140,000 480,000 80,000 0 700,000 $700,000

At Retail $ 220,000 720,000 160,000 1,100,000 (60,000) 1,040,000 750,000 $ 290,000

Ratio

63.64%

$184,556

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 8-124 Theory What is the difference between an executory contract and and onerous contract? Solution 8-124 An executory contract is one where neither party has performed (or fulfilled) its part of the contract. No asset or liability is recognized when the contract takes effect. However, if the amounts are abnormal in relation to the entity’s normal business operations or financial position, the contract details should be disclosed in the financial statement notes. On the other hand, an onerous contract is present if the unavoidable costs of completing the contract are higher than the benefits expected from the contract. IFRS requires the entity to recognize a loss provision (IAS 37). ASPE does not require a loss provision, but normal Canadian practice is to record such a loss/liability.

Pr. 8-125 Inventory cut-off At December 31, 2014, Dakota Corp.’s perpetual inventory showed as $43,100 in the general ledger. Towards the end of 2014, a new approach for compiling inventory was used and apparently a satisfactory cut-off for preparation of financial statements was not made. Some events that occurred are as follows: 1. Units shipped to a customer January 2, 2015, costing $6,000, were included in inventory at December 31, 2014. The sale was recorded in 2015. 2. Units costing $25,000 received December 30, 2014, were recorded as received on January 2, 2015. 3. Units received during 2014 costing $4,300 were recorded twice in the general ledger. 4. Units shipped to a customer December 28, 2014, f.o.b. shipping point, which cost $14,000, were not received by the customer until January 2015. The units were included in the ending inventory. 5. Units on hand that cost $5,600 were never recorded on the books. Instructions Calculate the correct inventory at December 31, 2014. Solution 8-125 Inventory per books ............................................................................. Add: Shipment received Dec 30 ....................................................... Units on hand never recorded ..................................................

Deduct:

Units recorded twice ............................................................ Units shipped Dec 28 ..........................................................

Correct inventory, Dec 31 ....................................................................

$43,100 $25,000 5,600

4,300 14,000

30,600 73,700

18,300 $55,400

Pr. 8-126 Inventory errors An audit of the inventory records of Missouri Inc. identified a number of errors. These errors are summarized in Exhibit A below: Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Inventory

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EXHIBIT A

Year 2010 2011 2012 2013 2014

Net Income Reported $120,000 $95,000 $99,000 $105,000 $120,000

Description of Error Overstatement of ending inventory Understatement of ending inventory Understatement of ending inventory Overstatement of ending inventory Overstatement of ending inventory

$11,000 $1,500 $18,000 $20,000 $5,200

Instructions a) As financial accountant for Missouri, you have been asked to calculate the corrected net income amounts for each of the five years based on the audit findings. b) Review your solution to part a) and consider the self correcting effect of inventory errors. Why does total reported net income not equal total corrected income? Solution 8-126 a)

Year 2010 2011 2012 2013 2014

ADD: DEDUCT: DEDUCT: ADD: Beginning Beginning Ending Ending Net Income Inventory Inventory Inventory Inventory Net Income As Over Under Over Under Reported Statement Statement Statement Statement Corrected $120,000 ($11,000) $109,000 $95,000 $11,000 $1,500 $107,500 $99,000 ($1,500) $18,000 $115,500 $105,000 ($18,000) ($20,000) $67,000 $120,000 $20,000 ($5,200) $134,800 $539,000

$533,800

b) While it is true that inventory errors are self correcting, the (self) correction occurs in the accounting period following the error. For Missouri, the over-statement of the 2014 ending inventory reduces corrected 2014 income by $5,200. If that amount were to be added back to total corrected net income, it would be equal to reported net income: Total corrected net income ....................................... Add: Self correction to take effect in 2015 ........................ Total.........................................................................

$533,800 5,200 $539,000

equal to reported net income

Pr. 8-127 Analysis of errors Indicate in each of the spaces provided the effect of the described errors on the various elements Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Test Bank for Intermediate Accounting, Tenth Canadian Edition

8 - 48

of a company's financial statements. Use the following codes: O = amount is overstated; U = amount is understated; NE = no effect. Assume a periodic inventory system and that all sales and purchases are on credit. Accounts Accounts Cost of Receivable Inventory Payable Sales Goods Sold EXAMPLE: Goods in rented warehouse were excluded from inventory count. NE U NE NE O ___________________________________________________________________________ 1. Goods in transit shipped "f.o.b. destination" by supplier were recorded as a purchase but were excluded from ending inventory. ___ ___ ___ ___ ___ 2.

Goods held on consignment were included in inventory count and recorded as a purchase.

___

Goods in transit shipped "f.o.b. shipping point" were not recorded as a sale and were included in ending inventory.

___

Goods were shipped and appropriately excluded from ending inventory but sale was not recorded. ___

___

Solution 8-127 1. NE NE

Pr. 8-128 Accounting for purchase discounts Texas Corp. purchased merchandise during 2014 on credit for $200,000; terms 2/10, n/30. All of the gross liability except $30,000 was paid within the discount period. The remainder was paid within the 30-day term. At the end of the annual accounting period, December 31, 2014, 90% of the merchandise had been sold and 10% remained in inventory. The company uses the periodic inventory system. Instructions a) Assuming that the net method is used for recording purchases, prepare the entries for the purchase and two subsequent payments. b) What dollar amounts should be reported for the ending inventory and cost of goods sold Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Inventory

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under the (1) net method and (2) gross method? Assume that there was no beginning inventory. Solution 8-128 a) Purchases ..................................................................................... Accounts Payable ................................................................ To record the purchase at net amount: 98% × $200,000 = $196,000 Accounts Payable ......................................................................... Cash .................................................................................... To record payment within the discount period: $200,000 – $30,000 = $170,000 x 98% = $166,600 Accounts Payable ......................................................................... Purchase Discounts Lost............................................................... Cash .................................................................................... To record final payment

b) (1) Net method: Purchases: ............................................................................. Ending inventory: 10% × $196,000 = ...................................... Cost of goods sold: 90% × $196,000 = ...................................

196,000 196,000

166,600 166,600

29,400 600 30,000

$196,000 19,600 $176,400

(The $600 discount lost is reported in the other expense section of the income statement.)

(2) Gross method: Purchases: ........................... Less purchase discounts: ..... .02 × $170,000 = ............ Goods available ................... Final inventory:..................... 10% × $196,600 = .......... Cost of goods sold: .............. 90% × $196,600 = ..........

$200,000 3,400 196,600 19,660 $176,940

(Assuming that the $2,400 discount is prorated between the cost of goods sold, 90%, and ending inventory, 10%)

OR Purchases: .................................. Less purchase discounts: .02 × $170,000 = ................... Goods available .......................... Final inventory: 10% × $200,000 = ................. Cost of goods sold: $196,600 – $20,000 = ...........

$200,000 3,400 196,600 20,000 $176,600

(Assuming that the $2,400 discount is used to reduce cost of goods sold. Ending inventory is carried at the gross amount.)

Pr. 8-129 Year end entries to update inventory under periodic system The accountant for the Oswego chain of retail stores is getting ready to prepare the 2014 year end inventory entries for its periodic inventory system. Her assistant has provided the following information: Beginning inventory .......................................................... $88,000 Inventory purchases during year ....................................... 900,000 Ending inventory ............................................................... 62,000 Instructions Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Record the journal entry(ies) that Oswego's accountant would prepare to bring the inventory and cost of goods sold up to date for 2014. Solution 8-129 Ending inventory (Note 1)................ .................................................... Cost of goods sold (Note 2)............. .................................................... Beginning inventory (Note 3)........................ ................................. Purchases (Note 4)................................... ....................................

62,000 926,000 88,000 900,000

Note 1: To record ending inventory Note 2: To record cost of goods sold ($88,000 + $900,000 - $62,000) Note 3: To remove beginning inventory Note 4: To clear purchases account

Pr. 8-130 Gross profit method Kiowa Ltd. prepares monthly financial statements. Inventory is counted only at year end; thus, month-end inventories must be estimated. All sales are made on account. The rate of mark-up on cost is 25%. The following information relates to the month of May: Accounts receivable, May 1............................................... $31,000 Accounts receivable, May 31 ............................................. 37,000 Collections of accounts during May ................................... 94,000 Inventory, May 1 ................................................................ 47,000 Purchases during May ....................................................... 75,000 Instructions Calculate the estimated cost of the inventory on May 31. Solution 8-130 Collections of accounts ..................................................... $ 94,000 Add accounts receivable, May 31 ...................................... 37,000 Deduct accounts receivable, May 1 ................................... (31,000) Sales during May............................................................... $ 100,000 Inventory, May 1 ................................................................ Purchases during May ....................................................... Goods available for sale .................................................... COGS ($100,000 ÷ 125%) ................................................ Estimated cost of inventory, May 31 ..................................

$ 47,000 75,000 122,000 (80,000) $ 42,000

Pr. 8-131 Gross profit method In the early morning of January 1, 2015, Minnesota Corp.'s inventory was destroyed by fire. The following information was available for calendar 2014: Sales ................................................................................. $950,000 Net purchases ................................................................... 600,000 Beginning inventory ........................................................... 110,000 Minnesota’s gross profit on sales has averaged 35% for several years.

Inventory

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Instructions a) Calculate the estimated cost of the inventory destroyed. b) Prepare entries at December 31, 2014 to close the sales and merchandise accounts. Solution 8-131 a) Beginning inventory ............................................................................. $ 110,000 Add net purchases ............................................................................... 600,000 Cost of goods available ........................................................................ 710,000 Less COGS ($950,000 x 65%) ............................................................. (617,500) Estimated inventory lost ....................................................................... $ 92,500 b) Sales .................................................................................................... Income Summary .......................................................................... Cost of Goods Sold .............................................................................. Fire Loss .............................................................................................. Beginning Inventory ...................................................................... Purchases .....................................................................................

950,000 950,000 617,050 92,500 110,000 600,000

*Pr. 8-132 Retail inventory method California Corp. is preparing the financial statements at its fiscal year end, January 31, 2015. The following information is available: At Cost At Retail Inventory, February 1, 2014...................................................... $ 83,400 $ 103,400 Markdowns ............................................................................... 47,000 Mark-ups .................................................................................. 71,000 Markdown cancellations ........................................................... 22,000 Mark-up cancellations............................................................... 9,000 Purchases ................................................................................ 241,200 294,300 Sales ........................................................................................ 329,000 Purchases returns and allowances ........................................... 5,150 6,700 Sales returns and allowances ................................................... 9,000 Instructions Calculate the ending inventory at cost at January 31, 2015, using the retail method that approximates lower of average cost and market. Your solution should be in good form with amounts clearly labelled. Carry the cost ratio to two decimals, e.g. 12.34%. *Solution 8-132 At Cost Beginning inventory $ 83,400 Purchases $241,200 Less purchase returns 5,150 236,050 Totals $319,450 Add mark-ups (net) ($71,000 – $9,000) Totals Deduct markdowns (net) ($47,000 – $22,000) Sales price of goods available

At Retail $ 103,400 $294,300 6,700 287,600 391,000 62,000 453,000 25,000 428,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Sales less sales returns ($329,000 – $9,000) Ending inventory at retail

320,000 $ 108,000

Ending inventory at cost: Ratio of cost to retail = $319,450 ÷ $453,000 = 70.52% $108,000 x 70.52% = $76,162 ......................................................

$ 76,162

*Pr. 8-133 Conventional retail inventory method The records of Little Hawaii Stores included the following data: Inventory, May 1, at retail, $14,500; at cost, $10,150 Purchases during May, at retail, $42,900; at cost, $31,550 Freight-in, $2,000; purchase discounts, $500 Additional mark-ups, $3,800; mark-up cancellations, $400; net markdowns, $1,300 Sales during May, $46,700 Instructions Calculate the estimated inventory at May 31 under the conventional retail inventory method. (Carry the cost ratio to two decimal places, e.g. 12.34%.) Show your calculations in good form and label all amounts. *Solution 8-133 Inventory, May 1 ....................................................... Purchases ................................................................ Freight-in .................................................................. Purchase discounts .................................................. Net mark-ups............................................................ ................................................................................. Net markdowns ........................................................ Goods available ....................................................... Sales ........................................................................ Inventory, May 31 .....................................................

Cost $10,150 31,550 2,000 (500) 0 $43,200

Retail $14,500 42,900

3,400 60,800 (1,300) 59,500 (46,700) $12,800

Ratio

71.05%

Estimated inventory, May 31 ($12,800 × 71.05% = $9,094.40

Inventory

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CHAPTER 9 INVESTMENTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

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

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

49. 50. 51. 52. 53. 54.

2 2 2 2 2 2

M M H H H H

73. 74. 75.

2 3 3

H E E

82. 83. 84.

1 2 2

E H M

92. 93.

2 3

M H

Note:

E = Easy

Item LO LOD Item LO LOD Multiple Choice–Conceptual 13. 2 M 25. 5 M 14. 2 H 26. 5 M 15. 3 E 27. 6 M 16. 3 M 28. 6 H 17. 4 E 29. 6 M 18. 4 M 30. 6 M 19. 4 M 31. 6 M 20. 4 M 32. 6 E 21. 4 M 33. 6 H 22. 4 H 34. 6 M 23. 5 H 35. 6 M 24. 5 H 36. 6 M Multiple Choice–Computational 55. 2 H 61. 3 E 56. 2 E 62. 4 M 57. 2 M 63. 6 E 58. 2 M 64. 6 E 59. 3 M 65. 6 M 60. 3 E 66. 6 M Multiple Choice–CPA Adapted 76. 3 E 79. 6 M 77. 4 M 80. 6 H 78. 6 M 81. 6 M Exercises 85. 2,5 E 88. 4 H 86. 2,6 E 89. 6 M 87. 3,6 M 90. 6 M Problems 94. 3 E 96. 3 M 95. 3 M 97. 3 M

M = Medium

Item

LOD

37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48.

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

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

67. 68. 69. 70. 71. 72.

6 6 6 6 6 6

M M M M M E

91.

6,7

98. 99.

3,6 6

H H

H = Hard

Test Bank for Intermediate Accounting, Tenth Canadian Edition

9-2

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

1. 2.

MC MC

3. 4.

MC MC

8. 9. 10. 11.

MC MC MC MC

12. 13. 14. 49.

MC MC MC MC

15. 16. 59.

MC MC MC

60. 61. 74.

MC MC MC

17. 18.

MC MC

19. 20.

MC MC

23.

24.

27. 28. 29. 30. 31. 32.

MC MC MC MC MC MC

33. 34. 35. 36. 37. 63.

MC MC MC MC MC MC

38.

39.

42.

43.

46.

47.

Note:

MC = Multiple Choice

Item Type Item Type Learning Objective 1 5. MC 7. MC 6. MC 82. Ex Learning Objective 2 50. MC 54. MC 51. MC 55. MC 52. MC 56. MC 53. MC 57. MC Learning Objective 3 75. MC 93. Pr 76. MC 94. Pr 87. Ex 95. Pr Learning Objective 4 21. MC 62. MC 22. MC 77. MC Learning Objective 5 25. MC 26. MC Learning Objective 6 64. MC 70. MC 65. MC 71. MC 66. MC 72. MC 67. MC 78. MC 68. MC 79. MC 69. MC 80. MC Learning Objective 7 40. MC 41. MC Learning Objective 8 44. MC 45. MC Learning Objective 9 48. MC Ex = Exercise

Item

Type

Item

Type

58. 73. 83. 84.

MC MC Ex Ex

85. 86. 92.

Ex Ex Pr

96. 97. 98.

Pr Pr Pr

88.

85.

81. 86. 87. 89. 90. 91.

MC Ex Ex Ex Ex Ex

98. 99.

Pr Pr

91.

Pr = Problem

Investments

9-3

CHAPTER STUDY OBJECTIVES 1. Understand the nature of investments including which types of companies have significant investments. This chapter deals with investments in basic debt and equity instruments of other companies. Debt instruments such as bonds generally carry contractual rights to receive principal and interest payments. Equity instruments such as shares may carry contractual rights to receive dividends (depending on the type of share) and may also carry voting rights and /or rights to receive residual assets upon windup of a company. Care must be taken to determine exactly what rights the investments entitle the holder to as this will help determine the accounting. Not all companies carry significant investments. It depends on the business model. Examples of types of companies that generally carry significant investments are financial institutions, insurance companies, and pension funds.

2. Explain and apply the cost/amortized cost model of accounting for investments. At acquisition, the cost of the investment is recognized as its fair value plus transaction costs. If the investment is a debt instrument, any premium or discount is amortized to interest income. Holding gains are recognized only when realized, as are holding losses, unless the investment is impaired. The investment is reported at its cost or amortized cost as either a current asset or a long-term investment, depending on its maturity and management’s intention to hold it. ASPE uses this model for most investments excluding equity investments where an active market exists for trading the shares and derivatives. IAS 39 uses this model for debt investments where the entity has the intent and ability to hold the investment to maturity. It is also used for equity investments where the entity is unable to measure fair value. IFRS 9 uses this model for debt instruments where the entity’s business model is to hold the investments to maturity.

3. Explain and apply the fair value through net income model of accounting for investments. At acquisition, the investment is recognized at its fair value, with transaction costs being expensed. At each reporting date, the investment is revalued to its current fair value, with holding gains and losses recognized in net income. Dividend and interest income is also recognized in net income. If the investment is not held for trading purposes, any interest income is reported separately and is adjusted for discount or premium amortization. If held for trading or other current purposes, the investment is reported as a current asset. ASPE uses this for equity instruments where there is an active market and derivatives. IAS 39 uses this for held for trading securities including derivatives. IFRS 9 uses this model for all investments not accounted for under the cost/amortized cost model or the FVOCI model. ASPE and IFRS both allow any investment to be accounted for using FV–NI under the fair value option.

4. Explain and apply the fair value through other comprehensive income model of accounting for investments. At acquisition, the investment is recognized at fair value plus transaction costs. At each reporting date, the investment is revalued to its current fair value, with the holding gains or losses reported in other comprehensive income. On disposal, the accumulated holding gains or losses are either recycled to net income (IAS 39) or transferred directly to retained earnings (IFRS 9). Investments are reported as current or long-term assets, depending on marketability and management intent. ASPE does not allow this method. IAS 39 allows this method for available for sale investments. IFRS 9 allows this method for certain equity investments.

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5. Explain and apply the incurred loss, expected loss, and fair value loss impairment models. The three impairment loss models differ in the timing of the recognition of impairment losses and the discount rate used. Under the incurred loss approach, a triggering event is required before a loss is recognized and measured, and the revised cash flows are discounted using either the historical or a current market rate. Under the expected loss approach, no triggering event is required, and revised cash flows and impairment losses are determined on a continual basis. The discount rate is the historical/original rate. Using the fair value loss model, the asset is written down to fair value taking into account market information (refer back to Chapter 2). ASPE and IFRS use the incurred loss model for all cost/amortized cost investments, although the post-impairment carrying values are measured differently. IAS 39 uses the incurred loss model for FV–OCI investments once a trigger or loss event has occurred and any resulting impairment loss is recognized in net income. Under IFRS 9, impairment losses on FV–OCI investments are not recognized in net income. Where the FV–NI model is used, there is no need to specifically assess impairment because the investment is continually revalued to fair value and any gains or losses are booked to income.

6. Explain the concept of significant influence and apply the equity method. Significant influence is the ability to have an effect on strategic decisions made by an investee’s board of directors, but not enough to control those decisions. The equity method, sometimes referred to as one-line consolidation, is used because income is recognized by the investor as it is earned. The investor’s income statement will reflect the performance of the investee company. Under this method, the investment account is adjusted for all changes in the investee’s book value and for the amortization of any purchase discrepancy. IFRS requires use of the equity method for its associates (investees a company can significantly influence). ASPE provides a policy choice: either the equity method or the cost method, except that associates with a quoted price in an active market cannot be accounted for at cost. Instead, the FV–NI model can be used.

7. Explain the concept of control and when consolidation is appropriate. Control relates to the ability to direct the strategic decisions of another entity and to generate returns for your own benefit or loss. When one company controls another, it controls all the net assets of that entity and is responsible for all its revenues and expenses. Therefore, all of the subsidiary’s assets and liabilities, and revenues and expenses, are reported by the parent investor on a line-by-line basis in consolidated financial statements. The interests of the noncontrolling shareholders in the subsidiary company are reported separately as noncontrolling interest. Under IFRS, all subsidiaries are consolidated. ASPE, on the other hand, allows consolidation or a choice of the equity or cost method. Investments in companies with shares traded in an active market cannot be reported using the cost method, but may use FV–NI.

8. Explain how investments are presented and disclosed in the financial statements noting how this facilitates analysis. The objectives of disclosure are to provide information so users can assess the significance of the financial asset investments to the entity’s financial position and performance, the extent of risks to which the company is exposed as a result, and how those risks are managed. As a result, the investments are identified on the statement of financial position according to how they are classified for accounting purposes, with the income statement reporting information on the returns by method of classification. Extensive disclosure

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is required, particularly under IFRS, on the entity’s risk exposures and how it manages those risks.

9. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. The differences are noted in Illustrations 9-13, 9-14, and 9-23. There are significant differences because there are two standards currently in effect under IFRS (IAS 39 and IFRS 9) and because the standards are currently in transition. It is expected that IFRS 9 will change in order to align more closely with the proposed U.S. standard. In addition, both the IASB and FASB are looking at a new impairment model.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c b c d b a a d a c b b a b c d b c c b d a c d b c a b a d a c c c c d b c a d b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41.

Description Debt securities Investment in debt instruments Equity instruments Definition of equity security Accounting for investments Valuation of debt instruments Transaction costs Cost model for debt securities Holding gains under cost model Equity investments and the cost model Recognition of interest for bond investment Amortization of premium or discount Recording amortization of bond discount Accounting for investments in associates Holding gains with FV–NI model FV–NI model and transaction costs Unrealized gains and losses with FV–OCI Classification of comprehensive income FV–OCI with recycling Inclusions in OCI Accumulated other comprehensive income The concept of “recycling” Indications for potential impairment Impairment – incurred loss model Impairment – expected loss model Impairment – fair value loss model Equity investments and significant influence Conditions for using the equity method Significant influence Degree of control Recording of dividends received under the equity method Recognition of earnings of investee using the equity method Effect of using the cost method in error Accounting for investments in associates Accounting for investments in associates Investor paying more than book value Equity Investments traded in active market Implications of control Investing in subsidiaries Accounting for subsidiary Reporting model for control

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MULTIPLE CHOICE—Conceptual (CONTINUED) Answer d b b a c c d

No. 42. 43. 44. 45. 46. 47. 48.

Description Classification as current assets Objectives of disclosure requirements Disclosures for private entities Consolidation under IFRS and ASPE Differences in disclosure for IFRS and ASPE Transaction costs under IFRS and ASPE Treatment of interest and dividend income under IFRS and ASPE

MULTIPLE CHOICE—Computational Answer b a c d a b c c b d d a c b a b c b b a c c b c

No. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

Description Acquisition of long-term investment in bonds Recording purchase of bonds Carrying value of long-term investment in bonds – cost model Carrying value of long-term investment in bonds – cost model Calculation of income from long-term investment in bonds Calculation of income from long-term investment in bonds Determine gain on sale of bond investment Cost model of accounting for share investment Recognition of interest income from bond Calculation of bond discount to be amortized Temporary investments in equity securities Year end adjustments for FV–NI investment Accounting for fair value adjustments Accounting for fair value adjustments Equity method of accounting for share investment Equity method of accounting for share investment Equity method of accounting for share investment Equity method of accounting for share investment Equity method of accounting for share investment Balance of investment account using the equity method Investment income recognized under the equity method Balance of investment account using the equity method Balance of investment account using the equity method Investment income recognized using the equity method

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Answer d d b c b c a c d

No. 73. 74. 75. 76. 77. 78. 79. 80. 81.

Description Carrying value of long-term investment in bonds Valuation of marketable equity securities Valuation of marketable equity securities Accounting method for investment Accounting method for investment Investment income recognized under equity method Balance of investment account using the equity method Sale of share investment Calculate acquisition price of an investment in associate

EXERCISES Item E9-82 E9-83 E9-84 E9-85 E9-86 E9-87 E9-88 E9-89 E9-90 E9-91

Description Motivation for investments Investment in debt securities at a premium Investment in debt securities at a premium Investments in debt securities Cost and equity methods Cost and equity methods Sale of equity investments – FV–OCI Significant influence Investment in equity securities True-false questions

PROBLEMS Item P9-92 P9-93 P9-94 P9-95 P9-96 P9-97 P9-98 P9-99

Description Accounting for bonds – amortized cost model Temporary investments – FV–NI model Year-end adjustments for temporary investments Accounting for debt investment purchased at premium – FV–NI model Accounting for investments – FV–NI model Long-term investment – FV–NI model Equity method (ASPE) Equity method – IFRS

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MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT a debt security? a) Convertible bonds b) Commercial paper c) Loans receivable d) Government treasury bills

2. An investment in an entity's debt instruments makes that investor a(n) a) owner of the issuing entity. b) creditor of the issuing entity. c) parent company. d) subsidiary.

3. Which of the following is NOT an equity instrument? a) Common shares b) Preferred shares c) Convertible bonds d) Put options 4. Any contract that is evidence of a residual interest in an entity’s assets is called a(n) a) debt security. b) liability. c) derivative. d) equity security.

5. How investments are accounted for does NOT usually depend on a) the type of investment. b) whether the investments are bought on margin. c) management intent. d) company strategy.

6. The price of a debt instrument is quoted as a percentage of its a) face or par value. b) fair market value. c) book value. d) present value.

7. Generally, transaction costs are a) capitalized when investments are accounted for using a cost based model. b) capitalized when investments are accounted for using a fair value model. c) always expensed. d) never expensed.

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8. When the cost model is applied to an investment in debt securities, such as bonds, it is referred to as the a) equity method. b) fair value through net income model. c) fair value through other comprehensive income model. d) amortized cost model.

9. Under the cost/amortized cost model, holding gains are a) recognized in net income only when realized. b) recognized in other comprehensive income. c) recognized depending on management's intention. d) not recognized at all.

10. Equity investments that are accounted for under the cost model will result in a) recognition of dividend income only when actually received. b) expensing transaction costs when incurred. c) recognition of a gain or loss in net income at disposal. d) recognition of a gain or loss in other comprehensive income at disposal.

11. To calculate the amount of interest to recognize each period for a bond investment (unless it held for trading purposes), a) ASPE requires the use of the effective-interest method. b) IFRS requires the use of the effective-interest method. c) IFRS allows the use of either the effective-interest or the straight-line method. d) ASPE requires the use of the straight-line method.

12. The premium or discount on bonds accounted for under the cost/amortized cost model is a) amortized over the expected holding period. b) amortized over the life of the bond. c) not amortized. d) treated as a transaction cost.

13. A bond is purchased at a discount and will be accounted for under the amortized cost model. The entry to record the amortization of the discount includes a a) debit to the investment account. b) debit to “Gain from Discount.” c) debit to Interest Revenue. d) credit to the investment account.

14. Under ASPE, for accounting for investments in associates, a) the cost method must be used for all such investments. b) the fair value method can be used for shares quoted in an active market. c) the investor may use the cost method for one investment and the fair value for another.

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d) the fair value method must be used for all such investments.

15. Under the fair value through net income model, holding gains are a) recognized in other comprehensive income only. b) recognized in either net income or other comprehensive income. c) recognized in net income only. d) ignored.

16. The fair value through net income model requires that a) investments are measured at fair value. b) transaction costs are expensed. c) investments are measured at fair value and transaction costs are capitalized. d) investments are measured at fair value and transaction costs are expensed.

17. Under the fair value through other comprehensive income model, unrealized gains and losses are a) recognized in net income. b) recognized in other comprehensive income. c) recognized in either net income or other comprehensive income. d) ignored.

18. Accumulated Comprehensive income is included as part of a) retained earnings. b) net income. c) shareholders’ equity. d) unearned revenue.

19. Under the fair value through other comprehensive income model, with recycling, previously unrealized holding gains and/or losses to the date of disposal are a) ignored. b) transferred to Retained Earnings. c) transferred to net income. d) transferred to “Unrealized Gain or Loss – OCI.”

20. Other comprehensive income does NOT include a) comprehensive income. b) net income. c) unrealized gains resulting from the application of the fair value through other comprehensive income model. d) unrealized losses resulting from the application of the fair value through other comprehensive income model.

21. Accumulated other comprehensive income includes a) current year's net income.

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b) all previous debits to other comprehensive income. c) all previous credits to other comprehensive income. d) all previous debits and credits to other comprehensive income.

22. The concept of recycling within the context of investments a) refers to the transfer of previously unrealized gains or losses to net income. b) refers to the switch of income between different investments categories. c) should be used in the fair value through net income model. d) should not be used in the fair value through other comprehensive income model.

23. Which of the following situations would NOT necessarily indicate the potential impairment of the underlying securities? a) The issuing entity is experiencing major financial difficulties. b) The issuing entity is unable to pay its liabilities. c) The issuing entity has temporarily halted dividend payments in order to retain cash for future expansion. d) The issuing entity is undergoing a major reorganization.

24. Assuming the revised amount and timing of cash flows for an investment can be reasonably determined, the incurred loss impairment model uses which discount rate? a) the investor’s internal rate of return b) the historical interest rate c) the current market rate d) either the historical rate or the current market rate.

25. Assuming the revised amount and timing of cash flows for an investment can be reasonably determined, the expected loss impairment model uses which discount rate? a) the investor’s internal rate of return b) the historical interest rate c) the current market rate d) either the historical rate or the current market rate

26. The fair value loss impairment model a) is used for all investments that are not accounted for as FV–NI. b) requires a separate impairment test. c) calculates the impairment loss as the difference between the asset’s fair value and its current carrying amount. d) calculates the impairment loss as the difference between the asset’s original cost and its current carrying amount.

27. The accounting for investments in another entity's equity instruments depends mainly on a) the level of influence the investor is able to exert. b) the level of influence the investor actually exerts. c) the quality of earnings of the investee. d) whether the investee pays dividends.

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28. When a public company holds between 20% and 50% of the outstanding common shares of an investee, which of the following statements applies? a) The investor should always use the equity method to account for its investment. b) The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise "significant influence" over the investee. c) The investor must use the cost method unless it can clearly demonstrate the ability to exercise "significant influence" over the investee. d) The investor should always use the cost method to account for its investment.

29. An investor who owns 15% of an entity's voting shares can a) potentially have influence over the investee if the shares are widely held. b) always be assumed to have little or no influence over the investee. c) be assumed to be using the cost model. d) be assumed to always use the equity method.

30. An investor who owns 11% of an entity's voting shares a) must use the equity method. b) would be likely to prepare consolidated statements. c) may have significant influence over the investee if the shares are closely held. d) may have significant influence over the investee if the shares are widely held.

31. Olde Corp. accounts for its investment in the common shares of Young Inc. under the equity method. Olde Corp. should record a cash dividend received from Young as a) a reduction of the carrying value of the investment. b) additional paid-in capital. c) an addition to the carrying value of the investment. d) dividend income.

32. Under the equity method of accounting for investments, an investor recognizes its share of the earnings in the period in which the a) investor sells the investment. b) investee declares a dividend. c) earnings are reported by the investee in its financial statements. d) investee pays a dividend.

33. Jabba Inc. owns 35% of Hutt Corp., and has significant influence over Hutt. During the calendar year 2014, Hutt reported net income of $300,000 and paid dividends of $30,000. Jabba mistakenly recorded these transactions using the cost method rather than the equity method of accounting. What effect would this have on Jabba’s investment account, net income, and retained earnings, respectively? a) understate, overstate, overstate b) overstate, understate, understate c) understate, understate, understate d) overstate, overstate, overstate

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34. When an investor is using the equity method and receives dividends from the investee, the journal entry will include a a) credit to Dividend Income. b) credit to Retained Earnings. c) credit to the Investment account. d) debit to the Investment account.

35. When an investor is using the equity method and the investee reports a net loss, the journal entry will include a a) debit to the Investment account. b) debit to Retained Earnings. c) credit to the Investment account. d) credit to Investment Income or Loss. 36. When an investor, using the equity method, pays more than its share of the investee’s book value, the difference is a) ignored. b) accounted for on the investor’s books by a debit to Goodwill. c) accounted for on the investee’s books by a debit to Goodwill. d) requires that the investor’s Investment account and any investment income from the associate be adjusted over time.

37. Current IFRS rules for equity investments that are traded in an active market require that they a) can be accounted for under the cost model. b) can be accounted for under the fair value through net income model. c) should generally be accounted for under the fair value through other comprehensive income model. d) cannot be accounted for under the fair value through net income model.

38. When one corporation has control over another corporation, the investor corporation a) is referred to as an associate. b) is referred to as the subsidiary. c) can determine the investee’s strategic operating and financing policies. d) must have obtained at least 50% of the investee’s issued common shares.

39. An investor who has subsidiaries a) is required to prepare consolidated financial statements under IFRS. b) is required to prepare consolidated financial statements under ASPE. c) does not have to prepare consolidated financial statements under IFRS. d) ignores the noncontrolling interest on the consolidated financial statements.

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40. If a parent company owns 90% of a subsidiary’s outstanding shares, the parent should generally account for the subsidiary's income under the a) cost/amortized cost model. b) fair value through net income model. c) fair value through other comprehensive model. d) consolidation method.

41. When the investor has control over the investee, the reporting model to be used is the a) cost model. b) consolidation model. c) market value model. d) equity method.

42. Under IFRS, which of the following is NOT a condition for an investment to be classified as current? a) It is held primarily for trading purposes. b) It is a cash equivalent. c) It must be expected to be sold or realized within 12 months from the balance sheet date. d) It must be accounted for under the cost model.

43. The objectives of disclosures required for investments in debt and equity investments do NOT include a) how significant the investments are to the investor's financial position and performance. b) whether the investments are classified as current or long-term. c) the nature and extent of the risks that the investor faces as a result of the investments. d) how the risks that the investor faces as a result of the investments are managed.

44. The disclosure requirements for private entities are usually less extensive as compared to those for public entities because a) investors in private entities are expected to have less information about the company. b) investors in private entities are expected to have more information about the company. c) investors in private entities tend to be more sophisticated. d) investors in private entities tend to be less sophisticated.

45. The standards relating to consolidation differ under ASPE and IFRS. Which of the following statements best describes the difference? a) IFRS requires consolidation whereas ASPE offers a choice of methods. b) ASPE requires consolidation whereas IFRS offers a choice of methods. c) Consolidation is specifically excluded as one of the choices under ASPE. d) Consolidation is specifically excluded as one of the choices under IFRS.

46. Which of the following is a reason for the differences in the disclosure requirements for investments in associates under IFRS and ASPE? a) ASPE requires that the associate must be a private entity. b) ASPE does not include an "associates" category.

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c) ASPE allows the use of methods other than the equity method. d) ASPE does not allow the equity method.

47. The standards relating to the treatment of transaction costs differ under ASPE and IFRS. Which of the following statements best describe the difference? a) ASPE requires that transaction costs are capitalized, except for those investments that are accounted for under the fair value through net income model. b) ASPE requires that transaction costs are expensed whenever cost-based measures are used. c) IFRS requires that transaction costs are capitalized except for those investments that are accounted for under the fair value through net income model. d) IFRS requires that all transaction costs are capitalized.

48. The standards relating to the treatment of interest and dividend income differ under ASPE and IFRS. Which of the following statements is INCORRECT? a) IFRS requires the use of the effective interest method when interest income is to be reported separately. b) IFRS requires certain dividends to be recognized in other comprehensive income. c) ASPE allows the use of either the straight-line or effective interest method. d) When using the equity method, IFRS allows a dividend from an investee to be recorded as income, while ASPE does not.

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MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

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

c b c d b a a d a c

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

b b a b c d b c c b

21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

d a c d b c a b a d

31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

a c c c c d b c a d

41. 42. 43. 44. 45. 46. 47. 48.

b d b b a c c d

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 49. On August 1, 2014, Harley Inc. acquired $180,000 (face value) 10% bonds of Davidson Corporation at 104 plus accrued interest. The bonds were dated May 1, 2014, and mature on April 30, 2017, with interest payable each October 31 and April 30. The bonds will be held to maturity. Assuming the amortized cost model is used, the entry to record the purchase of the bonds on August 1, 2014 is a) Investment in Bonds ............................ 191,700 Cash ............................................. 191,700 b) Investment in Bonds ............................ 187,200 Interest Revenue ................................. 4,500 Cash ............................................. 191,700 c) Investment in Bonds ............................ 191,700 Interest Revenue .......................... 4,500 Cash ............................................. 187,200 d) Investment in Bonds ............................ 180,000 Premium on Bonds .............................. 11,700 Cash ............................................. 191,700

50. On August 1, 2014, Canmore Corp. acquired 20, $1,000, 9% bonds at 97 plus accrued interest. The bonds were dated May 1, 2014, and mature on April 30, 2020, with interest paid semiannually on October 31 and April 30. The bonds will be held to maturity. Assuming the amortized cost model is used, the entry to record the purchase of the bonds on August 1, 2014 is a) Investment in Bonds ............................ 19,400 Interest Revenue ................................. 450 Cash ............................................. 19,850 b) Investment in Bonds ............................ 19,850 Cash ............................................. 19,850 c) Investment in Bonds ............................ 19,400 Interest Receivable .............................. 450 Cash ............................................. 19,850 d) Investment in Bonds ............................ 20,000 Interest Revenue ................................. 450 Discount on Debt Securities .......... 600 Cash ............................................. 19,850

51. On October 1, 2014, Golden Corp. purchased 800, $1,000, 9% bonds for $792,000, which included $12,000 accrued interest. The bonds, which mature on February 1, 2023, pay interest semiannually on February 1 and August 1. The bonds will be held to maturity. Golden uses the straight-line method of amortization. The bonds, which are accounted for under the amortized cost model, should be reported in the December 31, 2014 balance sheet at a carrying value of a) $792,240. b) $780,000. c) $780,600. d) $792,000.

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52. On November 1, 2014, Bieber Ltd. purchased 300 of the $1,000 face value, 9% bonds of Justin Corp., for $316,000, which included accrued interest of $4,500. The bonds, which mature on January 1, 2019, pay interest semiannually on March 1 and September 1. The bonds will be held to maturity. Assuming that Bieber uses the straight-line method of amortization and that the bonds are accounted for under the amortized cost method, the carrying value of the bonds should be shown on Bieber's December 31, 2014 balance sheet at a) $316,000. b) $300,000. c) $311,500. d) $311,040.

53. On November 1, 2014, Heckell Corp. purchased 10-year, 9%, bonds with a face value of $360,000, for $324,000. An additional $10,800 was paid for the accrued interest, which is paid semiannually on January 1 and July 1. The bonds mature on July 1, 2021 and will be held to maturity. Heckell uses the straight-line method of amortization and the amortized cost method for these bonds. Ignoring income taxes, the amount to be reported in Heckell’s 2014 income statement as a result of this investment is a) $6,300. b) $6,000. c) $5,400. d) $4,800.

54. On October 1, 2014, Claremont Corp. purchased 250, $1,000, 9% bonds for $260,000. An additional $7,500 was paid for the accrued interest, which is paid semiannually on December 1 and June 1. The bonds mature on December 1, 2018 and will be held to maturity. Claremont uses the straight-line method of amortization and the amortized cost model for these bonds. Ignoring income taxes, the amount to be reported in Claremont's 2014 income statement as a result of this investment is a) $3,750. b) $5,025. c) $5,625. d) $6,225.

55. During 2014, Brandon Inc. purchased 2,000, $1,000, 9% bonds. The bonds mature on March 1, 2019, and pay interest on March 1 and September 1. The carrying value of the bonds at December 31, 2014 was $1,960,000. On September 1, 2015, after the semiannual interest was received, Brandon sold half of these bonds for $988,000. Brandon uses straight-line amortization and has accounted for the bonds under the amortized cost model. The gain on the sale is a) $11,200. b) $8,000. c) $4,800. d) $0.

56. On January 2, 2014, Hull Corp. purchased 200 of the 1,000 outstanding common shares of Gatineau Ltd. for $120,000. During 2014, Gatineau declared total cash dividends of $20,000

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and reported net income for the year of $80,000. If Hull uses the cost model to account for its investment in Gatineau, Hull’s Investment in Gatineau Ltd. account at December 31, 2014 should be a) $136,000. b) $132,000. c) $120,000. d) $116,000.

Use the following information for questions 57–58. On July 1, 2014, Harry Ltd. purchased $200,000 (par value) of Prince’s 8% bonds. Because the market rate was 9%, Harry purchased them for $186,992. The bonds pay interest semiannually on December 31 and June 30. Harry uses the amortized cost model and the effective interest method to recognize interest income on bond investments.

57. Rounding values to the nearest dollar (if necessary), the entry to recognize receipt of the first interest payment on December 31, 2014 will include a a) Debit to Cash of $9,000. b) Credit to Interest Income of $8,415. c) Debit to Cash of $8,415. d) Credit to Interest Income of $8,000.

58. Rounding values to the nearest dollar (if necessary), the bond discount to be amortized on December 31, 2014 is a) $8,415. b) $8,000. c) $7,585. d) $415.

59. On its December 31, 2014 balance sheet, Holly Corp. reported a short-term investment in equity securities, under the fair value through net income model, at $660,000. At December 31, 2015, the fair value of the securities was $700,000. What should Holly report on its 2015 income statement as a result of the increase in fair value of the investments during 2015? a) $0. b) Loss on investments of $40,000. c) Unrealized gain of $40,000. d) Investment income of $40,000.

60. Ruskin Inc. owns bonds that are accounted for under the fair value through net income model. On December 31, 2014, the bonds have a carrying value of $124,365. The fair value at that date is $123,000. The entry to record the year-end adjustment is a) Investment Income or Loss ........................... 1,365 FV–NI Investments ................................ 1,365 b) Unrealized Holding Loss on FV–OCI Investments 1,365 FV–NI Investments ................................ 1,365 c) FV–NI Investments ....................................... 1,365

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Unrealized Holding Gain on FV–NI Investments d) No adjustment is required.

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1,365

61. At December 31, 2014, Morgan Corp.’s stock investment portfolio, which is being accounted for by the fair value through net income (FV–NI) model, shows a general ledger balance of $214,500. It is determined that the fair value of the securities is actually $225,400. The entry to adjust the portfolio to fair value will include a a) Debit to Investment Income or Loss of $10,900. b) Credit to Cash of $10,900. c) Debit to FV–NI Investments of $10,900. d) Credit to FV–NI Investments of $10,900.

62. At December 31, 2014, Swift Current Inc. has the following portfolio of common shares in which it does not have significant influence: Cost Fair Value Barrick Corp. $100,000 $120,000 Chester Inc. 200,000 205,000 Dooley Ltd. 300,000 500,000 $600,000 $825,000 Assuming Swift Current uses the fair value through other comprehensive income (FV–OCI) model to account for this portfolio of investments, the most informative entry to record the yearend adjustment is a) FV–OCI Investments .................................... 225,000 Unrealized Gain or Loss–OCI ................ 225,000 b) FV–OCI Investment in Barrick Corp. ............. 20,000 FV–OCI Investment in Chester Inc. .............. 5,000 FV–OCI Investment in Dooley Ltd................. 200,000 Unrealized Gain or Loss–OCI on Barrick Corp. 20,000 Unrealized Gain or Loss–OCI on Chester Inc. 5,000 Unrealized Gain or Loss–OCI on Dooley Ltd. 200,000 c) Unrealized Gain or Loss–OCI on Barrick Corp. 20,000 Unrealized Gain or Loss–OCI on Chester Inc. 5,000 Unrealized Gain or Loss–OCI on Dooley Ltd. 200,000 FV–OCI Investment in Barrick Corp. ...... 20,000 FV–OCI Investment in Chester Inc......... 5,000 FV–OCI Investment in Dooley Ltd. ......... 200,000 d) Unrealized Gain or Loss–OCI ....................... 225,000 FV–OCI Investments.............................. 225,000

Use the following information for questions 63–66. The summarized balance sheets of Thunder Bay Corp. and Fort William Corp. at December 31, 2014 are as follows: THUNDER BAY CORP. Balance Sheet December 31, 2014 Assets ......................................................................................... $400,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Liabilities ..................................................................................... $ 50,000 Common shares.......................................................................... 200,000 Retained earnings ....................................................................... 150,000 Total equities .............................................................................. $400,000 FORT WILLIAM CORP. Balance Sheet December 31, 2014 Assets ......................................................................................... $300,000 Liabilities ..................................................................................... $ 75,000 Common shares.......................................................................... 185,000 Retained earnings ....................................................................... 40,000 Total equities .............................................................................. $300,000

63. If Thunder Bay acquired a 20% interest in Fort William on December 31, 2014 for $65,000 and the equity method of accounting for the investment were used, the amount of the debit to Investment in Fort William Corp. would have been a) $65,000. b) $60,000. c) $45,000. d) $37,000.

64. If Thunder Bay acquired a 30% interest in Fort William on December 31, 2014 for $75,000 and the equity method of accounting for the investment were used, the amount of the debit to Investment in Fort William Corp. would have been a) $90,000. b) $75,000. c) $67,500. d) $60,000.

65. If Thunder Bay acquired a 20% interest in Fort William on December 31, 2014 for $45,000, and during 2015 Fort William reported net income of $25,000 and paid a total cash dividend of $10,000, applying the equity method would give a debit balance in the Investment in Fort William Corp. account at the end of 2015 of a) $37,000. b) $45,000. c) $48,000. d) $50,000.

66. If Thunder Bay acquired a 30% interest in Fort William on December 31, 2014 for $67,500 and during 2015 Fort William reported net income of $25,000 and paid a total cash dividend of $30,000, applying the equity method would give a debit balance in the Investment in Fort William Corp. account at the end of 2015 of a) $67,500. b) $66,000. c) $62,500.

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d) $58,500.

67. On January 2, 2014, Hull Corp. purchased 200 of the 1,000 outstanding common shares of Gatineau Ltd. for $120,000. During 2014, Gatineau declared total cash dividends of $20,000 and reported net income for the year of $80,000. If Hull uses the equity method of accounting for its investment in Gatineau, Hull’s Investment in Gatineau Ltd. account at December 31, 2014 should be a) $136,000. b) $132,000. c) $120,000. d) $116,000.

Use the following information for questions 68–69. During calendar 2014, Caraway Corp. reported net income of $60,000 and paid total cash dividends of $20,000. Seed Inc. owns 3,000 of the 10,000 outstanding shares of Caraway and exercises significant influence.

68. What amount should Seed show in the investment account at December 31, 2014 if the beginning of the year balance in the account was $80,000? a) $92,000. b) $98,000. c) $80,000. d) $120,000.

69. How much income from its Investment in Caraway should Seed report in 2014? a) $60,000. b) $20,000. c) $18,000. d) $30,000.

70. On December 31, 2014, Ryan Corp. acquired a 60% interest in Gosling Corp. for $315,000. During 2015, Gosling reported net income of $200,000 and paid total cash dividends of $50,000. Assuming Ryan uses the equity method, at December 31, 2015, the balance in the investment account should be a) $465,000. b) $435,000. c) $405,000. d) $315,000. Use the following information for questions 71–72. Red Corp. owns 3,000 of the 10,000 outstanding common shares of Grey Corp. and exercises significant influence. During 2014, Grey reported net income of $120,000 and paid total cash dividends of $40,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

71. If the beginning 2014 balance in the Investment In Grey Corp. account was $180,000, the balance at December 31, 2014 should be a) $260,000. b) $204,000. c) $180,000. d) $132,000.

72. Red Corp. should report investment revenue for 2014 of a) $12,000. b) $24,000. c) $36,000. d) $48,000.

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Investments

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

49. 50. 51. 52.

b a c d

53. 54. 55. 56.

a b c c

57. 58. 59. 60.

b d d a

61. 62. 63. 64.

c b a b

65. 66. 67. 68.

c b b a

69. 70. 71. 72.

c c b c

DERIVATIONS—Computational No. Answer 49. b

50.

51. 52.

c d

53. 54. 55.

a b c

56. 57. 58. 59. 60. 61. 62.

c b d d a c b

63. 64. 65. 66. 67. 68. 69. 70.

a b c b b a c c

Derivation Dr. Investment in Bonds: $180,000 × 1.04 = $187,200 Dr. Interest Revenue: $180,000 × .10% × 3 ÷ 12 = $4,500 Cr. Cash: $187,420 + $4,500 = $191,700 Dr. Investment in Bonds: 20 × $1,000 × .97 = $19,400 Dr. Interest Revenue: $20,000 × 9% × 3 ÷ 12 = $450 Cr. Cash: $19,400 + $450 = $19,850 $780,000 + ($20,000 × 3÷100) = $780,600 $316,000 – $4,500 = $311,500 $311,500 – ($11,500 × 2 ÷ 50) = $311,040 ($360,000 × .045) – $10,800 + ($36,000 × 2÷80) = $6,300 ($250,000 × .09 × 3 ÷ 12) – ($10,000 × 3÷50) = $5,025 Discount amortization: $40,000 × 8÷50 = $6,400 ($1,960,000 + $6,400) ÷ 2 = $983,200; $983,200 – $988,000 = $4,800 gain $120,000, acquisition cost Interest income = $186,992 x 9% x 6 ÷ 12 = $8,415 rounded Cash received $8,000; interest income $8,415; discount amortized $415 $700,000 – $660,000 = $40,000 $124,365 – $123,000 = $1,365 unrealized holding loss $225,400 – $214,500 = $10,900 increase to investment account $120,000 – $100,000 = $20,000 gain for Barrick $205,000 – $200,000 = $5,000 gain for Chester $500,000 – $300,000 = $200,000 gain for Dooley $65,000, acquisition cost $75,000, acquisition cost $45,000 + ($25,000 x .2) – ($10,000 x .2) = $48,000 $67,500 + ($25,000 × .3) – ($30,000 × .3) = $66,000 $120,000 + ($80,000 × .2) – ($20,000 × .2) = $132,000 $80,000 + ($60,000 × .3) – ($20,000 × .3) = $92,000 $60,000 × .3 = $18,000 $315,000 + ($200,000 × .6) – ($50,000 × .6) = $405,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

71. 72.

b c

$180,000 + ($120,000 × .3) – ($40,000 × .3) = $204,000 $120,000 × .3 = $36,000

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MULTIPLE CHOICE—CPA Adapted 73. On October 1, 2014, Moray Ltd. purchased 500 of the $1,000 face value, 8% bonds of Eel Ltd. for $585,000, including accrued interest of $10,000. The bonds, which mature on January 1, 2021, pay interest semiannually on January 1 and July 1. Moray used the straight-line method of amortization and appropriately recorded the bonds as long-term. On Moray's December 31, 2015 balance sheet, the carrying value of the bonds would be a) $575,000. b) $570,000. c) $568,000. d) $560,000. 74. Kipper Corp. began operations in 2014. An analysis of Kipper’s equity securities portfolio acquired in 2014 shows the following totals at the end of the year. Kipper accounts for these investments using the fair value through net income (FV–NI) model. Total cost $228,000 Total fair market value 192,000 Based on this information, what amount should Kipper report in its 2014 income statement for “Investment Income or Loss”? a) $16,000 loss b) $20,000 gain c) $36,000 gain d) $36,000 loss

75. At December 31, 2014, Escargot Corp. has the following equity securities (no significant influence) that were purchased earlier in 2014, its first year of operation: Cost Market Security A $ 40,000 $ 41,500 B 56,000 62,000 Totals $ 96,000 $ 103,500 If the investments are being accounted for under the fair value through net income (FV–NI) model, the total book value of the investment accounts should a) be decreased by $7,500. b) be increased by $7,500. c) be decreased by $16,000. d) remain unchanged.

76. In January 2014, Haddock Ltd. had purchased an investment for $150,000. By December 31, 2014, the fair market value of that investment had increased by $20,000. Assuming this gain was included in the company's 2014 net income, which accounting method did Haddock use to account for this investment? a) Cost b) Fair value through other comprehensive income (FV–OCI) c) Fair value through net income (FV–NI) d) Equity

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

77. Salmon Corporation purchased an investment in 2014 (an equity investment without significant influence). The purchase price of $94,000 included transaction costs of $1,000. Assuming the transaction costs were capitalized and Salmon follows IFRS, which accounting method did Salmon NOT use to account for this investment? a) Amortized cost b) Fair value through net income (FV–NI) c) Fair value through other comprehensive income (FV–OCI) d) Equity

Use the following information for questions 78–80. On January 1, 2014, Abalone Ltd. acquired 30% of Flounder Corp.'s common shares for $240,000. During 2014, Flounder reported net income of $100,000 and paid total dividends of $60,000. Abalone's 30% interest in Flounder gives Abalone the ability to exercise significant influence over their operating and financial policies. During 2015, Flounder reported net income of $150,000 and paid total dividends of $30,000 on April 1 and $40,000 on October 1. On July 1, 2015, Abalone sold half of its shares in Flounder for $158,000 cash.

78. Before income taxes, what income should Abalone include in its 2014 income statement as a result of this investment? a) $100,000 b) $60,000 c) $30,000 d) $18,000

79. The carrying amount of this investment in Abalone's December 31, 2014 balance sheet should be a) $252,000. b) $240,000. c) $270,000. d) $275,000.

80. The gain on sale of this investment in Abalone's 2015 income statement should be a) $8,000. b) $20,750. c) $25,250. d) $32,000.

81. On January 1, 2014, Scallop Corp. purchased 25% of Prawn Corp.'s common shares; no goodwill resulted from the purchase. Scallop correctly uses the equity method to account for this investment at equity. The Investment in Associate account related to the Scallop investment was reported on the December 31, 2014 balance sheet at $360,000. Prawn had reported net income of $225,000 for calendar 2014, and paid dividends totaling $90,000 during 2014. How much did Scallop pay for its 25% interest in Prawn? a) $393,750

Investments

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b) $382,500 c) $360,000 d) $326,250

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

73. 74.

d d

75. 76.

b c

77. 78.

b c

79. 80.

a c

81.

DERIVATIONS—CPA Adapted No. Answer 73. d

74. 75. 76. 77. 78. 79. 80.

d b c b c a c

81.

Derivation $585,000 – $10,000 = $575,000 15 $575,000 – ($75,000 × —––) = $560,000 75 $192,000 – $228,000 = $36,000 loss $103,500 – $96,000 = $7,500 gain Conceptual Conceptual $100,000 × 30% = $30,000 $240,000 + $30,000 – ($60,000 × 30%) = $252,000 $252,000 – ($30,000 × 30%) + ($150,000 × 50% × 30%) = $265,500 $158,000 – ($265,500 ÷ 2) = $25,250 $360,000 – ($225,000 × 25%) + ($90,000 × 25%) = $326,250

Investments

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EXERCISES Ex. 9-82 Motivation for investments List three reasons why an organization would make investments. Solution 9-82 1. for the returns provided (interest, dividends, capital appreciation) 2. to develop a special relationship with a supplier or customer. 3. to establish a long-term operating relationship with the investee (usually by influencing or controlling the investee)

Ex. 9-83 Investment in debt securities at a premium On April 1, 2014, Margarita Corp. purchased 6%, $120,000 (par value) bonds for $124,725 plus accrued interest. Interest is paid on July 1 and January 1 and the bonds mature on July 1, 2019. Margarita uses the amortized cost model to account for this investment, and intends to hold the bonds to maturity. Margarita Corp. follows ASPE. Instructions a) Prepare the journal entry to record the purchase. b) The bonds are sold on November 1, 2015 at 103 plus accrued interest. Amortization was recorded when interest was received by the straight-line method. Prepare all entries required to properly record the sale. Round values to the nearest dollar, if necessary. Solution 9-83 a) Bond Investment at Amortized Cost ........................... Interest Income ($120,000 × .06 × 3 ÷ 12).................. Cash.................................................................... Discount on bond: $124,725 – $120,000 = $4,725 b)

Interest Income ($4,725 × 4 ÷ 63) .............................. Bond Investment at Amortized Cost .................... Cash ($120,000 × .06 × 4 ÷ 12).................................. Interest Income ................................................... Cash .......................................................................... Gain on Sale of Investments................................ Bond Investment at Amortized Cost .................... $124,725 – ($4,725 x 19 ÷ 63)

124,725 1,800 126,525

300 300 2,400 2,400 123,600 300 123,300

Ex. 9-84 Investment in debt securities at a premium On January 1, 2014, Genevieve Ltd. purchased 8%, $100,000 (par value) bonds for $108,530. The bonds were purchased to yield 6%. Interest is paid on July 1 and January 1 and the bonds mature on January 1, 2019. Genevieve uses the amortized cost method and the effective interest method to amortize the premium. Genevieve has a year end of December 31. and follows ASPE. Instructions

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a) b) c)

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Prepare the journal entry to record the purchase. Prepare the journal entries for the receipt of interest and amortization of the premium for the remainder of 2014. Round all values to the nearest dollar. To the nearest dollar, what is the carrying value of the investment at the end of 2015?

Solution 9-84 a) Bond Investment at Amortized Cost ........................... Cash.................................................................... b)

July 1, 2014 Cash .......................................................................... Interest Income ................................................... Bond Investment at Amortized Cost .................... $108,530 × .06 × .5 = $3,256 December 31, 2014 Interest Receivable .................................................... Interest Income ................................................... Bond Investment at Amortized Cost .................... ($108,530 – $744) × .06 × .5 = $3,234

108,530 108,530

4,000 3,256 744

4,000 3,234 766

($108,530 – $744 – $766) × .06 × .5 = $3,211; $4,000 – $3,211 = $789 ($108,530 – $744 – $766 – $789) × .06 × .5 = $3,187; $4,000 – $3,187 = $813 Carrying value at the end of 2015: ($108,530 – $744 – $766 – $789 – $813) = $105,418

Ex. 9-85 Investments in debt securities Presented below are unrelated cases involving investments in debt securities. Case 1: A company owns another firm's debt securities in the form of bonds. The bonds were acquired at a discount and are accounted for under the amortized cost model. Case 2: An investment in notes receivable that had been held for several years is being sold. The investment was accounted for under the amortized cost model. Case 3: A portfolio of debt investments has been determined to be impaired. Instructions Indicate the accounting required and/or available for each individual case. Solution 9-85 Case 1: The bonds would have been recognized at their fair value plus transaction costs. The discount would be amortized to net income over the life of the bond. Case 2: The accrued interest and discount or premium would have to be updated up to the date of disposal. The resulting gain or loss (difference between carrying value and sales proceeds) would be recognized in net income and the investment would be removed from the investor's books.

Investments

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Case 3: Depending on whether ASPE or IFRS is followed, once the investment has been determined to be impaired, three different models are available to recognize the loss: the incurred loss impairment model, the expected loss impairment model, and the fair value loss impairment model.

Ex. 9-86 Cost and equity methods Compare the cost and equity methods of accounting for investments in stocks subsequent to acquisition (when permitted by ASPE). Solution 9-86 Under the cost method, the investment is originally recorded at fair value plus any direct transaction costs, i.e. cost. The investment remains at this value unless the investment becomes impaired. Dividends are reported as income. Similarly, under the equity method, the investment is originally recorded at cost. Subsequently, however, the investment account is adjusted for the investor's share of the investee's net income or loss and this amount is recognized in the net income of the investor. Dividends received from the investee are recorded as reductions in the investment account.

Ex. 9-87 Cost and equity methods Fill in the dollar changes caused in the Investment account and Dividend Income or Investment Income account by each of the following transactions, assuming Norah Corp. uses a) the fair value through net income (FV–NI) method and b) the equity method for accounting for its investments in Jessica Ltd. a) FV–NI Method b) Equity Method Investment Dividend Investment Investment Transaction Account Income Account Income or Loss —————————————————————————————————————————— 1. At the beginning of Year 1, Norah bought 30% of Jessica's common shares at their book value. At this time, the book value of all Jessica's common shares was $450,000. —————————————————————————————————————————— 2. During Year 1, Jessica reported $25,000 net income and paid a total of $12,500 in dividends. —————————————————————————————————————————— 3. During Year 2, Jessica reported $10,000 net income and paid a total of $12,500 in dividends. —————————————————————————————————————————— 4. During Year 3, Jessica reported a net loss of $6,000 and paid a total of $2,500 in dividends. —————————————————————————————————————————— 5. Indicate the Year 3 ending balance in the Investment account, and cumulative totals

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

for Years 1, 2, and 3 for dividend income and investment income. —————————————————————————————————————————— Solution 9-87 a) FV–NI Method Investment Dividend Account Income

b) Equity Method Investment Investment Transaction Account Income or Loss —————————————————————————————————————————— 1. 135,000 135,000 —————————————————————————————————————————— 2. 7,500 7,500 3,750 (3,750) —————————————————————————————————————————— 3. 3,000 3,000 3,750 (3,750) —————————————————————————————————————————— 4. (1,800) (1,800) 750 (750) —————————————————————————————————————————— 5. 135,000 8,250 135,450 8,700 —————————————————————————————————————————— Ex. 9-88 Sale of equity investment – fair value through other comprehensive income Rowena Corp., a company that follows IFRS, holds 10,000 preferred shares of Tabitha Corp. The investment is not considered significant and has been accounted for under the fair value through other comprehensive income (FV–OCI) model. In previous years, Rowena had recorded a cumulative total of $15,000 (Cr) in “Unrealized Gain or Loss–OCI” in connection with the Tabitha investment. The shares are sold for $275,000, which is $12,000 more than the current carrying value of $263,000. Instructions Prepare the following entries: a) the entry required to adjust this investment to its fair value at the date of sale. b) the sale of the investment. c) the reclassification entry assuming Rowena uses FV–OCI with recycling. d) the reclassification entry assuming Rowena uses FV–OCI without recycling. Solution 9-88 a) FV–OCI Investments .................................................. Unrealized Gain or Loss–OCI ..............................

12,000

Cash .......................................................................... FV–OCI Investments ...........................................

275,000

Unrealized Gain or Loss–OCI ($15,000 + $12,000) .... Gain on Sale of Investments................................

27,000

12,000

275,000

27,000

Investments

Unrealized Gain or Loss–OCI..................................... Retained Earnings ...............................................

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27,000 27,000

Ex. 9-89 Significant influence Describe how to determine if an investment results in significant influence. Solution 9-89 If the ownership is less than 20%, it is presumed that the investor does not have significant influence. However, if there is evidence indicating that such influence exists, such as the investor having seats on the board of directors, then the investment should be accounted for as one with significant influence. If the ownership is 20% or greater, then it is presumed the investor has significant influence. If the facts of the situation indicate that there is not significant influence, such as the existence of a larger shareholder and the investor having no seats on the board of directors, then the investment should be accounted for as one without significant influence.

Ex. 9-90 Investment in equity securities On January 1, 2014, Sally Corp. acquired 30% of Wally Ltd.’s common shares for $500,000. At that time, Wally had 1 million no par common shares issued and outstanding. During 2014, Wally paid total cash dividends of $220,000, and later declared and issued a 5% common stock dividend when the market value was $2 per share. Wally's net income for 2014 was $480,000. Sally is using the equity method to account for this investment. What should be the balance in Sally’s investment account at the end of 2014? Solution 9-90 Cost ........................................................................... Share of net income (.3 × $480,000) .......................... Share of dividends (.3 × $220,000) ............................ Balance in investment account ...................................

$500,000 144,000 (66,000) $578,000

Ex. 9-91 True-false questions Mark T or F in the left margin opposite the question number. When one entity (investor) acquires the shares of another entity (investee) and the investment results in significant influence: ___ 1. The investor may use the equity method to account for the investment if certain conditions are met and ASPE is followed. ___ 2. Under IFRS, the investment would generally require more extensive disclosures. ___ 3. The investor may use the cost method to account for the investment if certain conditions are met and IFRS is followed. When an investor follows IFRS in accounting for its investments: ___ 4. Transaction costs must be capitalized except when the investment is accounted for under the fair value through net income model. ___ 5. Gains and losses are always recognized in net income. ___ 6. Investments in subsidiaries must be accounted for under the equity method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

___ 7.

Reclassifications between measurement models are allowed in rare circumstances.

Solution 9-91 1. T 2.

Investments

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PROBLEMS Pr. 9-92 Accounting for bonds – amortized cost model (IFRS) On January 1, 2014, on their issue date, Diogenes Inc. purchased 9%, $200,000, 10-year bonds. Interest is paid annually on December 31. Diogenes uses the amortized cost model and the effective interest method for amortizing premium or discount. The current market rate was 10% and as a result Diogenes paid $187,711 for the bonds. On December 31, 2014, the bonds have a market value of $185,000. Instructions a) Record the receipt of interest and amortization of the discount for 2014. b) Record any year-end adjustment required. Solution 9-92 a) Interest income = $187,711 × .10 ............................... Actual interest ............................................................ Discount amortization ................................................. Cash .......................................................................... Bond Investment at Amortized Cost ........................... Interest Income ................................................... b)

$18,771 18,000 $ 771 18,000 771 18,771

No entry is required. Using the amortized cost model, an entry would only be required if there had been an impairment in value. Since this is not mentioned, we can assume there is no impairment. The investment is reported at amortized cost.

Pr. 9-93 Temporary investments – FV–NI model During the course of your examination of the financial statements of Venus Corporation for the year ended December 31, 2014, you found a new account called "Investments." Your examination revealed that during 2014, Venus began a program of investments, and all investment-related transactions were entered in this account. Your analysis of this account for 2014 follows: VENUS CORPORATION Analysis of Investments Year Ended December 31, 2014 Date—2014 (i) Jupiter Ltd. Common Shares Feb 14 Purchased 3,000 shares @ $55 per share. ..... Jul 26 Received 300 Jupiter common shares as a stock dividend. (Memorandum entry) Sep 28 Sold the 300 Jupiter common shares received July 26 @ $70 per share...................

Debit

Credit

$165,000

$21,000

(ii) Debit

Credit

Mars Ltd. Common Shares

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Apr 30 Oct 28

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Purchased 5,000 shares @ $40 per share. ..... Received dividend of $1.20 per share. ............

$200,000 $6,000

Additional information: 1. The market values for each security during 2014 follow: Security Feb 14 Apr 30 Jul 26 Sep 28 Dec 31 Jupiter Ltd. $55 $62 $70 $72 Mars Ltd. $40 32 Venus Corp. 25 28 30 33 35 2. All of the investments of Venus are nominal in respect to percentage of ownership (five percent or less). 3. Each investment is considered by Venus’s management to be temporary. 4. The company has adopted ASPE and intended to use the FV–NI method to account for these investments. 5. Venus follows a policy of separately reporting dividend income. Instructions a) Prepare any necessary correcting journal entries related to investments (i) and (ii). b) Prepare the entry, if necessary, to record the proper valuation of these investments at December 31, 2014. Solution 9-93 a) (i) Jupiter Ltd.

original purchase stock dividend total holding

3,000 shares 300 shares 3,300 shares

Total cost of $165,000 ÷ Total shares of 3,300 = $50 average cost per share Sold 300 shares Correct entry: Cash (300 × $70) ....................................................... FV–NI Investments—Jupiter (300 x $50) ............. Investment Income or Loss .................................

21,000

Entry made: Cash .......................................................................... Investments .....................................................

21,000

Correction: FV–NI Investments—Jupiter....................................... Investment Income or Loss .................................

6,000

15,000 6,000

21,000

6,000

(ii) Mars Ltd. - should record cash dividend as dividend income. Correct entry: Cash .......................................................................... Dividend Income..................................................

6,000 6,000

Entry made:

Investments

Cash .......................................................................... Investments ..................................................... Correction: FV–NI Investments—Mars ......................................... Dividend Income.................................................. b)

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6,000 6,000

Valuation at year end:

Jupiter Mars

Quantity 3,000 shares 5,000 shares

Cost $150,000 200,000 $350,000

Market Value $216,000 160,000 $376,000

Year-end Adjustment: FV–NI investments—Jupiter ....................................... Investment Income or Loss ................................. Investment Income or Loss ........................................ FV–NI Investments—Mars ..................................

Increase (Decrease) $66,000 (40,000) $26,000

66,000 66,000 40,000 40,000

Pr. 9-94 Year-end adjustments for temporary investments Mercury Corp. has the following portfolio of common shares (without significant influence) at December 31, 2014: Investment Cost Fair value Albania Inc. $480,000 $575,000 Bulgaria Ltd. 90,000 620,000 Czech Corp. 120,000 220,000 Total $690,000 $1,410,000 Instructions Provide the entry to record the year-end adjustment for these investments, assuming Mercury uses one control account and has adopted the FV–NI model. Solution 9-94 FV–NI Investments..................................................... Investment Income or Loss .................................

720,000 720,000

Pr. 9-95 Accounting for debt investments purchased at a premium – FV–NI model On January 1, 2014, Pluto Corp. acquired 8%, $100,000 (face value) bonds of Uranus Ltd., to yield 6%. The bonds were dated January 1, 2014, and mature on December 31, 2018, with interest payable each January 1. Pluto intends to hold the bonds to maturity, and will use the FV–NI model and the effective interest method of amortization of bond premium or discount. Instructions Prepare the following entries in Pluto’s books: a) Acquisition of bonds on January 1, 2014, b) Year-end adjusting entry at December 31, 2014,

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c) Receipt of the first interest payment on January 1, 2015. Round all values to the nearest dollar. Solution 9-95 a) Acquisition of bonds on January 1, 2014 PV of principal: $100,000 (PVF*5, 6%) = $100,000 x 0.74726 ............. PV of interest: (PVF*OA 5, 6%) = $8,000 x 4.21236 ............................ Present value of bond ..........................................................................

$74,726 $33,699 $108,425

OR 5 N 6 I 8000 PMT 100000 FV CPT PV => 108,425 FV–NI Investment in Bonds ........................................ 108,425 Cash....................................................................

108,425

b) Year-end adjusting entry at December 31, 2014 Interest receivable ...................................................... FV–NI Investment in Bonds ................................. Interest income ....................................................

8,000 1,495 6,505

$100,000 x 8% = $8,000 $108,425 x 6% = $6,505 $8,000 – $6,505 = $1,495 c) Receipt of first interest payment on January 1, 2015 Cash .......................................................................... Interest receivable ...............................................

8,000 8,000

Pr. 9-96 Accounting for investments – FV–NI On December 31, 2014, Hubble Corp. has the following securities in its portfolio of temporary investments: Cost Market 5,000 common shares of Orion Corp. $ 80,000 $ 69,500 10,000 common shares of Rigel Ltd. 91,000 92,500 $171,000 $162,000 All of the securities had been purchased in 2014. In 2015, Hubble completed the following securities transaction: Apr 1 Bought 300 common shares of Aries Corp. @ $50 each, plus fees of $550. On December 31, 2015, Hubble’s portfolio of trading equity securities appeared as follows: Cost Market 5,000 common shares of Orion Corp. $ 80,000 $ 78,000 10,000 common shares of Rigel Ltd. 91,000 99,250 600 common shares of Aries Corp. 15,550 12,750 $186,550 $190,000 Instructions Assuming Hubble uses the FV–NI model, prepare the general journal entries for: a) the 2014 year-end adjusting entry, b) the purchase of the Aries Corp. shares,

Investments

the 2015 year-end adjusting entry.

Solution 9-96 a) Dec 31, 2014 Investment Income or Loss ........................................ FV–NI Investments .............................................. ($171,000 – $162,000) b)

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Apr 1, 2015 FV–NI Investments..................................................... Cash [(300  $50) + $550] ................................... Dec 31, 2015 FV–NI Investments..................................................... Investment Income or Loss ................................. 190,000 – (162,000 + 15,550) = 12,450

9,000 9,000

15,550 15,550

12,450 12,450

Pr. 9-97 Long-term investment – FV–NI method Ceres Corporation is considering making a significant long-term investment in Pisces Ltd., a young and very promising company. Ceres decides to make a smaller investment first, and if Pisces turns out to be successful, Ceres intends to make an additional investment to reach significant influence. Pisces has 200,000 shares authorized, 110,000 shares issued and 90,000 shares outstanding. On January 1, 2014, Pisces issues Ceres 10,000 shares for $400,000 in cash (so now there are 120,000 shares issued, and 100,000 shares outstanding). Additional information: 1. On November 1, 2014, Pisces declares a total cash dividend of $180,000. 2. Pisces reports $225,000 net income for 2014. Its stock price on December 31, 2014 is $38. 3. On November 1, 2015, Pisces announces a total dividend of $270,000 to be paid on January 2, 2016. 4. Pisces reports $360,000 net income for 2015. Its stock price on December 31, 2015 is $44. 5. On March 15, 2016, Ceres is approached by an investment fund which offers to buy all their Pisces shares for $55 per share, a 25% premium over the current stock price of $44. Ceres accepts the offer and sells the shares on that day. Instructions Assuming Ceres uses the fair value through net income model (FV–NI) to account for this investment: a) Prepare the journal entries in Ceres’s books for the 2014 calendar year. b) Prepare the journal entries in Ceres’s books for the 2015 calendar year. c) Prepare the journal entries in Ceres’s books for the 2016 calendar year. Solution 9-97 a) 2014 Entries FV–NI Investment—Pisces........................................ . Cash.......................................................................

.400,000 400,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

To record the initial investment on January 1, 2014 Cash ........................................................................... 18,000 Dividend Income .................................................... To record Ceres’s share of the dividend on November 1, 2014 $180,000 x 10,000 ÷ 100,000 = $18,000 Investment Income or Loss ........................................ 20,000 FV–NI Investment—Pisces ................................................ To record holding loss on December 31, 2014 ($38 – $40) x 10,000 = $20,000 b)

20,000

2015 Entries Dividend receivable........................................ ............. 27,000 Dividend Income................................................... 27,000 To record Ceres’s share of the dividend declared on November 1, 2015 $270,000 x 10,000 ÷ 100,000 = $27,000 FV–NI Investment—Pisces .......................................... Investment Income or Loss........................... ....... To record holding gain on December 31, 2015 ($44 – $38) x 10,000 = $60,000

18,000

60,000

2016 Entries Cash ....................................... ................................... 27,000 Dividend Receivable.................................................. To record receipt of dividend on January 2, 2016 Cash .......................................................................... 550,000 FV–NI Investment—Pisces .................................. Gain on sale of investment .................................. To record gain on sale of Pisces shares on March 15, 2016 $55 x 10,000 = $550,000 ($55 – $44) x 10,000 = $110,000

60,000

27,000

440,000 110,000

Pr. 9-98 Equity method (ASPE) On January 1, 2013, Titanic Corp. bought 30,000 shares of the available 100,000 common shares of Iceberg Inc., a publicly traded firm. This acquisition provided Titanic with significant influence. Titanic paid $700,000 cash for the investment. At the time of the acquisition, Iceberg reported assets of $2,500,000 and liabilities of $1,200,000. Asset values reflected fair market value, except for capital assets that had a net book value of $500,000 and a fair market value of $730,000. These assets had a remaining useful life of five years. For 2013 Iceberg reported net income of $400,000 and paid total cash dividends of $100,000. On May 16, 2014, Titanic sold 15,000 of its shares in Iceberg for $425,000. Titanic has no immediate plans to sell its remaining investment in Iceberg. Iceberg is actively traded, and stock price information follows: January 1, 2013 $23 December 31, 2013 $25 January 1, 2014 $26

Investments

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Instructions a) Assuming Titanic is using ASPE, did the initial investment include a payment for goodwill? Provide support for your answer. b) At the end of 2013, what would appear on the income statement and balance sheet of Titanic in connection with its investment in Iceberg? Show supporting calculations. c) Provide the entry to account for Titanic’s sale of the shares in May 2014. How should Titanic account for its remaining investment in Iceberg? Solution 9-98 a) Note that, even using ASPE, since Iceberg is quoted in an active market, Titanic must use the equity method. Purchase price .................................................................. $700,000 Market value of identifiable assets* ................................... $2,730,000 Less: liabilities ................................................................... (1,200,000) Total market value of net assets acquired ......................... 1,530,000 Portion purchased (30% x $1,530,000) ............................. (459,000) Goodwill ............................................................................ $241,000 *$2,500,000 + ($730,000 – $500,000) b) Share of net income ($400,000 x 30%) ............................. Less: amortization of fair value increment ($730,000 – $500,000) ÷ 5 ................................................ Investor portion 30% ......................................................... Investment income on income statement ..........................

$120,000 $ 46,000 (13,800) $106,200

Cost .................................................................................. Plus: investment income ................................................... Less: dividends received ($100,000 x 30%) ...................... Investment account on balance sheet ...............................

$700,000 106,200 (30,000) $776,200

c) Cash.......................... ................................................. Investment in Associate....................................... Gain on Sale of Investment........................... .......

425,000 388,100 36,900

To record the sale of the shares $776,200 x 50% = $388,100 After this sale, Titanic will no longer have significant influence over Iceberg. As a result, the use of the equity method will no longer be appropriate. Under ASPE, Titanic can choose the cost or fair value through net income (FV–NI) model for its remaining investment in Iceberg. Pr. 9-99 Equity method – IFRS Capricorn Corporation decided to purchase 35% of the outstanding shares of Aquarius Ltd. Capricorn’s CFO conducted an extensive evaluation of the financial statements of Aquarius and reported his findings to the Board of Directors in the following memo:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Dear Board of Directors, Following your request, I conducted a detailed analysis of Aquarius Ltd. I found out that the liabilities reported in its books at December 31, 2013 in the amount of $20M fairly represent their economic values. As for the assets, their book value is $45M. The company owns an office building in downtown Toronto where its headquarters are located. The net book value of this building, including the land, is $10M. Aquarius purchased the land for $6M some 20 years ago and then constructed the building. I consulted with real estate experts and currently the fair value of the land is $9M and the fair value of the building is $8M. The remaining useful life of the building in Aquarius’s books is 20 years and I find this estimate realistic. The firm has developed a patent. According to my analysis, the fair value of the patent is $12M. Given future advances in technology, I expect the value of the patent to decline and become worthless 6 years from now. The patent was developed by the company and all the related costs were recorded as research and development expenses. Sincerely, Jake Connor, CA The Board of Directors of Capricorn Corporation adopted the report by Mr. Connor and on January 1, 2014 purchased 35% of the shares of Aquarius, based on its fair value according to Mr. Connor’s analysis. After the acquisition of the shares, Capricorn was able to exercise significant influence over Aquarius. In 2014, Aquarius reported net income of $10M and distributed 40% of it as cash dividends. In 2015, the earnings of Aquarius doubled compared with 2014. Aquarius distributed 60% of its income as cash dividends. On December 31, 2015, Capricorn sold its investment in Aquarius Ltd. for $20M. Instructions Assuming Capricorn accounts for this investment using the method required under IFRS, a) Record the initial purchase by Capricorn Corp. b) Record the entries related to the investment in Aquarius Ltd. for 2014. c) Record the entries related to the investment in Aquarius Ltd. for 2015. Solution 9-99 a) Calculation of amount paid Net book value of Aquarius (45 – 20) ................................ Fair value of patent ........................................................... Excess value of land (9 – 6) .............................................. Excess value of building (8 – (10 – 6)) .............................. Fair value of Aquarius ....................................................... Shares held....................................................................... Amount paid ...................................................................... b)

Journal entries for 2014 Investment in Associate.................... .......................... Cash............................................ ........................ To record initial investment

Calculation of income to be recorded by Capricorn: Aquarius’s net income ....................................................... Capricorn’s ownership.......................................................

25M 12M 3M 4M 44M 35% 15.4M

15.4M 15.4M

10M 35%

Investments

Capricorn’s share of net income ........................................ Amortization of patent (12M ÷ 6) x 35% ............................ Excess depreciation of the building (4M x 35%) ÷ 20 ........ Capricorn’s adjusted share in Aquarius’s net income ........

3.5M (0.7M) (0.07M) 2.73M

Investment in Associate ............................................. Investment income ..............................................

2.73M

Cash .......................................................................... Investment in Associate....................................... To record dividend distribution (10M x 40% x 35%)

1.4M

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2.73M

1.4M

c) Journal entries for 2015 For recording its share in Aquarius’s net income, the only adjustment to the 2014 calculations is that income now is 20M and Capricorn’s share is $7M, an increase of $3.5M compared with 2014. Thus investment income increases to 6.23M (2.73 + 3.5). Investment in Associate........................ ...................... Investment income................................. ..............

6.23M 6.23M

Cash........................................... ................................ 4.2M Investment in Associate.......................... ............. To record dividend distribution (10M x 2 x 60% x 35%)

4.2M

By the end of 2015, the value of the investment in Capricorn’s books is as follows: Initial investment ............................................................... 15.4 Investment income 2014 ................................................... 2.73 Dividend 2014 ................................................................... (1.4) Investment income 2015 ................................................... 6.23 Dividend 2015 ................................................................... (4.2) Investment in Aquarius Dec 31/15..................................... 18.76M Selling price ...................................................................... 20.00M Gain on sale of investment ................................................ 1.24M Cash......................................... .................................. Investment in Associate....................................... Gain on Sale of Investment........................ ..........

20M 18.76M 1.24M

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 10 PROPERTY, PLANT, AND EQUIPMENT: ACCOUNTING MODEL BASICS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

2 2 3 3 3 4 4 5

E M M M M M M M

30. 31. 32. 33. 34. 35. 36.

4,6 5 5 5 5 5 5

H M M M H H M

58. 59.

5 5

H M

66. 67. 68. 69.

3 4,10,12 5 5

M M M M

79. 80. 81.

5 5 5

M H M

Note:

E = Easy

Item LO LOD Item LO LOD Multiple Choice–Conceptual 9. 5 H 17. 6 M 10. 5 H 18. 6 H 11. 5 H 19. 6 E 12. 5 M 20. 6 E 13. 5 H 21. 8 M 14. 5 M 22. 8 M 15. 6 M 23. 9 M 16. 6 M 24. 10 H 5Multiple Choice–Computational 37. 5 M 44. 7 M 38. 5 M 45. 7 M 39. 6 H 46. 8 M 40. 6 H 47. 8 M 41. 6 H 48. 8 M 42. 6 H 49. 9 E 43. 6 M 50. 10 M 5Multiple Choice–CPA Adapted 60. 5 E 62. 6 M 61. 6 M 63. 6 M Exercises 70. 5 M 74. 7,8,9 M 71. 5 M 75. 8 M 72. 6 M 76. 9 M 73. 6 M *77. 12 H Problems 82. 5 M 85. 6,9 M 83. 5 H 86. 8 M 84. 6 M *87. 12 M

M = Medium

Item

LOD

25. *26. *27. *28. *29.

10 12 12 12 13

M M M M M

*51. *52. *53. *54. *55. *56. *57.

12 12 12 12 12 13 13

M M M M M H H

64. *65.

10 12

H M

*78.

*88.

H = Hard

Test Bank for Intermediate Accounting, Tenth Canadian Edition

10 - 2

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

8. 9. 10. 11. 12.

MC MC MC MC MC

13. 14. 31. 32. 33.

MC MC MC MC MC

15. 16. 17. 18.

MC MC MC MC

19. 20. 30. 39.

MC MC MC MC

44.

45.

21. 22.

MC MC

46. 47.

MC MC

23.

49.

24.

25.

*26. *27. *28.

MC MC MC

*51. *52. *53.

MC MC MC

*29.

*56.

Note:

MC = Multiple Choice

Item Type Item Type Learning Objective 2 Learning Objective 3 5. MC 66. Ex Learning Objective 4 30. MC *67. Ex Learning Objective 5 34. MC 58. MC 35. MC 59. MC 36. MC 60. MC 37. MC 68. Ex 38. MC 69. Ex Learning Objective 6 40. MC 61. MC 41. MC 62. MC 42. MC 63. MC 43. MC 72. Ex Learning Objective 7 74. Ex Learning Objective 8 48. MC 75. Ex 74. Ex 86. Pr Learning Objective 9 74. Ex 76. Ex Learning Objective 10 50. MC 64. MC Learning Objective 12 *54. MC *67. Ex *55. MC *77. Ex *65. MC *78. Ex Learning Objective 13 *57. MC Ex = Exercise

Item

Type

Item

Type

70. 71. 79. 80. 81.

Ex Ex Pr Pr Pr

82. 83.

Pr Pr

73. 84. 85.

Ex Pr Pr

85.

*67.

*87. *88.

Pr Pr

Pr = Problem

Property, Plant, and Equipment: Accounting Model Basics

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CHAPTER STUDY OBJECTIVES 1. Understand the importance of depreciation, impairment, and disposition from a business perspective. The economic benefits of property, plant, and equipment are typically consumed as the items are used by the organization. Because the benefits are consumed over multiple periods, companies use depreciation to allocate the benefits of the PP&E to each period as the capacity of the assets is used up. By allocating the cost of property, plant, and equipment over its useful life, businesses are better able to match the costs and benefits of the assets to the revenues that they help generate. Companies also need to assess their PP&E each year under IFRS for indications of impairment, and if these indications are present they should re-estimate how much will be recoverable. Following GAAP should also help companies better understand their business.

2. Explain the concept of depreciation and identify the factors to consider when determining depreciation charges. Depreciation is the process of allocating the cost of property, plant, and equipment assets in a systematic and rational manner to the periods that are expected to benefit from their use. The allocation of the cost of intangible capital assets is termed “amortization” and the allocation of the costs of mineral resource assets is termed “depletion.” Four factors involved in determining depreciation expense are (1) the recognition of the appropriate asset components, (2) the amount to be depreciated (depreciable amount), (3) the estimated useful life, and (4) the pattern and method of depreciation.

3. Identify how depreciation methods are selected. The depreciation method chosen should amortize an asset in a pattern and at a rate that corresponds to the benefits received from that asset. The choice often involves the use of professional judgement. Tax reporting, simplicity, perceived economic consequences, and impact on ratios are examples of factors that influence such judgements in practice.

4. Calculate depreciation using the straight-line, decreasing charge, and activity methods and recognize the effects of using each. The straight-line method assumes that an asset provides its benefits as a function of time. As such, cost less residual value is divided by the useful life to determine the depreciation expense per period. The decreasing charge method provides for a higher depreciation charge in the early years and lower charges in later periods. For this method, a constant rate (such as double the straight-line rate) is multiplied by the net book value (cost less accumulated depreciation and accumulated impairment losses) at the start of the period to determine each period’s expense. The main justification for this approach is that the asset provides more benefits in the earlier periods. The activity method assumes that the benefits provided by the asset are a function of use instead of the passage of time. The asset’s life is considered in terms of either the output that it provides or an input measure, such as the number of hours it works. The depreciation charge per unit of activity (depreciable amount divided by estimated total units of output or input) is calculated and multiplied by the units of activity produced or consumed in a period to determine the depreciation.

5. Explain the accounting issues for depletion of mineral resources. After the depletion base has been established through accounting decisions related to the acquisition, exploration

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

and evaluation, development, and restoration obligations associated with mineral resources, these costs are allocated to the natural resources that are removed. Depletion is normally calculated using the units of production method. In this approach, the resource’s cost less residual value, if any, is divided by the number of units that are estimated to be in the resource deposit, to obtain a cost per unit of product. The cost per unit is then multiplied by the number of units withdrawn in the period to calculate the depletion.

6. Explain and apply the accounting procedures for partial periods and a change in depreciation rate. Because all the variables in determining depreciation are estimates—with the exception, perhaps, of an asset’s original cost—it is common for a change in those estimates to result in a change in the depreciation amount. When this occurs, there is no retroactive change and no catch-up adjustment. The change is accounted for in the current and future periods.

7. Explain the issues and apply the accounting standards for capital asset impairment under both IFRS and ASPE. A capital asset is impaired when its carrying amount is not recoverable. The cost recovery method (ASPE) defines recoverable as the undiscounted cash flows from the asset’s use and later disposal. If impaired, the asset is written down to its fair value, and this loss cannot be reversed later if the asset’s value recovers. The rational entity model (IFRS) defines recoverable amount as the higher of the asset’s value in use and fair value less costs of disposal. Both these values are discounted cash flow amounts. If the recoverable amount subsequently improves, the impairment losses recognized are reversed.

8. Explain and apply the accounting standards for long-lived assets that are held for sale. Assets held for sale are no longer depreciated. They are remeasured to their fair value less costs of disposal at each statement of financial position date. Recoveries in value may be recognized to the extent of previous losses. Held-for-sale items of property, plant, and equipment are separately reported as non-current assets unless they meet the definition of current assets. Under ASPE, assets held for sale are only permitted to be reported in current assets if sold before the financial statements are completed and the proceeds on sale are expected within 12 months from the date of the statement of financial position (or operating cycle, if longer).

9. Account for derecognition of property, plant, and equipment. Depreciation continues for PP&E assets until they are classified as held for sale or derecognized. At the date of disposal, all accounts related to the retired asset are removed from the books. Gains and losses from the disposal of plant assets are shown on the income statement in income before discontinued operations, unless the conditions for reporting as a discontinued operation are met. For property, plant, and equipment donated to an organization outside the reporting entity, the donation is reported at its fair value with a gain or loss on disposal recognized.

10. Describe the types of disclosures required for property, plant, and equipment. The type of information required to be disclosed for property, plant, and equipment is governed by the information needs of users. Because users of private entities’ financial information are often able to seek further specific information from a company, there are fewer required disclosures than for public companies reporting under IFRS. The required disclosures under IFRS include

Property, Plant, and Equipment: Accounting Model Basics

10 - 5

those relating to measurement, changes in account balances and the reasons for the changes, information about how fair values are determined, and many others. 11. Analyze a company’s investment in assets. The efficiency of use of a company’s investment in assets may be evaluated by calculating and interpreting the asset turnover rate, the profit margin, and the rate of return on assets.

12. Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future. In most major ways, international and Canadian accounting standards for the depreciation of property, plant, and equipment are similar. Significant differences do exist, however, in the extent of componentization for depreciation, the impairment models applied, and the extent of disclosure. The impairment differences relate to how it is determined whether an asset is impaired, how the impairment is measured, and the ability to recognize recoveries in value.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c b d c c b b c a d b b a b a b d d d c a d b d c d b d c

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. *26. *27. *28. *29.

Description Definition of PPE Examples of PPE Recognition of PPE acquisitions Items included in cost of PPE Capitalization of borrowing costs Treatment of restoration costs Accounting for PST Purchase of PPE on long-term contract PPE acquired by issuance of public company’s shares PPE acquired by issuance of private company’s shares Accounting for donated assets Valuation of donated assets Exchange of assets Accounting for asset exchanges Accounting for land costs Inclusion of land in PPE Costs of land improvements Accounting for land and building purchase Measurement of biological assets Features of the cost model Features of the revaluation model (asset adjustment method) Accounting with revaluation model Features of the fair value model Revenue expenditures Capital expenditures Capitalization of borrowing costs Weighted-average accumulated expenditures Capitalization of borrowing costs Features of the revaluation model (proportionate method)

*This topic is dealt with in an Appendix to the chapter.

Property, Plant, and Equipment: Accounting Model Basics

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MULTIPLE CHOICE—Computational Answer c c d d c c c b d b a d b c c c a. d b a b a c b b c a c

No. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. *51. *52. *53. *54. *55. *56. *57.

Description Calculate cost of truck purchased Calculate cost of land acquired Allocation of cost of a lump sum purchase Acquisition of equipment by exchange of shares held as an investment Exchange of similar assets Exchange of similar assets Purchase of asset with long term note Purchase of asset with long term note Gain or loss with no commercial substance Calculate cost of land Calculate cost of building Calculate cost of land and building Calculate cost of machine purchased Calculate cost of machine purchased Application of the cost model Components of PP&E assets Application of the revaluation model Application of the revaluation model Application of the revaluation model Application of the fair value model Components of PP&E assets Calculate weighted-average accumulated expenditures Calculate amount of interest to be capitalized Calculate weighted-average accumulated expenditures Calculate weighted-average accumulated expenditures Calculate weighted-average accumulated expenditures Revaluation model (proportionate method) Revaluation model (proportionate method)

MULTIPLE CHOICE—CPA Adapted Answer d c b c b c d b

No. 58. 59. 60. 61. 62. 63. 64. *65.

Description Valuation of a nonmonetary exchange Exchange of similar assets Accounting for government grant Determine cost of land Classification of sale of building Valuation of replacement equipment Costs subsequent to acquisition Calculate amount of interest to be capitalized

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E10-66 *E10-67 E10-68 E10-69 E10-70 E10-71 E10-72 E10-73 E10-74 E10-75 E10-76 *E10-77 *E10-78

Description Componentization Plant asset accounting Asset exchange with commercial substance Non-interest bearing note Nonmonetary transaction without commercial substance Asset exchange Acquisition cost Costs included in assets Measurement models Application of the revaluation model Application of the fair value model Capitalization of interest Capitalization of interest

PROBLEMS Item P10-79 P10-80 P10-81 P10-82 P10-83 P10-84 P10-85 P10-86 * P10-87 *P10-88

Description Purchase of asset by non-interest bearing note Asset exchanges Asset exchange – no commercial substance Asset exchange – no commercial substance Nonmonetary exchange Costs included in assets Fair value model Revaluation model Capitalization of borrowing costs Capitalization of borrowing costs

*This topic is dealt with in an Appendix to the chapter.

Property, Plant, and Equipment: Accounting Model Basics

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MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT included in the IAS16 definition of property, plant, and equipment (PPE)? a. PPE will be used over more than one accounting period. b. PPE is held for use in the production of goods and services. c. PPE can be tangible or intangible. d. PPE is tangible.

2. Examples of property, plant, and equipment include a. land, equipment, goodwill. b. equipment, apple trees, mineral resource property. c. machinery, livestock, patents. d. computers, cherry orchards, copyrights.

3. Which of the following statements applies to the recognition of property, plant and equipment acquisitions? a. It is certain that the item’s associated future benefits will flow to the entity. b. It is probable that the item’s associated future benefits will flow to the entity. c. The cost can be measured reliably. d. It is probable that the item’s associated future benefits will flow to the entity, and the cost can be measured reliably.

4. Which of the following would NOT be included in the cost of an item of property, plant and equipment? a. the purchase price net of any trade discounts and rebates b. delivery costs c. costs of training employees to use the asset d. costs of obligations associated with the asset’s eventual disposal

5. Which of the following does NOT apply to the capitalization of borrowing costs for the purchase of assets? a. They can have a significant impact on a company's earnings. b. This is allowed under both ASPE and IFRS. c. This is not allowed under IFRS. d. They must be disclosed in the notes to the financial statements. 6. Under ASPE, the costs for environmental clean-up at the end of an asset’s useful life a. are always expensed as incurred. b. are recognized only if they represent a legal obligation. c. are capitalized once they have become apparent. d. include only costs related to the acquisition of the asset.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

7. The debit for Provincial Sales Tax correctly calculated and paid on the purchase of machinery should be included in a. Provincial Sales Tax Expense. b. Machinery. c. Accumulated Depreciation—Machinery. d. Provincial Sales Tax Refundable.

8. Property, plant, and equipment purchased on long-term credit contracts should be accounted for at the a. actual cash to be paid in the future. b. future amount of the future payments. c. present value of the future payments. d. future value of the current payments. 9. When a plant asset is acquired by the issuance of a public company’s common shares, the cost of the plant asset is properly measured by the a. market value of the plant asset. b. stated value of the shares. c. book value of the shares. d. par value of the shares.

10. When a closely held corporation issues preferred shares for land, the land should be recorded at the a. total no par value of the shares issued. b. total book value of the shares issued. c. total liquidating value of the shares issued. d. fair market value of the land.

11. When an enterprise is the recipient of a donated asset, the account credited would probably NOT be a(n) a. equity account. b. revenue account. c. deferred revenue account. d. asset account.

12. A plant site donated by a city to a manufacturer that plans to open a new factory should be recorded on the manufacturer's books at a. the nominal cost of taking title to it. b. its market value. c. one dollar (since the site cost nothing but should be included in the balance sheet). d. the value assigned to it by the company's directors.

13. Spock Inc. exchanged merchandise that cost $19,000 and normally sold for $27,000 for a new delivery truck with a list price of $31,000. The delivery truck should be recorded on Spock's books at

Property, Plant, and Equipment: Accounting Model Basics

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a. $31,000. b. $27,000. c. $19,000. d. $12,000.

14. When accounting for asset exchanges, a. if a transaction lacks commercial substance, it is not recorded. b. an asset cannot be recognized at more than its fair value. c. if the fair values of either the asset given up or the asset received cannot be ascertained, then the Board of Directors may assign an arbitrary value. d. when an exchange lacks commercial substance, either a gain or loss may be recognized.

15. Chiquita Corp. purchased a large area of land with the intention to transform it into a banana plantation. Before the new seedlings can be planted, the site, which is prone to flooding, must be drained. The cost of the draining should be a. capitalized as part of the cost of the land. b. expensed only after the first crop of bananas has been harvested. c. expensed immediately. d. reported as loss from discontinued operations.

16. Land is generally included in property, plant and equipment EXCEPT when a. it is not yet ready for use. b. it is held for resale by land developers. c. it includes a building that must be demolished. d. special amounts are assessed for local improvements such as sewers.

17. The costs of land improvements with limited lives, such as a parking lot, are a. added to the land account. b. recorded in a separate account. c. depreciated over their useful lives. d. recorded in a separate account and depreciated over their useful lives.

18. If a corporation purchases a lot and building and subsequently tears down the building and uses the property as a parking lot, the proper accounting treatment of the cost of the building would depend on a. the significance of the cost allocated to the building in relation to the combined cost of the lot and building. b. the length of time for which the building was held prior to its demolition. c. management’s plans for the property when the building was acquired. d. the planned future use of the parking lot.

19. Under IFRS, biological assets should normally be measured at a. cost. b. cost less accumulated depreciation.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. fair value. d. fair value less costs to sell.

20. The cost model of accounting for PP&E assets a. should be applied to investment property only. b. should be applied to other PP&E assets only. c. can be applied to all classes of PP&E including investment property. d. is not appropriate under ASPE.

21. The revaluation model of accounting for PP&E assets a. uses a revaluation surplus account to hold net increases in the asset's fair value. b. may be applied to all classes of PP&E including investment property. c. may be applied to investment property under ASPE. d. is not allowed under IFRS.

22. When using the revaluation model of accounting for PP&E assets (asset-adjustment or elimination method) a. the related Accumulated Depreciation account is closed to OCI. b. depreciation continues to be charged in the original pattern. c. the difference between fair value and book value is always debited to Revaluation Surplus (OCI). d. a new depreciation rate must be calculated.

23. The fair value model of accounting for PP&E assets a. recognizes changes in the asset's fair value in other comprehensive income. b. should be applied to investment property only. c. once chosen for one investment property does not have to be applied to all investment property. d. is acceptable under both IFRS and ASPE.

24. Which of the following expenditures after acquisition would NOT be capitalized? a. adding a new wing to a hospital b. replacing the air conditioning system in an office building c. major overhaul of a fleet of trucks d. replacing all the tires on an 18-wheel semi-trailer 25. A major overhaul made to a machine increased its fair value and its production capacity by 25% without extending the machine's useful life. The cost of the improvement should be a. expensed. b. debited to accumulated depreciation. c. capitalized. d. allocated between accumulated depreciation and the machine account.

*26. Borrowing costs incurred for the acquisition of assets may be capitalized if certain

Property, Plant, and Equipment: Accounting Model Basics

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conditions are met. Which of the following issues is irrelevant in making that determination? a. the capitalization period b. the avoidable borrowing costs c. whether the asset is a “qualifying asset” d. the depreciation period

*27. Construction of a qualifying asset is started on April 1 and finished on December 1. The fraction used to multiply an expenditure made on April 1 to find weighted-average accumulated expenditures is a. 8 ÷ 8. b. 8 ÷ 12. c. 9 ÷ 12. d. 11 ÷ 12.

*28. Borrowing costs that are capitalized should a. be written off over the remaining term of the debt. b. be accumulated in a separate deferred charge account and written off straight-line over a 40-year period. c. not be written off until the related asset is fully depreciated or disposed of. d. be amortized over the related asset’s useful life.

*29. When using the revaluation model of accounting for PP&E assets (proportionate method) a. a Revaluation Surplus account is not used. b. depreciation continues to be charged in the original pattern. c. the asset account and its related contra-asset are both adjusted. d. over the life of the asset, it is possible that there can be a net increase in net income from revaluations.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

c b d c c

6. 7. 8. 9. 10.

b b c a d

11. 12. 13. 14. 15.

b b a b a

16. 17. 18. 19. 20.

b d d d c

21. 22. 23. 24. 25.

a d b d c

*26. *27. *28. *29.

d b d c

Property, Plant, and Equipment: Accounting Model Basics

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MULTIPLE CHOICE—Computational 30. Zambia Ltd. buys a lift truck with a list price of $40,000. The dealer grants a 15% reduction in the list price, and an additional 2% cash discount on the net price if payment is made in 30 days. Provincial sales tax is $2,380 and Zambia pays an extra $500 to have a special horn installed. The recorded cost of the truck should be a. $36,880. b. $36,380. c. $36,200. d. $35,700.

31. Liberia Corporation exchanged 2,000 shares of its no par value common stock for a parcel of land to be held as a future plant site. The book value of the shares is currently $90 per share, and their current market value is $110 per share. Liberia received $30,000 from the sale of scrap when an existing building on the property was removed from the site. Based on these facts, the land should be capitalized at a. $150,000. b. $180,000. c. $190,000. d. $220,000.

32. Chad Corporation purchased a tract of land for $765,000, which included a warehouse and office building. The following data were collected concerning the property: Current Assessed Valuation Vendor’s Original Cost $300,000 $250,000 200,000 150,000 400,000 300,000 $900,000 $700,000 What are the appropriate amounts that Chad should record for the land, warehouse, and office building, respectively? a. Land, $250,000; warehouse, $150,000; office building, $300,000 b. Land, $300,000; warehouse, $200,000; office building, $400,000 c. Land, $273,214; warehouse, $163,929; office building, $327,857 d. Land, $255,000; warehouse, $170,000; office building, $340,000 Land Warehouse Office building

33. Benin Ltd. exchanged 500 common shares of Lesotho Corp., which Benin was holding as an investment, for new equipment from Easter Sales. The Lesotho Corp. common shares, which had been purchased by Benin for $100 per share, had a quoted market value of $116 per share at the date of exchange. The equipment had a recorded amount on Easter’s books of $55,000, but the fair value was not available. The journal entry that Benin should make to record this exchange is a. Equipment ................................................................................ 50,000 Investment in Lesotho Corp Common Shares .................... 50,000 b. Equipment ................................................................................ 55,000 Investment in Lesotho Corp. Common Shares ................... 50,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Gain on Disposal of Investment ......................................... c. Equipment ................................................................................ Loss on Disposal of Investment ................................................ Investment in Lesotho Corp. Common Shares ................... d. Equipment ................................................................................ Investment in Lesotho Corp. Common Shares ................... Gain on Disposal of Investment .........................................

5,000 55,000 3,000 58,000 58,000 50,000 8,000

34. On January 2, 2014, Congo Delivery Company traded in an old delivery truck for a newer model. Data relative to the old and new trucks follow: Old Truck Original cost ............................................................... $18,000 Accumulated Depreciation at January 2, 2014 ........... 12,000 Fair value ................................................................... 6,000 New Truck List price .................................................................... $30,000 Cash price without trade-in ......................................... 27,000 Cash paid with trade-in............................................... 22,000 The cost of the new truck for financial accounting purposes is a. $18,000. b. $22,000. c. $27,000. d. $30,000.

35. Tanzania Inc. acquired a new delivery truck in exchange for an old delivery truck that it had acquired several years earlier for $40,000. On the date of the exchange, the old truck had a fair value of $16,000, and its net book value (carrying value) was $15,200. In addition, Tanzania paid $52,000 cash for the new truck, which had a list price of $72,000. At what amount should Tanzania record the new truck for financial accounting purposes? a. $52,000 b. $67,200 c. $68,000 d. $72,000

36. On January 2, 2014, Zanzibar Corp. purchases a new machine. The company makes a $2,000 cash down payment, and agrees to pay four annual instalments of $4,000 each, starting December 31, 2014, signing a non-interest bearing note to this effect. The cash equivalent price of the machine is not known, but the appropriate interest rate for this type of transaction is 9% p.a. Rounding to the nearest dollar (if necessary), Zanzibar should record the cost of the machine at a. $18,000. b. $16,000. c. $14,959. d. $12,959.

37. On January 2, 2014, Zimbabwe Corp. purchases a new machine. The company makes a $3,000 cash down payment, and agrees to pay eight semi-annual instalments of $2,000 each, starting July 1, 2014, signing a non-interest bearing note to this effect. The cash equivalent price

Property, Plant, and Equipment: Accounting Model Basics

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of the machine is not known, but the appropriate interest rate for this type of transaction is 8% p.a. Rounding to the nearest dollar (if necessary), Zimbabwe should record the cost of the machine at a. $15,413. b. $16,465. c. $16,000. d. $19,000.

38. Algeria Inc. traded one of its used trailers (cost $20,000, accumulated depreciation $18,000) for another used trailer with a fair value of $3,200. Algeria also paid $300 to complete the transaction. Since the exchange will leave Algeria in the same economic position, this transaction lacks commercial substance. What is the gain or loss on the exchange? a. $1,200 gain b. $900 gain c. $300 loss d. $0 (no gain or loss)

Use the following information for questions 39–40. Morocco Corp. purchased land as a factory site for $250,000. They paid $10,000 to tear down two buildings on the land, and the salvage from these old buildings was sold for $1,350. Legal fees of $870 were paid for title investigation and making the purchase. Architect's fees were $10,300. Title insurance cost $600, and liability insurance during construction cost $650. Excavation costs were $2,610. A contractor was paid $600,000 to construct the new building. An assessment made by the city for pavement was $1,600. Interest costs during construction were $42,500.

39. The cost of the land should be recorded at a. $260,120. b. $261,720. c. $262,470. d. $264,070.

40. The cost of the building should be recorded at a. $656,060. b. $655,800. c. $653,710. d. $653,450.

41. On February 1, 2014, Sudan Corp. purchased a parcel of land for $300,000 as a factory site. An old building on the property was demolished, and construction began on a new building which was completed on November 1, 2014. Costs incurred during this period are listed below: Demolition of old building ..................................................... $ 25,000 Architect's fees ..................................................................... 35,000 Legal fees for title investigation and purchase contract ........ 5,000 Construction costs................................................................ 990,000 (Salvaged materials resulting from demolition were sold for $10,000.)

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Sudan should record the cost of the land and new building, respectively, at a. $330,000 and $1,015,000. b. $315,000 and $1,030,000. c. $315,000 and $1,025,000. d. $320,000 and $1,025,000.

42. On August 1, 2014, Dahomey Corp. purchases a new machine. The company makes a $6,000 cash down payment, and agrees to pay four monthly instalments of $9,000 each, starting September 1, 2014, signing a non-interest bearing note to this effect. The cash equivalent price of the machine is $36,000. As well, Dahomey pays installation costs of $1,000. The recorded cost of the machine should be a. $7,000. b. $37,000. c. $42,000. d. $43,000.

43. On August 1, 2014, Volta Corp. purchases a new machine. The company makes a $2,000 cash down payment, and agrees to pay four annual instalments of $3,000 each, starting August 1, 2015, signing a non-interest bearing note to this effect. The cash equivalent price of the machine is $12,500. Due to an employee strike, Volta could not install the machine immediately, and thus incurred $300 of storage costs. As well, Volta pays installation costs of $400. The recorded cost of the machine should be a. $14,000. b. $13,200. c. $12,900. d. $12,500.

44. Mali Corporation uses the cost model to account for its property, plant and equipment, which were acquired on January 1, 2014 for $175,000. Mali uses straight-line depreciation and estimates the assets will have a ten year life with no residual value. Assuming Mali did not experience any impairment losses, the December 31, 2015 net book value of the assets is a. $175,000. b. $157,500. c. $140,000. d. $136,000.

45. Nigeria Ltd. acquires a new machine. It is comprised of two different components (A and B) that are expected to be overhauled at different times. The acquisition costs of the machine are as follows: Component A: $198,000 Component B: $240,000 Component A is expected to have a useful life of 5 years and a residual value of $20,000 before the first major overhaul is required. Component B is expected to have a useful life of 7 years and a residual value of $15,000 before its first overhaul. Nigeria uses straight-line depreciation for all its equipment. What is the net book value of component A after 5 years? a. $0 b. $19,000

Property, Plant, and Equipment: Accounting Model Basics

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c. $20,000 d. $55,600

Use the following information for questions 46–48. Tunisia Inc. owns assets to which it applies the revaluation model (asset-adjustment method). The following additional information is available: 1. Accumulated Depreciation at December 31, 2015 (prior to any fair value adjustments) was $12,000. 2. Between December 31, 2014 and December 31, 2015, the property's fair value had increased by $30,000. 3. The December 31, 2015 balance in the revaluation surplus account (prior to any fair value adjustments) was $2,000.

46. The adjusted December 31, 2015 balance in the related contra-asset account will be a. $0. b. $10,000. c. $12,000. d. $14,000.

47. The adjusted December 31, 2015 in the revaluation surplus account will be a. $0. b. $28,000. c. $30,000. d. $32,000.

48. Assume the same facts as indicated above, except that, between December 31, 2014 and December 31, 2015, the property's fair value had decreased by $10,000. As a result, Tunisia's 2015 income statement will include a a. $10,000 loss. b. $ 8,000 loss. c. $ 8,000 gain (other comprehensive income). d. $ 2,000 loss.

49. Uganda Corporation uses the fair value model of accounting for its investment property. The fair values of its property were: December 31, 2014, $225,000 and December 31, 2015, $233,000. At December 31, 2015 Uganda should a. recognize a gain of $8,000 in income. b. report a gain of $8,000 in other comprehensive income. c. defer the gain until the property is sold. d. do nothing (ignore it).

50. Nigeria Ltd. acquires a new machine. It is comprised of two different components (A and B) that are expected to be overhauled at different times. The acquisition costs of the machine are as follows:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Component A: $198,000 Component B: $240,000 Component A is expected to have a useful life of 5 years and a residual value of $20,000 before the first major overhaul is required. Component B is expected to have a useful life of 7 years and a residual value of $15,000 before its first overhaul. Nigeria uses straight-line depreciation for all its equipment. At the beginning of year 6, component A undergoes a major overhaul at a cost of 100,000. The work is expected to extend its life by 3 years, but the residual value will then be zero. What is the net book value of component A one year after the overhaul? a. $120,000 b. $ 80,000 c. $ 66,667 d. $ 40,000

*51. On May 1, 2014, Ethiopia Ltd. began construction of a new building for its own use. Expenditures of $75,000 were incurred monthly for five months beginning on May 1. The building was completed and ready for occupancy on September 1, 2014. For the purpose of determining the amount of interest cost to be capitalized, the weighted-average accumulated expenditures on the building during 2014 were a. $62,500. b. $75,000. c. $187,500. d. $375,000.

*52. During calendar 2014, Somalia Corp. incurred weighted-average accumulated expenditures of $800,000 during construction of assets that qualified for capitalization of interest. The only debt outstanding during 2014 was a $900,000, 8%, five-year note payable dated January 1, 2012. The amount of interest that should be capitalized during calendar 2014 is a. $0. b. $32,000. c. $64,000. d. $72,000.

*53. On March 1, Senegal Inc. began construction of a small building for its own use. Payments of $150,000 were made monthly for three months beginning March 1. The building was completed and ready for occupancy on June 1. In determining the amount of interest cost to be capitalized, the weighted-average accumulated expenditures are a. $0. b. $75,000. c. $150,000. d. $450,000.

Use the following information for questions *54–*55. On March 1, 2014, Mauritania Ltd. purchased land for $270,000 cash, which they intend to use for their new head office. Construction on the office building began on March 1. The following expenditures were incurred for construction:

Property, Plant, and Equipment: Accounting Model Basics

Date March 1, 2014 April 1, 2014 May 1, 2014 June 1, 2014

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Expenditures $450,000 252,000 450,000 720,000

The office building was completed and ready for occupancy on July 1. To help pay for construction, Mauritania borrowed $360,000 on March 1, 2014 on a 9%, three-year note payable. Other than this note, the only other debt outstanding during 2014 was a $150,000, 10%, six-year note payable dated January 1, 2013.

*54. The weighted-average accumulated expenditures on the construction project during 2014 were a. $1,467,000. b. $348,000. c. $258,000. d. $156,000.

*55. The actual interest cost incurred during 2014 was a. $27,000. b. $39,500. c. $42,000. d. $47,400.

Use the following information for questions *56–*57. Egypt Corp. owns equipment that originally cost $100,000. At December 31, 2014, the equipment’s book value (after 2014 depreciation was booked) is $60,000. It is determined that the fair value of the equipment at this date is $90,000. Although Egypt’s policy is to apply the revaluation model using the proportionate method, this is the first time the company has done it.

*56. By how much must the accumulated depreciation account be increased (decreased) at December 31, 2014? a. $20,000 b. $40,000 c. $60,000 d. $(60,000)

*57. The adjusting entry to record the revaluation will include a a. debit to Accumulated Deprecation of $20,000. b. credit to Equipment of $10,000. c. credit to Revaluation Surplus (OCI) of $30,000. d. debit to Revaluation Surplus (OCI of $10,000.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

30. 31. 32. 33.

c c d d

34. 35. 36. 37.

c c c b

38. 39. 40. 41.

d b a d

42. 43. 44. 45.

b c c c

46. 47. 48. 49.

a d b a

50. *51. *52. *53.

b a c b

*54. *55. *56. *57.

b c a c

DERIVATIONS—Computational No. Answer 30. c 31. c 32. d

33. 34. 35. 36.

d c c c

37.

38. 39. 40. 41.

d b a d

42. 43. 44. 45. 46. 47. 48. 49. 50. *51.

b c c c a d b a b a

*52. *53.

c b

*54.

Derivation ($40,000 × .85 × .98) + $2,380 + $500 = $36,200 ($2,000 × $110) – $30,000 = $190,000 Warehouse: 2 ÷ 9 × $765,000 = $170,000 Land: 3/9 x $765,000= $255,000 Office Building: 4 ÷ 9 × $765,000 = $340,000 Gain = 500 x ($116 – $100) = $8,000 $27,000 (fair value of new truck, since this is known) $16,000 + $52,000 = $68,000 PV of note: 4 N 9 I 4000 PMT PV = $12,959 plus DP of $2,000 = $14,959 PV of note: 8 N 8 I (2P ÷ Y) 2000 PMT PV = $12,413 plus DP of $3,000 = $15,413 No gain or loss. Asset is recorded at BV of old plus cash paid $250,000 + $10,000 – $1,350 + $870 + $600 + $1,600 = $261,720 $10,300 + $650 + $2,610 + $600,000 + $42,500 = $656,060 Land: $300,000 + $25,000 + $5,000 – $10,000 = $320,000 Building: $35,000 + $990,000 = $1,025,000 $36,000 + $1,000 = $37,000 $12,500 + $400 = $12,900 $175,000 – ($175,000 x 2 ÷ 10) = $140,000 $20,000 (residual value) $12,000 – $12,000 = 0 (Acc. Dep. is eliminated) $2,000 + $30,000 = $32,000 $10,000 – $2,000 = $8,000 loss $233,000 – $225,000 = $8,000 $20,000 + $100,000 = $120,000; $120,000 – ($120,000 ÷ 3) = $80,000 $75,000 x (4 + 3 + 2 + 1) = $75,000 x 10 ÷ 12 = $62,500 12 $800,000 × .08 = $64,000 $150,000 x ( 3 + 2 + 1) = $150,000 x 6 ÷ 12 = $75,000 12 ($450,000 × 4 ÷ 12) + ($252,000 × 3 ÷ 12) + ($450,000 × 2 ÷ 12) +

Property, Plant, and Equipment: Accounting Model Basics

*55. *56.

c a

*57.

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($720,000 × 1 ÷ 12) = $348,000 ($360,000 × 9% × 10 ÷ 12) + ($150,000 × 10%) = $42,000 Increase in FV over BV = ($90,000 – $60,000) ÷ $60,000 = 50% Acc Dep = $100,000 – $60,000 = $40,000; therefore Acc Dep S ÷ B increased by $40,000 x 50% = $20,000 AJE is Dr Equipment $50,000, Cr Acc Dep $20,000, Cr Revaluation $30,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 58. Ghana Football Club had a player contract with Mowgli that is recorded in its books at $300,000 on July 1, 2014. Ivory Coast Football Club had a player contract with Eeyore that is recorded in its books at $375,000 on July 1, 2014. On this date, Ghana traded Mowgli to Ivory Coast for Eeyore and paid a cash difference of $37,500. The fair value of the Eeyore contract was $450,000 on the exchange date. After the exchange, the Eeyore contract should be recorded in Ghana’s books at a. $337,500. b. $375,000. c. $412,500. d. $450,000.

59. Libya Corp. exchanged similar pieces of equipment with Kenya Corp. No cash was exchanged. Since this exchange will not significantly change the economic position of either company, this transaction lacks commercial substance. At this time, the net book value of Libya’s asset is $40,000, while the net book value of Kenya’s asset on their books is $37,000. However, it has been reliably determined that the fair value of Libya’s asset is $41,000, while the fair value of Kenya’s asset is $38,000. Given these facts, at what amount should Libya record the asset it receives from Kenya? a. $41,000 b. $40,000 c. $38,000 d. $37,000

60. Transvaal Ltd. received a $250,000 grant from the federal government to help buy equipment as an incentive for them to establish manufacturing operations in Ottawa. Assuming that Transvaal uses the cost reduction method for such transactions, they should record this transaction as a a. memo entry only. b. credit to Equipment for $250,000. c. credit to Deferred Revenue for $250,000. d. credit to Contribution Revenue for $250,000.

61. On December 1, 2014, Guinea Corp. purchased a tract of land as a factory site for $500,000. The old building on the property was razed, and salvaged materials resulting from demolition were sold. Additional costs incurred and salvage proceeds realized during December 2014 were as follows: Cost to raze old building ................................................................ $25,000 Legal fees for purchase contract and to record ownership ............ 5,000 Property purchase tax ................................................................... 8,000 Proceeds from sale of salvaged materials ..................................... 4,000 On Guinea’s December 31, 2014 balance sheet, what amount should be reported for the land? a. $513,000 b. $521,000 c. $534,000

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d. $538,000

62. Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin. The proceeds from the sale of the building should be a. classified as other income. b. deducted from the cost of the land. c. netted against the costs to clear the land and expensed as incurred. d. netted against the costs to clear the land and amortized over the life of the plant.

63. On January 2, 2014, Botswana Inc. replaced its boiler with a more efficient one. The following information was available on that date: Purchase price of new boiler ...................................... $45,000 Carrying amount of old boiler ..................................... 5,000 Fair value of old boiler ................................................ 3,000 Installation cost of new boiler ..................................... 4,000 The old boiler was sold for $3,000. At what amount should Botswana capitalize the cost of the new boiler? a. $47,000 b. $48,000 c. $49,000 d. $50,000

64. On September 10, 2014, Angola Printing incurred the following costs for one of its printing presses: Purchase of stapling attachment ................................................... $84,000 Installation of attachment .............................................................. 10,000 Replacement parts for renovation of press .................................... 36,000 Labour and overhead in connection with renovation of press ........ 14,000 Neither the attachment nor the renovation increased the estimated useful life of the press. However, the renovation resulted in significantly increased productivity. What amount of the costs should be capitalized? a. $0 b. $108,000 c. $130,000 d. $144,000

*65. A company is constructing an asset for its own use. Construction began in 2014. The asset is being financed entirely with a specific new borrowing. Construction expenditures were made in 2014 and 2015 at the end of each quarter. The total amount of interest cost capitalized in 2015 should be determined by applying the interest rate on the specific new borrowing to the a. total accumulated expenditures for the asset in 2014 and 2015. b. weighted-average accumulated expenditures for the asset in 2014 and 2015. c. weighted-average expenditures for the asset in 2015. d. total expenditures for the asset in 2015.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

58. 59.

d c

60. 61.

b c

62. 63.

b c

64. *65.

d b

DERIVATIONS—CPA Adapted No. Answer 58. d 59. c 60 b 61. c 62. b 63. c 64. d *65. b

Derivation $450,000 FV of asset received $38,000 (FV of asset received). Record a loss of $2,000 Conceptual $500,000 + $25,000 + $5,000 + $8,000 – $4,000 = $534,000 Conceptual $45,000 + $4,000 = $49,000 $84,000 + $10,000 + $36,000 + $14,000 = $144,000 Conceptual

Property, Plant, and Equipment: Accounting Model Basics

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EXERCISES Ex. 10-66 Componentization Explain the concept of componentization as it applies to the recognition of PP&E assets. Solution 10-66 Componentization refers to recognizing major parts of an asset as separate assets for accounting purposes, such as the separate parts of a building (roof, heating system, flooring, elevators, foundation). Each part is then depreciated separately to reflect differing useful lives and different patterns of delivering economic benefits to the organization. The extent of componentization is left to professional judgment, with the primary consideration being the significance of the “parts” to the “whole.”

*Ex. 10-67 Plant asset accounting During 2014 and 2015, Mauritius Corporation experienced several transactions involving plant assets. A number of errors were made in recording some of these transactions. For each item listed below, indicate the effect of the error (if any) in the blanks provided by using the following codes: O = Overstate; U = Understate; NE = No Effect If no error was made, write NE in each of the four columns.

Transaction

2014 Net Book Value of Plant 2014 Assets at Net Dec 31/2014 Income

2015 Net Book Value of Plant 2015 Assets at Net Dec 31/2015 Income

The cost of installing a new computer system in 2014 was not recorded in 2014. It was charged to expense in 2015.

_____

In 2015, clerical workers were trained to use the new computer system at a cost of $15,000, which was incorrectly capitalized. The cost is to be written off over the expected life of the new computer system.

_____

3. A major overhaul of factory machinery in 2014, which extended its useful life by five years, was charged to accumulated depreciation in 2014.

_____

4. Interest cost qualifying for capitalization in 2014 was charged to interest expense in 2014.

_____

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

5. In 2014, land was bought for an employee parking lot. The $2,000 title search fee was charged to expense in 2014.

_____

6. The cost of moving several manufacturing facilities from metropolitan locations to suburban areas in 2014 was capitalized. The cost was written off over a 10-year period beginning in 2014.

_____

Solution 10-67 Net Book Value of Plant Assets at Dec 31/2014 1. U

2014 Net Income O

Net Book Value of Plant Assets at Dec 31/2015 U

2015 Net Income U

Ex. 10-68 Asset exchange with commercial substance In 2015, Malawi Inc. exchanged equipment for two delivery trucks. The equipment had been purchased for $95,000 ten years ago and has since been fully depreciated. While the equipment was recently appraised at $22,000, a reliable valuation for the trucks was not available. This transaction has commercial substance. Instructions Prepare the journal entry to record the exchange. Solution 10-68 Trucks ........................................................................................... Accumulated depreciation – equipment......................................... Equipment .............................................................................. Gain on disposal of equipment ...............................................

22,000 95,000 95,000 22,000

Ex. 10-69 Non-interest bearing note Togo Auto purchased several trucks by issuing a $40,000, 4 year, non interest bearing note to Rabat Motors. The market interest rate for this type of transaction is 8%.

Property, Plant, and Equipment: Accounting Model Basics

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Instructions Prepare the journal entry to record the purchase of these trucks. Solution 10-69 Truck ($40,000 x .0.73503)* .......................................................... Notes Payable ........................................................................

$ 29,401 $ 29,401

* OR 4 N 8 I FV 40000 CPT PV = 29,401

Ex. 10-70 Nonmonetary transaction without commercial substance Malawi Auto traded one of its used trailers (cost $40,000, accumulated depreciation $36,000) for another used trailer with a fair value of $6,400. Malawi also paid $600 to complete the transaction. Instructions Assuming the transaction lacks commercial substance, prepare the journal entry to record the exchange. Solution 10-70 Trailer (new) .................................................................................. Accumulated Depreciation ............................................................ Trailer (old) ............................................................................. Cash.......................................................................................

$ 4,600 36,000 $40,000 600

Note: Since the transaction lacks commercial substance, no gain is recognized, and the new asset is recognized at the book value of the old asset plus the cash paid.

Ex. 10-71 Asset exchange Arabia Inc. traded its fleet of rental cars for a new fleet. Two thirds of the old fleet's original cost of $375,000 had been depreciated. The new fleet is valued at $500,000 and Arabia was required to make a cash payment of $400,000. Instructions Prepare the required entr(ies) to record the exchange. Solution 10-71 Fleet (new) .................................................................................... Accumulated depreciation ............................................................. Loss on disposal of fleet ................................................................ Fleet (old) ................................................................................. Cash .........................................................................................

500,000 250,000 25,000 375,000 400,000

Ex. 10-72 Acquisition Cost Gabon Corporation purchased land at a cost of $100,000. Closing costs were $3,800, plus Gabon paid $48,000 for site preparation so they could construct a building on the site. Instructions

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Calculate the amount that should be recorded as the cost of the land. Solution 10-72 $100,000 + $3,800 + $48,000 = $151,800

Ex. 10-73 Costs included in assets Burkina Ltd. is expanding its operations. Due to the expansion, they incurred the following costs during the fiscal period when they constructed a new factory: Direct labour ..................................................................... 70,000 Loan Interest to finance expansion.................................... 3,000 Architectural drawings ....................................................... 15,000 Purchase of company car for the new plant manager........ 44,000 Direct material for factory .................................................. 81,000 Allocation of overhead based on labour hours worked on factory .................................................... 58,000 Imputed interest on lost opportunity costs ......................... 9,000 Instructions Which of these costs should be included in the cost of the new factory? Solution 10-73 Direct labour ..................................................................... Loan interest to finance expansion .................................... Architectural drawings ....................................................... Direct material for factory .................................................. Allocation of overhead based on labour hours worked on factory .................................................... Total..................................................................................

$ 70,000 3,000 15,000 81,000 58,000 $227,000

Ex. 10-74 Measurement models Identify and briefly describe the three main models to accounting for PP&E assets. Solution 10-74 The following three models are available and may be used subject to the asset type and whether IFRS or ASPE is used: 1. The cost model: This model can be used for all types of PP&E assets, and is acceptable under both ASPE and IFRS. The assets, after acquisition, are measured at cost less accumulated depreciation and adjusted for impairment as necessary. 2. The revaluation model: This model can be used for all types of PP&E assets except for investment property, and is only used under IFRS. Net increases in fair value are accumulated in a separate account, Revaluation Surplus, and reported in other comprehensive income. There are two accounting methods allowed, the proportionate method and the asset-adjustment or elimination method. 3. The fair value model: This model can only be used for investment property, and again, is only used under IFRS. Assets are not depreciated and all changes in fair value are recognized in net income.

Property, Plant, and Equipment: Accounting Model Basics

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Ex. 10-75 Application of the revaluation model Aden Motels Inc. owns a motel that it had purchased on January 1, 2014 for $1.5 Million cash and is accounted for in a separate account, classified as "Structures." The company is using the revaluation model to account for its structures and revalues them annually. Aden uses straightline depreciation over the asset's 15-year useful life with no residual value. The asset's fair values were as follows: Dec 31, 2014: Equal to its book value, Dec 31, 2015: $1,450,000. Instructions Assuming Aden uses the asset adjustment (elimination) method for revaluation, prepare all required journal entries for 2014 and 2015. Solution 10-75 Journal Entries – 2014: January 1: Structures...................................................................................... 1,500,000 Cash....................................................................................... 1,500,000 To account for acquisition December 31 Depreciation expense ................................................................... 100,000 Accumulated depreciation – Structures .................................... To record 2014 depreciation ($1,500,000 – 0) ÷ 15 = $100,000 Journal Entries – 2015: December 31: Depreciation expense ................................................................... Accumulated depreciation – Structures .................................... To record 2015 depreciation (prior to revaluation) ($1,500,000 – 0) ÷ 15 = $100,000 December 31: Accumulated depreciation – Structures ......................................... Structures ................................................................................. To eliminate accumulated depreciation (as part of the revaluation process) ($100,000 x 2 = $200,000) December 31: Structures...................................................................................... Revaluation Surplus (OCI) ........................................................ To adjust the Structures account to fair value $1,450,000 – ($1,500,000 – $200,000) = $150,000

100,000

100,000 100,000

200,000 200,000

150,000 150,000

Ex. 10-76 Application of the fair value model On January 20, 2015, Trail Corp. purchased a luxury apartment complex in British Columbia for

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

$10 Million cash. In addition to the purchase price, Trail paid transfer fees of $150,000, and legal fees of $20,000. Wages paid to maintenance staff during each of the following three years: 2015: $103,000 2016: $107,000 2017: $110,000 Fair value information: Dec 31, 2015: $9.1 Million Dec 31, 2016: $10.9 Million Dec 31, 2017: $11.7 Million Other information: The complex qualifies as investment property. Trail applies the fair value method to all its investment property. Instructions Prepare all required journal entries for 2015, 2016, and 2017. Solution 10-76 Journal Entries – 2015 Investment Property – Apartment Complex ................................... 10,170,000 Cash ......................................................................................... 10,170,000 To account for acquisition on January 20 ($10,000,000 + $150,000 + $20,000 = $10,170,000) Wages expense ............................................................................ Cash....................................................................................... To account for wages paid during 2015

103,000 103,000

Loss in value of investment property ............................................. 1,070,000 Investment property – Apartment Complex............................. 1,070,000 To adjust the value of the investment property to fair value at Dec 31, 2015 ($10,170,000 – $9,100,000 = $1,070,000) Journal Entries – 2016 Wages expense ............................................................................ Cash....................................................................................... To account for wages paid during 2016

107,000 107,000

Investment property – Apartment Complex ................................... 1,800,000 Gain in value of investment property ...................................... 1,800,000 To adjust the value of the investment property to fair value at Dec 31, 2016 ($10,900,000 – $9,100,000 = $1,800,000) Journal Entries – 2017 Wages expense ............................................................................

110,000

Property, Plant, and Equipment: Accounting Model Basics

Cash....................................................................................... To account for wages paid during 2017 Investment property – Apartment Complex ................................... Gain in value of investment property ...................................... To adjust the value of the investment property to fair value at Dec 31, 2017 ($11,700,000 – $10,900,000 = $800,000)

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110,000

800,000 800,000

*Ex. 10-77 Capitalization of interest In February 2015, Quorum Corp. began the construction of a 10 story building. The construction is expected to be completed by January 2016. During 2015, the following payments were made: Apr 1: $1,000,000 Jun 1: $1,500,000 Aug 1: $900,000 Oct 1: $950,000 No asset specific debt was incurred. During 2015, Quorum's general debt consisted of the following: $2 Million, 5%, 2-year note, $1.2 Million, 4.5%, 2-year note, $0.75 Million, 3%, 5-year note. Instructions a) Calculate the weighted-average accumulated expenditures for the year ended December 31, 2015. b) Calculate the weighted-average capitalization rate on Quorum's general-purpose debt for the year ended December 31, 2015. c) Calculate the avoidable borrowing costs. d) Calculate the amount of Quorum's borrowing costs that should be capitalized. Solution 10-77 a) Weighted-average accumulated expenditures for the year ended December 31, 2015: Date

Amount

Capitalization Period

Weighted Average Accumulated Expenditures ____________________________________________________ Apr 1 1,000,000 9 ÷ 12 750,000 Jun 1 1,500,000 7 ÷ 12 875,000 Aug 1 900,000 5 ÷ 12 375,000 Oct 1 950,000 3 ÷ 12 237,500 ____________________________________________________ Total 4,350,000 2,237,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Weighted-average capitalization rate on Quorum's general-purpose debt for the year ended December 31, 2015:

Borrowing Description Principal Costs _______________________________________________ $2 Mill. 5%. 2-year note 2,000,000 100,000 $1.2 Mill. 4.5% 2-year note 1,200,000 54,000 $0.75 Mill. 3% 5-year note 750,000 22,500 _______________________________________________ Total 3,950,000 176,500 Weighted average rate = $176,500 ÷ $3,950,000 = 4.47% c) Avoidable borrowing costs: ($2,237,500 – $0) x 4.47% = $100,016 d)

Borrowing costs to be capitalized: $0 + $100,016 = $100,016

*Ex. 10-78 Capitalization of interest On March 1, Dubai Corp. began construction of a small building. The following expenditures were incurred for construction: Mar 1 $ 75,000 Jun 1 $300,000 Apr 1 84,000 Jul 1 100,000 May 1 180,000 The building was completed and occupied on July 1. To help pay for construction, $60,000 was borrowed on March 1 on a 10%, three-year note payable. The only other debt outstanding during the year was a $500,000, 8% note issued two years ago. Instructions a) Calculate the weighted-average accumulated expenditures. b) Calculate avoidable interest. Solution 10-78 a) Date Expenditures March 1 $ 75,000 April 1 84,000 May 1 180,000 June 1 300,000 July 1 100,000

Weighted-Average Accum. Expend. $ 60,000

Capitalization Period 4 ÷ 12 3 ÷ 12 2 ÷ 12 1 ÷ 12 0

Rate .10

Weighted-Average Accum. Expend. $ 25,000 21,000 30,000 25,000 0 $101,000

Avoidable Interest $6,000

Property, Plant, and Equipment: Accounting Model Basics

41,000 $101,000

.08

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3,280 $9,280

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 10-79 Purchase of asset by non-interest bearing note Lebanon Corporation is a Calgary-based manufacturer of automobile parts. In early January 2014, the company acquired land and a building to be used as the company's new head office. Lebanon issued a $2M, five-year non-interest bearing note to the seller. Payment is to be made in five equal instalments of $400,000 at the end of each year. As a result of a depressed real estate market, the fair value of the building cannot be readily determined. However, it has been ascertained that, given Lebanon's credit rating and market conditions, an interest rate of 9% would properly reflect the substance and credit risk of the negotiated payment schedule. Other information: 1. One third of the total value of the acquisition is attributable to the land. 2. The building is expected to have a useful life of 25 years. 3. Throughout the year, Lebanon incurred maintenance costs of $87,000 and paid them in cash. 4. A parking lot was built at a cost of $100,000 cash. The work was completed on July 1 and is expected to have a useful life of 10 years. 5. Lebanon uses straight-line depreciation for all its PP&E assets. Instructions Prepare all journal entries that are required to record the above events and transactions. Round all values to the nearest dollar. Solution 10-79 Land .............................................................................................. 518,620 Building ......................................................................................... 1,037,240 Note Payable.......................................................................... 1,555,860 To record the acquisition of land and building $400,000 x 3.88965 = $1,555,860 OR 5 N 9 I 400000 PMT CPT PV = 1,555,860 Land: $1,555,860 x 1 ÷ 3 = $518,620 Building: $1,555,860 x 2 ÷ 3 = $1,037,240 Maintenance expense ................................................................... Cash....................................................................................... To record maintenance costs

87,000

Land improvements – parking lot .................................................. Cash....................................................................................... To record creation of parking lot

100,000

Depreciation expense ................................................................... Accumulated depreciation – building ...................................... Accumulated depreciation – land improvements..................... To record annual depreciation Building: $1,037,240 ÷ 25 = $41,490 Land improvements: ($100,000 ÷ 10) x 6 ÷ 12 = $5,000

46,490

87,000

100,000

41,490 5,000

Property, Plant, and Equipment: Accounting Model Basics

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Pr. 10-80 Asset exchanges Bahrain Corporation follows a policy of a 10% depreciation charge per year on machinery and a 5% depreciation charge per year on buildings. The following transactions occurred in 2014: March 31, 2014 A warehouse which Bahrain had purchased on January 1, 2005 for $1.7 million (with a current fair value of $1 million) was exchanged for another warehouse which also had a current fair value of $1 million. Depreciation has been properly charged from Jan 1, 2005 through Dec 31, 2013. Both parcels of land on which the warehouses were located were equal in value, and had a fair value equal to book value. June 30, 2014 Machinery with a cost of $120,000 and accumulated depreciation through December 31, 2013 of $90,000 was exchanged, along with $75,000 cash, for a parcel of land with a fair market value of $115,000. Instructions Prepare all appropriate journal entries for Bahrain Corporation for the above dates. Solution 10-80 Mar 31, 2014 Depreciation Expense ............................................... Accumulated Depreciation—Warehouse ............ ($1,700,000 × 5% × 3 ÷ 12) Warehouse (“new”) ................................................... Accumulated Depreciation—Warehouse .................. Warehouse (“old”) .............................................. ($1,700,000 × 5% × 9 3 ÷ 12 = $786,250)

21,250 21,250

913,750 786,250 1,700,000

Note: Since this transaction would leave Bahrain in basically the same economic position as before, the transaction lacks commercial substance; therefore the “new” warehouse is recorded at the book value of the old one. Recording it at its fair value would create a gain, which is not correct when there is no commercial substance. June 30, 2014

Depreciation Expense ............................................... Accumulated Depreciation—Machinery ............. ($120,000 × 10% × 1 ÷ 2)

6,000

Land ......................................................................... Accumulated Depreciation—Machinery .................... Gain on Exchange ............................................. Machinery .......................................................... Cash .................................................................. [$40,000 – ($120,000 – $96,000)] = $16,000

115,000 96,000

6,000

16,000 120,000 75,000

Note: Since the assets involved are sufficiently dissimilar, this transaction will change Bahrain’s economic position, and the transaction has commercial substance. Therefore a gain on exchange can be recorded. Note the new asset cannot be recorded at higher than fair value.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Pr. 10-81 Asset exchange – no commercial substance Turkey Corp. has a computer that they purchased on March 30, 2010 for $106,000. This computer had an estimated life of ten years and a residual value of $6,000. On December 31, 2014, the old computer is exchanged for a similar computer with a fair value of $58,000. Turkey also received $2,000 cash. Assume that the last fiscal period ended on December 31, 2013, and that straight-line depreciation is used. Instructions Prepare all entries that are necessary on December 31, 2014. Solution 10-81 Depreciation Expense ($106,000 – $6,000) ÷ 10........................... Accumulated Depreciation—Computer................................... Accumulated Depreciation—Computer ($10,000 x 4 ¾) ................ Computer (“new”) .......................................................................... Cash ............................................................................................. Computer (“old”) .....................................................................

10,000 10,000 47,500 56,500 2,000 106,000

Note: Since this transaction would leave Turkey in basically the same economic position as before, the transaction lacks commercial substance; therefore the “new” computer is recorded at the book value of the old one minus the cash received ($106,000 – $47,500 = $58,500 – $2,000 = $56,500). Recording it at the fair value of the new computer would create a gain, which is not correct when there is no commercial substance. Pr. 10-82 Asset exchange – no commercial substance Syria Corp. exchanged Building 24, which has an appraised value of $1,700,000, a cost of $2,800,000 and accumulated depreciation of $1,300,000, for Building M which belongs to Russia Ltd. Building M has an appraised value of $1,620,000, a cost of $3,100,000, and accumulated Depreciation of $1,750,000. Russia paid Syria the difference between the appraised values of the two buildings. Assume depreciation has been updated to the date of exchange. Instructions Prepare the entries on both companies’ books, assuming the buildings are similar assets. Solution 10-82 Syria Corp.: Accumulated Depreciation ............................................................ 1,300,000 Building M ..................................................................................... 1,420,000 Cash ............................................................................................. 80,000 Building 24 ............................................................................. 2,800,000 ($1,700,000 – $1,620,000 = $80,000 cash received) Cost of Building M = book value of Building 24 less cash received. Russia Ltd.: Accumulated Depreciation ............................................................ 1,750,000 Building 24 .................................................................................... 1,430,000 Building M .............................................................................. 3,100,000 Cash....................................................................................... 80,000

Property, Plant, and Equipment: Accounting Model Basics

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Cost of Building 24 = book value of Building M plus cash paid. Note: Since this transaction would leave both companies in basically the same economic position as before, the transaction lacks commercial substance; therefore the “new” buildings are recorded at the book value of the old one, less cash received, or plus cash paid. Recording them at fair value would create a gain, which is not correct when there is no commercial substance.

Pr. 10-83 Nonmonetary exchange Athens Inc. exchanged machinery with an appraised value of $1,170,000, a recorded cost of $1,800,000 and accumulated depreciation of $900,000, for machinery that Sparta Corp. owns. Sparta’s machinery has an appraised value of $1,140,000, a recorded cost of $2,160,000, and accumulated depreciation of $1,188,000. Sparta also gave Athens $30,000 in the exchange. Assume depreciation has been updated to the date of exchange. Instructions a) Prepare the entries on both companies’ books assuming that the transaction has commercial substance. b) Prepare the entries on both companies’ books assuming that the transaction lacks commercial substance. Solution 10-83 a) Commercial substance Athens Inc. Machinery ....................................... 1,140,000 Cash 30,000 Accum. Depreciation— Machinery................................. 900,000 Gain on Exchange of Plant Assets ...................... 270,000 Machinery .......................... 1,800,000 Sparta Corp. Machinery ....................................... 1,170,000 Accum. Depreciation— Machinery................................. 1,188,000 Gain on Exchange of Plant Assets ...................... 168,000 Machinery .......................... 2,160,000 Cash .................................. 30,000 b)

No commercial substance Athens Inc. Machinery ..................................................................................... Cash ............................................................................................. Accumulated Depreciation—Machinery......................................... Machinery...............................................................................

Cost A/D BV FV Gain

$1,800,000 900,000 900,000 1,170,000 $ 270,000

Cost A/D BV FV Gain

$2,160,000 1,188,000 972,000 1,140,000 $ 168,000

870,000 30,000 900,000 1,800,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Sparta Corp. Machinery ..................................................................................... 1,002,000 Accumulated Depreciation—Machinery......................................... 1,188,000 Machinery............................................................................... 2,160,000 Cash....................................................................................... 30,000 Note: When there is no commercial substance, no gain is recorded. Instead, the asset is recorded at its book value plus any cash paid or less any cash received. For Athens, the value would be $900,000 – $30,000 cash received = $870,000. For Sparta, the value would be $972,000 + $30,000 cash paid = $1,002,000. Note also that the “new” asset cannot be recorded at higher than fair value.

Pr. 10-84 Costs included in assets Below is a list of various expenditures that an organization could make. In the columns marked Land, Building, Equipment and Expensed, indicate by a “+” or “–“ which columns the expenditure would be added to or subtracted from. The first has been done for you as an example. Item 0. Construction costs 1. Title search 2. Property transfer tax 3. Installation of equipment 4. Soil decontamination costs 5. Transportation costs of equipment 6. Labour to construct building 7. Special foundation for machinery 8. Damage to machinery while uncrating 9. Proceeds from salvage of old building on land purchased for factory site 10. Property taxes in arrears paid on purchase 11. Insurance on building after occupancy 12. Clearing land for factory site

Land

Building +

Equipment

Expensed

Land

Building +

Equipment

Expensed

Solution 10-84 Item 0. Construction costs 1. Title search 2. Property transfer tax 3. Installation of equipment 4. Soil decontamination costs 5. Transportation costs of equipment 6. Labour to construct building 7. Special foundation for machinery 8. Damage to machinery while uncrating 9. Proceeds from salvage of old building

+ + + + + + + + +

Property, Plant, and Equipment: Accounting Model Basics

on land purchased for factory site 10. Property taxes in arrears paid on purchase 11. Insurance on building after occupancy 12. Clearing land for factory site

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+ + +

Pr. 10-85 Fair value model In February 2014, Jordan Corp. purchased a vineyard in southern Ontario for $7.5 Million cash. This amount included legal fees of $18,000 and property taxes of $40,000 (of that amount, $30,000 were in arrears). Based on appraisals, the property's year-end fair values were $8.2 Million at the end of 2014, and $8 Million at the end of 2015. Other information: 1. The vineyard qualifies as investment property. 2. Jordan applies the fair value method to all its investment property. Instructions Prepare all required journal entries for 2014 and 2015. Solution 10-85 Journal Entries – 2014 Investment Property—vineyard ..................................................... 7,490,000 Property tax expense .................................................................... 10,000 Cash ......................................................................................... 7,500,000 To account for acquisition in February 2014 $7,500,000 – ($40,000 – $30,000) = $7,490,000 Investment property—vineyard...................................................... Gain in value of investment property ...................................... To adjust the value of the investment property to fair value at Dec 31, 2014 ($8,200,000 – $7,490,000 = $710,000) Journal Entry – 2015 Loss in value of investment property ............................................. Investment property—vineyard ................................................. To adjust the value of the investment property to fair value at Dec 31, 2015 ($8,200,000 – $8,000,000 = $200,000)

710,000 710,000

200,000 200,000

Note that the gain/loss is booked through net income, not OCI.

Pr. 10-86 Revaluation model Mongolia Inc. owns equipment that it purchased on January 1, 2015 for $4 Million. The following additional information is available: Dec 31, 2015 – Book value (after recording 2015 depreciation): $3,600,000 Dec 31, 2015 – Fair value: $4,100,000 The company uses the revaluation model (asset adjustment method) to account for its property,

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plant and equipment. Instructions Assuming the entry for the current year's depreciation has already been recorded, prepare the entr(ies) to adjust the asset's carrying amount to fair value. Solution 10-86 Accumulated Depreciation—Equipment ........................................ Equipment ................................................................................ To eliminate accumulated depreciation ($4,000,000 ÷ 10 = $400,000) Equipment ..................................................................................... Revaluation Surplus (OCI) ........................................................ To adjust the equipment account to fair value $4,100,000 – ($3,600,000 + $400,000) = $100,000

400,000 400,000

100,000 100,000

*Pr. 10-87 Capitalization of borrowing costs During 2014, Tibet Building Company constructed various assets at a total cost of $4.2 million. The weighted-average accumulated expenditures on assets qualifying for capitalization of interest during 2014 were $2.8 million. The company had the following debts outstanding at December 31, 2014: 1. 8%, five-year note to finance construction of various assets, dated January 1, 2014, with interest payable annually on January 1 $1,800,000 2. 10%, ten-year bonds issued at par on December 31, 2009, with interest payable annually on December 31 2,000,000 3. 7%, three-year note payable, dated January 1, 2013, with interest payable annually on January 1 1,000,000 Instructions Calculate the amounts of the following for 2014 (show calculations): a) avoidable interest, b) total interest to be capitalized. Solution 10-87 a) Weighted-Average Accumulated Expenditures $1,800,000 1,000,000 $2,800,000

Applicable Interest Rate .08 .09*

*Calculation of weighted-average interest rate: Principal 10% ten-year bonds $2,000,000 7% three-year note 1,000,000 $3,000,000

Avoidable Interest $144,000 90,000 $234,000 = Avoidable Interest

Interest $200,000 70,000 $270,000

Property, Plant, and Equipment: Accounting Model Basics

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Weighted-average interest rate = $270,000 ÷ $3,000,000 = 9%. b)

Actual interest cost during 2014: Construction note, $1,800,000 × .08 10% ten-year bonds, $2,000,000 × .10 7% three-year note, $1,000,000 × .07

$144,000 200,000 70,000 $414,000

The interest cost to be capitalized is $234,000 (the lesser of the $234,000 avoidable interest and the $414,000 actual interest).

*Pr. 10-88 Capitalization of borrowing costs Early in 2014, Qatar Corporation engaged Emirate Ltd. to design and construct a complete modernization of Qatar’s manufacturing facility. Construction began on June 1, 2014 and was completed on December 31, 2014. Qatar made the following payments to Emirate Ltd. during 2014: Date Payment June 1, 2014 $3,300,000 August 31, 2014 4,800,000 December 31, 2014 4,000,000 In order to help finance the construction, Qatar issued the following during 2014: 1. $2,000,000, ten-year, 9% bonds payable, issued at par on May 31, 2014, with interest payable annually on May 31, 2. 1,000,000 no-par common shares, issued at $10 per share on October 1, 2014. In addition to the 9% bonds payable, the only other debt outstanding during 2014 was a $700,000, 12% note payable dated January 1, 2013 and due January 1, 2016, with interest payable annually on January 1. Instructions Calculate the amounts of each of the following (show calculations): a) weighted-average accumulated expenditures qualifying for capitalization of interest cost, b) avoidable interest incurred during 2014, c) total amount of interest cost to be capitalized during 2014. Solution 10-88 a) Date June 1 August 31 December 31

Capitalization Expenditures $3,300,000 4,800,000 4,000,000

Weighted-Average Accumulated Appropriate Expenditures Interest Rate

Period 7 ÷ 12 4 ÷ 12 0

Weighted-Average Accumulated Expenditures $1,925,000 1,600,000 0 $3,525,000

Avoidable Interest

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$2,000,000 1,525,000 $3,525,000

.09 .12

$180,000 183,000 $363,000

Actual interest incurred during 2014: 9% bonds payable, $2,000,000 × .09 × 7 ÷ 12 ........... 12% note payable, $700,000 × .12 .............................

$105,000 84,000 $189,000

The interest cost to be capitalized is $189,000 (the lesser of the $363,000 avoidable interest and the $189,000 actual interest cost).

Property, Plant, and Equipment: Accounting Model Basics

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CHAPTER 11 DEPRECIATION, IMPAIRMENT, AND DISPOSITION SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

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

1 2 2 2 2 4 4 4 4

E E E E E E M E E

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

34. 35. 36. 37. 38. 39. 40. 41.

2,4 4 4 4 4 4 4 4

M M M H M H M E

42. 43. 44. 45. 46. 47. 48. 49.

65. 66. 67.

2 4 4

H M M

68. 69. 70.

75. 76.

2 2

M M

77. 78.

83.

*84.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 4 E 19. 7 M 4 E 20. 7 M 5 E 21. 7 H 5 E 22. 7 M 5 M 23. 7 M 6 M 24. 7 M 6 M 25. 8 M 6 M 26. 9 M 6 M 27. 9 E Multiple Choice–Computational 4 M 50. 7 E 4 M 51. 7 M 4 H 52. 7 E 4 H 53. 8 M 5 H 54. 8 M 5 M 55. 9 H 6 H 56. 9 H 6 H 57. 9 M Multiple Choice–CPA Adapted 4 H 71. 11 M 5 M 72. 11 H 11 M *73. 13 M Exercises 2-4,6,7 M *79. 4,13 M 4,9 M 80. 7 M Problems 4,13 H 85. 6,7 M

M = Medium

Item

LOD

28. 29. 30. 31. *32. *33.

10 10 11 11 13 13

M M M M H M

58. 59. 60. 61. 62. 63. *64.

9 9 9 9 11 11 13

M H H H E M M

*74.

81. *82.

7 13

M M

86.

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

4. 5.

MC MC

2. 3.

MC MC

77.

6. 7. 8. 9. 10.

MC MC MC MC MC

11. 34. 35. 36. 37.

MC MC MC MC MC

12.

13.

15. 16.

MC MC

17. 18.

MC MC

19. 20. 21.

MC MC MC

22. 23. 24.

MC MC MC

25.

53.

26. 27.

MC MC

55. 56.

MC MC

28.

29.

30. 31.

MC MC

62. 63.

MC MC

*32. *33.

MC MC

*64. *73.

MC MC

MC = Multiple Choice

Item Type Item Type Learning Objective 1 Learning Objective 2 34. MC 75. Ex 65. MC 76. Ex Learning Objective 3 Learning Objective 4 38. MC 43. MC 39. MC 44. MC 40. MC 45. MC 41. MC 66. MC 42. MC 67. MC Learning Objective 5 14. MC 46. MC Learning Objective 6 48. MC 77. Ex 49. MC 85. Pr Learning Objective 7 50. MC 77. Ex 51. MC 80. Ex 52. MC 81. Ex Learning Objective 8 54. MC Learning Objective 9 57. MC 59. MC 58. MC 60. MC Learning Objective 10

Item

Type

Item

Type

77.

68. 77. 78. 79. 83.

MC Ex Ex Ex Pr

84.

47.

69.

85.

61. 78.

MC Ex

Learning Objective 11 70. Ex 72. Ex 71. Ex 86. Pr Learning Objective 13 *74. MC *82. Ex *79. Ex *84. Pr Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

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5. Explain the accounting issues for depletion of mineral resources. After the depletion base has been established through accounting decisions related to the acquisition, exploration and evaluation, development, and restoration obligations associated with mineral resources, these Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

costs are allocated to the natural resources that are removed. Depletion is normally calculated using the units of production method. In this approach, the resource’s cost less residual value, if any, is divided by the number of units that are estimated to be in the resource deposit, to obtain a cost per unit of product. The cost per unit is then multiplied by the number of units withdrawn in the period to calculate the depletion.

Depreciation, Impairment, and Disposition

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11. Analyze a company’s investment in assets. The efficiency of use of a company’s investment in assets may be evaluated by calculating and interpreting the asset turnover rate, the profit margin, and the rate of return on assets.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer d c b c b c b a d a b a d b d c c a c b d a d b d b a c d b c c d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. *32. *33.

Description Knowledge of depreciation accounting Factors in depreciation accounting Definition of componentization Asset’s useful life Depreciation commencement or continuation Graphic depiction of straight-line and declining-balance methods Disadvantage of using straight-line method Depreciation as variable expense Units of production depreciation Units of production depreciation Time based depreciation Classification of depletion expense Depletion expense method Definition of liquidating dividend Knowledge of double declining-balance method Effect of accelerated depreciation on the income statement Revision of depreciation Disclosure of changes in depreciation ASPE requirements for impairment IFRS requirements for impairment Indicators of asset impairment Cost recovery impairment model Rational entity impairment model Definition of cash generating unit (CGU) Assets held for sale Discontinuation of depreciation Loss on sale of asset PP&E disclosures Depreciation cessation Asset turnover ratio Rate of return on assets Objectives of CCA method Factors to consider for CCA

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Computational Answer c b c b b b d c a a d d c c c a b d a a b d b c b b c a c b c

No. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. *64.

Description Componentization of assets Calculate depreciation using double declining-balance. Calculate depreciation using double declining-balance. Calculate accumulated depreciation using straight-line. Calculate depreciation using double declining-balance. Double declining-balance method Calculate book value of asset. Calculate depreciation using straight-line. Calculate depreciation using double declining-balance. Calculate acquisition cost from straight-line depreciation. Calculate acquisition cost from units of production. Calculate depreciation expense. Calculate units-of-production depletion expense. Calculate depletion expense. Calculate revised depreciation expense. Calculate revised depreciation expense after major overhaul. Calculate recoverable amount. Proper accounting treatment for impairment loss Journal entry for impairment loss under ASPE Depreciation on asset held for sale Fair value adjustment on equipment held for sale Calculate depreciation expense from change in contra-asset account. Calculate depreciation expense from change in contra-asset account. Calculate gain for held for sale assets. Accounting treatment for gain under involuntary conversion Calculate loss on sale. Calculate gain on sale. Calculate loss on disposal. Calculate asset turnover ratio. Calculate rate of return on assets. Calculate CCA for the year.

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Answer d b c c c a b c b d

No. 65. 66. 67. 68. 69. 70. 71. 72. *73. *74.

Description Calculate depreciation expense using double declining-balance. Calculate depreciation using double declining-balance. Calculate accumulated depreciation using units of production. Calculate accumulated depreciation using double declining-balance. Units-of-production depletion expense Calculate asset turnover ratio. Calculate profit margin ratio. Calculate rate of return on assets. Calculate CCA for the year. Calculate recapture or terminal loss on sale.

EXERCISES Item E11-75 E11-76 E11-77 E11-78 *E11-79 E11-80 E11-81 *E11-82

Description Definitions Componentization and depreciation of PP&E assets True or false Asset depreciation and disposition Calculate depreciation and CCA. Rational entity impairment model Impairment Calculate depreciation and CCA.

PROBLEMS Item P11-83 *P11-84 P11-85 P11-86

Description Asset overhaul Calculate depreciation and CCA. Cost recovery impairment model, revision of depreciation Calculation of ratios.

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Conceptual 1. Which of the following is INCORRECT regarding depreciation? a. It is not a matter of valuation. b. It is part of the matching of revenues and expenses. c. It is a means of cost allocation. d. It is an attempt to reflect the fair market values of the related assets.

2. Factors to consider in the depreciation process do NOT include a. the asset’s depreciable amount. b. the period over which to depreciate the asset. c. the asset’s fair market value. d. which asset components should be depreciated separately.

3. Deciding which PPE components to depreciate separately is called a. separate depreciation. b. componentization. c. group depreciation. d. individual asset depreciation. 4. An asset’s useful life a. remains unchanged once it has been determined. b. is the same as its physical life. c. is affected by physical and economic factors. d. is not affected by physical and economic factors.

5. Depreciation commences or continues when a. The asset has been paid for. b. The asset is available for use. c. The asset’s fair value can be recovered. d. The asset is taken out of service.

6. A graph is set up with "yearly depreciation expense" on the vertical axis and "time" on the horizontal axis. Assuming linear relationships, how would the graphs for straight-line and declining-balance depreciation, respectively, be drawn? a. vertically and sloping down to the right b. vertically and sloping up to the right c. horizontally and sloping down to the right d. horizontally and sloping up to the right

7. A principal objection to the straight-line method of depreciation is that it a. provides for the declining productivity of an aging asset. b. ignores variations in the rate of asset use. c. tends to result in a constant rate of return on a diminishing investment base. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. gives smaller periodic write-offs than decreasing charge methods.

8. For income statement purposes, depreciation is a variable expense if the depreciation method used is a. units of production. b. straight-line. c. increasing charge. d. declining-balance.

9. If a company uses the units of production method for calculating depreciation on its factory machinery, the credit to accumulated depreciation from period to period during the life of the firm will a. be constant. b. vary with unit sales. c. vary with sales revenue. d. vary with production.

10. When the units of production method of depreciation is used, which of the following best describes depreciation expense? a. Depreciation expense will vary directly with output. b. Depreciation expense will vary directly with sales. c. Depreciation rate per unit will vary directly with output. d. Depreciation rate per unit will vary directly with sales.

11. Which of the following is NOT a time-based depreciation method? a. straight-line b. units of production c. double-declining balance d. any diminishing balance method

12. Depletion expense a. is usually part of cost of goods sold. b. includes tangible equipment costs in the depletion base. c. excludes intangible development costs from the depletion base. d. excludes restoration costs from the depletion base.

13. The most common method of recording depletion for accounting purposes is the a. single-declining method. b. double-declining method. c. straight-line method. d. units of production method. 14. When all of, or a portion of, shareholders’ capital investments are returned to them, this is called a a. return dividend. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Depreciation, Impairment, and Disposition

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b. liquidating dividend. c. stock dividend. d. investment dividend.

15. Which of the following does NOT apply to the double declining-balance method? a. It results in a decreasing charge to depreciation expense. b. Residual value is not deducted in calculating the depreciation base. c. The book value should not be reduced below residual value. d. In certain circumstances, the book value may be reduced below residual value.

16. If income tax effects are ignored, accelerated depreciation methods a. provide funds for the earlier replacement of assets. b. increase funds provided by operations. c. tend to offset the effect of steadily increasing repair and maintenance costs on the income statement. d. tend to decrease the current ratio.

17. On January 1, 2009, Rabbit Corp. acquired machinery which it depreciated using the straightline method with an estimated useful life of fifteen years and no residual value. On January 1, 2014, Rabbit estimated that the remaining life of this machinery was six years with no residual value. This change should be accounted for a. as a prior period adjustment. b. as the cumulative effect of a change in accounting principle in 2014. c. by setting future annual depreciation equal to one-sixth of the book value on January 1, 2014. d. by continuing to depreciate the machinery over the original fifteen year life.

18. Changes in the depreciation rate are accounted for as a(n) a. adjustment to current and future periods. b. adjustment to the current period only. c. adjustment to future periods only. d. catch-up adjustment to prior periods.

19. ASPE requires that assets must be assessed for indications of impairment a. at the end of each reporting period. b. at the end of every quarter. c. when events and circumstances indicate that asset's carrying amount may not be recoverable. d. whenever the method of depreciation has changed.

20. IFRS require that assets must be assessed for indications of impairment a. at the end of every quarter. b. at the end of each reporting period. c. when events and circumstances indicate that asset's carrying amount may not be recoverable. d. whenever the method of depreciation has changed. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

21. Which of the following is NOT likely to be an indicator of possible asset impairment? a. evidence of obsolescence or physical damage b. a significant decrease in the asset's market value c. the book value of the entity’s net assets is greater than the entity’s market capitalization d. costs incurred for asset acquisition or construction are significantly lower than originally expected

22. The cost recovery impairment model a. uses undiscounted cash flows in its determination of impairment. b. uses discounted cash flows in its determination of impairment. c. is the method used under IFRS. d. requires the calculation of value in use.

23. The rational entity impairment model a. does not allow the reversal of previously recognized impairment losses. b. is the method used under ASPE. c. uses undiscounted cash flows in its determination of impairment. d. compares the asset’s carrying value with its recoverable amount.

24. Which of the following best describes the concept of cash-generating units (CGU)? a. Their cash flows are dependent on those of other CGU's. b. The individual assets that are included in the CGU do not generate cash flows on their own. c. A CGU is the largest identifiable group of assets that generate cash inflows predominantly independent from other CGUs. d. IFRS does not recognize the concept of cash-generating units (CGU).

25. Long-lived assets that are held for sale a. continue to be depreciated. b. are carried at the higher of book value and fair values less costs of disposal. c. are generally not remeasured at each balance sheet date. d. are reported separately from other assets.

26. Depreciation should be discontinued when an asset has been a. derecognized or taken out of service. b. derecognized or classified as held for sale. c. taken out of service. d. taken out of service or classified as held for sale.

27. The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were a. less than book value. b. greater than cost. c. greater than book value. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Depreciation, Impairment, and Disposition

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d. less than current market value.

28. Disclosures relating to PP&E assets are a. identical under IFRS and ASPE. b. less extensive under IFRS. c. less extensive under ASPE. d. more extensive under ASPE.

29. A general description of the depreciation methods applicable to major classes of depreciable assets a. is not a current practice in financial reporting. b. is not essential to a fair presentation of financial position. c. is needed in financial reporting when company policy differs from income tax policy. d. should be included in corporate financial statements or notes thereto.

30. The asset turnover ratio is calculated by dividing a. net income by ending total assets. b. net sales by average total assets. c. net sales by ending total assets. d. net income by average total assets.

31. The rate of return on assets (ROA) is calculated by dividing a. average total assets by net income. b. net revenue by average total assets. c. net income by average total assets. d. net income by net revenue.

*32. A major objective of capital cost allowance for tax depreciation is to a. reduce the amount of depreciation expense claimed for income tax purposes. b. assure that the amount of depreciation for income tax and book purposes will be the same. c. help taxpayers achieve a faster write-off of their capital assets. d. require taxpayers to use the actual economic lives of assets in calculating tax depreciation.

*33. Under the capital cost allowance system, which of the following is NOT relevant? a. the capital cost of the asset b. the asset class c. the half-year rule d. the asset’s residual value

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

d c b c b

6. 7. 8. 9. 10.

c b a d a

11. 12. 13. 14. 15.

b a d b d

16. 17. 18. 19. 20.

c c a c b

21. 22. 23. 24. 25.

d a d b d

26. 27. 28. 29. 30.

b a c d b

31. *32. *33.

c c d

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MULTIPLE CHOICE—Computational 34. Consider an asset that was separated into its main components (A, B and C). The $1,200,000 purchase price was allocated to these components in equal proportions. The useful lives are 12, 4, and 7 years for components A, B and C respectively. Components A and B are not expected to have any residual value, but Component C is expected to have a residual value of $18,000. Assuming straight-line depreciation, total annual depreciation expense, to the nearest dollar, relating to these assets is a. $100,100. b. $125,120. c. $187,905. d. $190,476.

35. On July 1, 2014, Buffalo Corporation purchased factory equipment for $600,000. Residual value was estimated to be $16,000. The equipment will be depreciated over ten years using the double declining-balance method. Counting the year of acquisition as one-half year, Buffalo should record depreciation expense on this equipment for the calendar year 2015 of a. $120,000. b. $108,000. c. $105,120. d. $96,000.

36. Marmoset Corporation purchased factory equipment that was installed and put into service on January 2, 2014, at a total cost of $110,000. Residual value was estimated at $6,000. The equipment is being depreciated over four years using the double declining-balance method. For the calendar year 2015, Marmoset should record depreciation expense on this equipment of a. $55,000. b. $48,000. c. $27,500. d. $21,000.

37. On April 10, 2014, Tiger Corp. purchased machinery for $240,000. Residual value was estimated at $10,000. The machinery will be depreciated over ten years using the straight-line method. If depreciation is calculated on the basis of the nearest full month, the related Accumulated Depreciation account at December 31, 2015 will be a. $46,000. b. $40,250. c. $23,000. d. $17,250.

38. Mink Inc. purchased machinery that was installed and ready for use on January 3, 2014, at a total cost of $230,000. Residual value was estimated at $30,000. The machinery will be depreciated over five years using the double declining-balance method. For the calendar year 2015, Mink should record depreciation expense on this machinery of a. $48,000. b. $55,200. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. $60,000. d. $92,000.

39. A machine has a cost of $24,000, a residual value of $6,000, and an estimated three-year life. If depreciation in the second year was $2,000, which depreciation method was used? a. straight-line b. double declining-balance c. units of production d. cannot tell from information given

40. On January 1, 2014, Leopard Corp. purchased a new machine for $700,000. The new machine has an estimated useful life of nine years and the residual value was estimated to be $50,000. Depreciation was calculated using the double declining-balance method. To the nearest dollar, what amount should be shown in Leopard's balance sheet at December 31, 2015, net of accumulated depreciation, for this machine? a. $550,000 b. $445,000 c. $427,778 d. $423,457

41. On April 1, 2009, Bear Ltd. purchased equipment for $80,000. The equipment was estimated to have a residual value of $10,000 and is being depreciated over eight years using the straightline method. What should be the depreciation expense for this equipment for the year ended December 31, 2014? a. $5,250 b. $7,000 c. $8,750 d. $10,000

42. On September 25, 2014, Panther Corp. purchased machinery for $336,000. Residual value was estimated to be $15,000. The machinery will be depreciated over eight years using the double declining-balance method. If depreciation is calculated on the basis of the nearest full month, Panther should record depreciation expense for calendar 2015 on this machinery of a. $78,750. b. $63,000. c. $60,000. d. $42,000.

43. On January 3, 2014, Coyote Corp. purchased machinery. The machinery has an estimated useful life of nine years and an estimated residual value of $45,000. Coyote uses straight-line depreciation for all their machinery, and recorded $77,000 depreciation expense for 2016. The acquisition cost of the machinery was a. $738,000. b. $710,000. c. $693,000. d. $685,000.

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44. On January 2, 2014, Zebra Ltd. purchased equipment to be used in its manufacturing operations. The equipment has an estimated useful life of ten years, and an estimated residual value of $22,000. It was also estimated that the equipment would be used a total of 42,000 hours over its useful life. The depreciation expense for this equipment was $104,000 for calendar 2015, using the units of production method. The machine was used for 5,000 hours in 2015. The acquisition cost of the equipment was a. $815,600. b. $872,400. c. $873,600. d. $895,600.

45. Consider an asset for which the following information is available: Carrying value at Dec 31, 2014 before depreciation ... $9,000 Calculated depreciation for 2014 ................................ $2,400 Original cost ............................................................... $24,000 Residual value ........................................................... $8,500 Remaining useful life .................................................. 3 years The depreciation expense for 2014 is a. $3,100. b. $3,000. c. $2,400. d. $500.

46. In January, 2014, Camel Corporation purchased a mineral mine for $2,550,000 with removable ore estimated by geological surveys at 1 million tons. The property has an estimated (residual) value of $150,000 after the ore has been extracted. The company incurred $750,000 in development costs preparing the mine for production. During 2014, 250,000 tons were removed and 200,000 tons were sold. What is the amount of depletion that Camel should expense for 2014? a. $480,000 b. $600,000 c. $787,500 d. $840,000

47. In 2014, Elk Corporation purchased a mine for $200 million (of this, $30 million was applicable to the land). An independent evaluation estimated the mine's reserves at 7.5 million tons. During 2014, Elk extracted 900,000 tons. Elk’s depletion expense for 2014 is a. $200,000. b. $18,000,000. c. $20,400,000. d. $24,000,000.

48. On July 1, 2011, Puppy Corp. purchased a machine for $500,000. The machine was estimated to have a useful life of ten years with an estimated residual value of $28,000. During 2014, it became apparent that the machine would become uneconomical after December 31, 2018, and that the machine would have no salvage value. Accumulated depreciation on this machine at December 31, 2013, was $118,000, using the straight-line method. The depreciation Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

expense for 2014 should be a. $95,500. b. $82,000. c. $76,400. d. $70,800.

49. On January 3, 2007, Hippo Corp. purchased a machine for $600,000. The machine was being depreciated using the straight-line method over an estimated useful life of ten years, with no residual value. At the beginning of 2014, the company paid $150,000 to overhaul the machine. As a result of this improvement, the company estimated that the useful life of the machine would be extended an additional five years (15 years total). The depreciation expense for 2014 should be a. $41,250. b. $50,000. c. $60,000. d. $66,000.

50. Monkey Shines Ltd., a Canadian public corporation, owns equipment for which the following year-end information is available: Carrying amount (book value) .................. $120,000 Value in use ............................................. $102,000 Fair value less disposal costs ................... $108,000 The recoverable amount to be used in the determination of impairment is a. $102,000. b. $108,000. c. $120,000. d. Cannot be determined from the information given.

51. Gibbon Corp., a Canadian public corporation, owns equipment for which the following yearend information is available: Carrying amount (book value) .................. $59,000 Recoverable amount ................................ $52,000 Fair value less disposal costs ................... $55,000 Which of the following best describes the proper accounting treatment for Gibbon's equipment? a. It is not impaired and a loss should not be recognized. b. It is impaired and a loss must be recognized. c. It is not impaired, but a loss must be recognized. d. It is impaired and a loss must be recognized, but the loss but may be reversed in future periods.

52. For a company that uses ASPE, the required year-end journal entry to record an impairment loss includes a. A debit to Loss on Impairment and a credit to Accumulated Impairment Losses. b. A debit to Other Comprehensive Income and a credit to Accumulated Impairment Losses. c. A debit to Loss on Impairment and a credit to the related asset. d. A debit to Other Comprehensive Income and a credit to the related asset.

53. On January 1, 2004, Antelope Ltd. purchased a building for $800,000. At this time, the Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Depreciation, Impairment, and Disposition

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building had an estimated residual value of $300,000 and an estimated useful life of twenty years. The company has recorded monthly depreciation using the straight-line method. On January 1, 2014, it is decided to put the building up for sale at for $1,200,000. At December 31, 2014, the building is still for sale. The correct depreciation to record for 2014 is a. $0. b. $25,000. c. $40,000. d. $60,000.

54. Golden Goose Corp. has a piece of equipment, which is being held for sale, and has a carrying value of $100,000. When the decision to sell had been made, the equipment had been written down from a carrying value of $180,000. At December 31, 2014, it is estimated that the fair value less disposal costs (net realizable value) is $130,000. For the calendar year 2014, Golden Goose should recognize a recovery (gain) of a. $0. b. $30,000. c. $50,000. d. $80,000.

55. On January 1, 2014, the Accumulated Depreciation—Machinery account of Bonobo Corp. showed a balance of $760,000. At the end of 2014, after the adjusting entries were posted, it showed a balance of $820,000. During 2014, one of the machines which cost $240,000 was sold for $118,000 cash. This resulted in a loss of $7,000. Assuming that no other assets were disposed of during the year, depreciation expense for 2014 was a. $189,000. b. $182,000. c. $180,000. d. $175,000.

56. During 2014, Jersey Ltd. sold equipment that had originally cost $206,000 for $127,600. This resulted in a gain of $9,600. The balance in the Accumulated Depreciation—Equipment was $660,000 on January 1, 2014, and $630,000 on December 31, 2014. No other equipment was disposed of during 2014. Depreciation expense for 2014 was a. $20,000. b. $58,000. c. $59,600. d. $101,000.

57. The following information is available for an asset that is classified as held for sale: Accumulated Depreciation (at March 31, 2014) .......... $24,300 Asset cost .................................................................. $50,000 If the asset were sold on April 1, 2014 for $27,600, there would be a. a loss of $1,900. b. a gain of $1,400. c. a gain of $1,900. d. a loss of $22,400.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

58. One of Cheetah Corp.’s assets was expropriated by government authorities. The following additional information is available: Book value at the time of expropriation ....................... $1,200,000 Cash received ............................................................ $3,000,000 Under ASPE, this situation would be reflected in the company's financial statements as a $1,800,000 a. gain that would be included in other comprehensive income. b. gain that would be included in net income. c. gain from discontinued operations. d. gain that would appear on the Statement of Shareholders Equity.

59. On May 1, 2005, Platypus Ltd. purchased a new machine for $132,000. At the time of acquisition, the machine was estimated to have a useful life of ten years and an estimated residual value of $6,000. The company has recorded monthly depreciation using the straight-line method. On March 1, 2014, the machine was sold for $18,000. The loss to be recognized from the sale is a. $0. b. $2,700. c. $6,000. d. $8,700.

60. On January 1, 2006, Owl Corporation purchased equipment for $76,000, having a useful life of ten years and an estimated residual value of $4,000. Owl has recorded monthly depreciation using the straight-line method. On December 31, 2014, the equipment was sold for $14,000. The gain to be recognized from the sale is a. $14,000. b. $6,800. c. $2,800. d. $0.

61. On June 1, 2013 Morgan Manufacturing acquired a machine for $100,000 with an estimated useful life of 5 years and an estimated residual value of $10,000. The company uses the double declining method of depreciation and takes a full year’s depreciation in the year of acquisition and none in the year of disposition. If the machine were disposed of for $16,000 on May 1, 2015, the loss on disposal would be a. $20,000. b. $26,400. c. $24,000. d. $36,000.

62. For 2014, Walrus Company reported net revenues, average total assets, and net income of $180,000, $24,000, and $100,000 respectively. Walrus Company’s asset turnover ratio for 2014 was a. 1.8. b. 3.8. c. 7.5. d. 8.0.

Depreciation, Impairment, and Disposition

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63. In 2014, Elephant Corporation's financial statements included the following information: Net income ................................................................. $19,000 Sales .......................................................................... $98,000 Total assets, beginning of year................................... $85,000 Total assets, end of the year ...................................... $112,000 Inventory .................................................................... $70,000 To one decimal, Elephant's return on assets (ROA) for 2014 was a. 21.0%. b. 19.3%. c. 17.2%. d. 0.99%.

*64. On January 1, 2014, Seal Corp. purchased a machine costing $250,000. The machine is in an asset class for tax purposes with a 30% CCA rate. It has an estimated $40,000 residual value at the end of its five year useful life. The CCA deduction for tax purposes for the year 2014 is a. $25,000. b. $31,500 c. $37,500. d. $75,000.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

34. 35. 36. 37. 38.

c b c b b

39. 40. 41. 42. 43.

b d c a a

44. 45. 46. 47. 48.

d d c c c

49. 50. 51. 52. 53.

a b d a a

54. 55. 56. 57. 58.

b d b c b

59. 60. 61. 62. 63.

b c a c b

*64.

DERIVATIONS—Computational No. Answer 34. c 35. 36. 37. 38. 39.

b c b b b

40.

41. 42. 43. 44.

c a a d

45. 46. 47. 48. 49.

d c c c a

50. 51.

b d

52. 53. 54. 55. 56. 57. 58.

a a a d b c b

Derivation $1,200,000 ÷ 3 = $400,000 (400,000 ÷ 12) + (400,000 ÷ 4) + (400,000–18,000) ÷ 7 = $187,905 [$600,000 – ($600,000 × 2 ÷ 10 x 50%)] × 2 ÷ 10 = $108,000 [$110,000 – ($110,000 x 2 ÷ 4)] × 2 ÷ 4 = $27,500 $240,000 – ($10,000 ÷ 10 x 1.75 years) = $40,250 [$230,000 – ($230,000 × 2 ÷ 5]] × 2 ÷ 5 = $55,200 $24,000 × 2 ÷ 3 = $16,000; $24,000 – $16,000 = BV of $8,000 $8,000 × 2 ÷ 3 = $5,333, but only need $2,000 to arrive at residual value of $6,000 $700,000 × 2 ÷ 9 = $155,556; ($700,000 – $155,556) × 2 ÷ 9 = $120,987 $700,000 – ($155,556 + $120,987) = $423,457 ($80,000 – $10,000) ÷ 8 = $8,750 $336,000 × 2 ÷ 8 × 3 ÷ 12 = $21,000; ($336,000 – $21,000) × 2 ÷ 8 = $78,750 Original cost = ($77,000 × 9) + $45,000 residual = $738,000 UOP rate = $104,000 ÷ 5,000 hours = $20.80; $20.80 x 42,000 hours = $873,600 (depreciable amount) + $22,000 residual = $895,600 original cost $9,000 – $8,500 = $500 (maximum) [($2,550,000 – $150,000 + $750,000) ÷ 1,000,000] × 250,000 = $787,500 [($200 million – $30 million) ÷ 7.5 million] x 900,000 = $20.4 million ($500,000 – $118,000) ÷ 5 = $76,400 Acc Dep to end 2013 = ($600,000 ÷ 10) × 7 = $420,000 BV = $600,000 – $420,000 + $150,000 = $330,000; $330,000 ÷ 8 = $41,250 Higher of value in use and FV less disposal costs Since recoverable amount (higher of value in use and FV less disposal costs) is lower than BV, there is impairment Conceptual $0 (no depreciation on property held for sale) $0. Assets held for sale are reported at lower of amortized cost (BV) and NRV ($820,000 – $760,000) + [$240,000 – ($118,000 + $7,000)] = $175,000 $630,000 – {$660,000 – [$206,000 – ($127,600 – $9,600)]} = $58,000 $27,600 – ($50,000 – $24,300) = $1,900 gain Conceptual

Depreciation, Impairment, and Disposition

59.

60.

61.

62. 63. *64.

c b c

11 - 23

($132,000 – $6,000) ÷ (10 × 12) = $1,050 per month $18,000 – [$132,000 – ($1,050 × 106 mo.)] = $2,700 loss ($76,000 – $4,000) ÷ (10 × 12) = $600 per month $14,000 – [$76,000 – ($600 × 108 mo.)] = $2,800 2013 – $100,000 x 2 ÷ 5 = $40,000; 2014 ($100,000 – $40,000) x 2 ÷ 5 = $24,000 BV now $100,000 – $40,000 – $24,000 = $36,000 Loss on disposal is $36,000 – $16,000 = $20,000 $180,000 ÷ $24,000 = 7.5 $19,000 ÷ [(85,000 + 112,000) ÷ 2] = 19.3% $250,000 × 30% × 1 ÷ 2 = $37,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 65. Swallow Ltd. takes a full year's depreciation expense in the year of an asset's acquisition and no depreciation expense in the year of disposition. Data relating to one of Swallow’s pieces of equipment at December 31, 2013 are as follows: Acquisition year ........................................ 2011 Cost .......................................................... $280,000 Residual value .......................................... 40,000 Accumulated depreciation ........................ 219,520 Estimated useful life ................................. 5 years Using the same depreciation method that was used in 2011, 2012, and 2013, how much depreciation expense should be recorded in 2014 for this asset? a. $60,480 b. $48,000 c. $32,000 d. $20,480

66. On July 1, 2014, Eland Corp. purchased a machine for $375,000. The machine has an estimated useful life of five years and a residual value of $50,000. The machine is being depreciated using the double declining-balance method. For the year ended December 31, 2014, Eland should record depreciation expense on this machine of a. $65,000. b. $75,000. c. $130,000. d. $150,000.

67. On March 24, 2014, Lion Ltd. purchased a new machine for $100,000. This machine has an eight-year estimated useful life, an estimated residual value of $5,000, and is expected to produce 190,000 units over its useful life. The machine produced 11,000 units in 2014 and 13,000 units in 2015. Using the units of production method, to the nearest dollar, the related Accumulated Depreciation account on the adjusted trial balance at December 31, 2015 would be a. $5,500. b. $6,500. c. $12,000. d. $12,632.

68. On April 1, 2012, Chickadee Corp. purchased new machinery for $400,000. The machinery has an estimated useful life of ten years, a residual value of $20,000, and depreciation is calculated using the double declining-balance method. Chickadee’s year end is December 31. The accumulated depreciation on this machinery at March 31, 2014, should be a. $102,500. b. $131,200. c. $141,600. d. $182,400.

69. Roan Corp. acquired a tract of land containing an extractable natural resource. The company Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Depreciation, Impairment, and Disposition

11 - 25

is required by the government to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 6.2 million tons, and that the land will have a value of $1.2 million after restoration. Relevant cost information follows: Land ......................................................... $8,000,000 Estimated restoration costs ...................... 2,100,000 If Roan maintains no inventories, what is the depletion charge per ton of extracted resource? a. $1.00 b. $1.32 c. $1.44 d. $1.63

Use the following data for questions 70–72. Wren Corp. reported the following data on its most recent financial statements: Net revenues:......................... $312,500 Net income ............................. $ 58,200 Total assets, Jan 1 ................. $174,280 Total assets, Dec 31 .............. $168,420 70. To two decimals, what is Wren Corp.’s asset turnover ratio? a. 1.82 b. 1.79 c. 0.35 d. 0.34 71. To two decimals, what is Wren Corp.’s profit margin ratio? a. 33.97% b. 18.62% c. 18.24% d. 5.37% 72. To two decimals, what is Wren Corp.’s rate of return on assets (ROA)? a. 18.24% b. 18.62% c. 33.97% d. 34.56%

Use the following information to answer questions *73–*74. Tarantula Corp. reported the following information about the only machine that it owns: Date of purchase ......................... March 31, 2014 Capital cost ................................. $200,000 Estimated useful life .................... 10 years Estimated residual value ............. $20,000 CCA Class .................................. Class 10 (30%) Tarantula uses straight-line depreciation to the nearest month for accounting purposes. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*73. Assuming Tarantula always takes the maximum CCA, what is the CCA for calendar 2014? a. $22,500 b. $30,000 c. $45,000 d. $60,000

*74. Assume that at the end of calendar 2016, the UCC for this machine is $83,300. Tarantula sells the machine on January 2, 2017 for $90,000, and does not replace it. The recapture of CCA or terminal loss would be a. $60,500 terminal loss. b. $56,000 recapture. c. $6,700 terminal loss. d. $6,700 recapture.

Depreciation, Impairment, and Disposition

11 - 27

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

65. 66.

d b

67. 68.

c c

69. 70.

c a

71. 72.

b c

*73. *74.

b d

DERIVATIONS—CPA Adapted No. Answer 65. d 66. 67.

b c

68.

69. 70. 71. 72. *73. *74.

c a b c b d

Derivation $280,000 × .6 × .6 × .6 = $60,480 $60,480 – $40,000 = $20,480 maximum $375,000 x 2 ÷ 5 x 1 ÷ 2 = $75,000 UOP rate = ($100,000 – $5,000) ÷ 190,000 = $0.50 per unit; Acc Dep to end 2015 = $0.50 x ((11,000 + 13,000) = $12,000 2012 ($400,000 x 2 ÷ 10 x 9 ÷ 12) = $60,000 2013 ($400,000 – $60,000) x 2 ÷ 10 = $68,000 2014 ($400,000 – $60,000 – $68,000) x 2 ÷ 10 x 3 ÷ 12 = $13,600 Acc Dept = $60,000 + $68,000 + $13,600 = $141,600 ($8,000,000 + $2,100,000 – $1,200,000) ÷ 6,200,000 = $1.44 $312,500 ÷ ($174,280 + $168,420) ÷ 2 = 1.82 ($58,200 ÷ $312,500) x 100 = 18.62% [$58,200 ÷ ($174,280 + $168,420) ÷ 2] x 100 = 33.97% $200,000 x 30% x ½ = $30,000 $83,000 (UCC) – $90,000 (sale price) = $6,700 recapture

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 11-75 Definitions Provide clear, concise answers for the following: 1. Define depreciation. 2. Define depreciation accounting. 3. Does depreciation accounting provide cash? If not, what does provide cash? In relation to cash, what does depreciation accounting do? Solution 11-75 1. Depreciation is the decline in service potentials or in future economic benefits of a PP&E asset due to physical or economic factors. 2.

Depreciation accounting is the systematic and rational allocation of the cost of PP&E assets to the periods benefited from the use of the assets.

Depreciation accounting does not provide cash. Revenues provide cash. Depreciation accounting retains cash by reducing income taxes and dividends.

Ex. 11-76 Componentization and depreciation of PP&E assets You are the accountant for a manufacturing company. You have just been advised of the acquisition of a new machine. You have received a memo which only gives you the following information: Grinding Equipment Model: XZ-1-1000 Cost: $1,250,000 Instructions To be able to properly account for this asset, list and briefly describe what additional information you require. Solution 11-76 The information should include details on the machine’s • Components • Depreciable amount • Depreciation period (useful life) • Usage pattern The machine may include different parts that may have different usage and maintenance patterns. If so, and if these parts are significant, they should be accounted for separately, so these patterns can be captured in the depreciation process. The depreciable amount will likely not be the same as the given cost of $1,250,000, since it will have to be adjusted for residual value(s), if any. The depreciation period will be affected by the date that the machine is installed and ready for use. Finally, the usage pattern will drive the decision of which depreciation method to use: straightline, declining balance, or units of production.

Depreciation, Impairment, and Disposition

11 - 29

Ex. 11-77 True or false? Place T or F in front of each of the following statements. 1. The choice of depreciation method is specified in GAAP and does not require the use of professional judgment. 2. Depreciation is the process of allocating the cost of assets in a manner that is consistent with the desired effect on income. 3. Changes in the depreciation rate due to changes in the estimate of the asset's useful life are accounted for in the current and future periods. 4. Gains and losses from the disposal of property, plant and equipment are always reported as part of other comprehensive income. 5. The term "recoverable amount" with respect to a capital asset's impairment has the same definition under ASPE and IFRS. 6. Once a loss has been recognized, IFRS prohibits the subsequent reversal of that loss. 7. Only assets with cash flows that are independent from those of other assets are included in a cash-generating unit (CGU). 8. When using the straight-line method, an asset's residual value is deducted in the calculation of depreciation expense 9. An asset that has been depreciated to its residual value can continue to be depreciated until it reaches a net book value of zero. Solution 11-77 1. F 2.

Ex. 11-78 Asset depreciation and disposition Answer each of the following questions. 1. On January 2, 2014, a machine was purchased for $180,000. It has an estimated useful life of ten years and an estimated residual value of $14,000. Depreciation for 2015, using the double declining-balance method, is $_____________. 2. A vehicle purchased for $50,000 has an estimated useful life of five years and a residual value of $3,800. It is expected to be driven 210,000 kilometres over its useful life. The asset was driven 45,000 kilometres in the second year. Depreciation for the second year, using the units of production method is $______________. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Equipment costing $43,000 and accumulated depreciation of $12,000, is given together with cash of $16,000 in exchange for similar equipment with a fair value of $44,000. The gain or loss recognized on the exchange (indicate by "G" or "L") is $______________. Assume this transaction has commercial substance. A machine costing $72,000, estimated useful life of five years, and residual value of $12,000, is depreciated by the straight-line method. This asset is sold for $50,000 at the end of the second year of use. The gain or loss on the disposal (indicate by "G" or "L") is $___________.

Solution 11-78 1. Year 1 depreciation = $180,000 x 2 ÷ 10 = $36,000; NBV now $144,000 Year 2 depreciation = $144,000 x 2 ÷ 10 = $28,800 2.

Depreciation per km = ($50,000 - $3,800) ÷ 210,000 = $0.22 Year 2 depreciation = $0.22 x 45,000 = $9,900

$3,000 L Journal Entries are: New asset ................................................ Acc Dep, old asset.................................... Loss on exchange .................................... Old asset ........................................... Cash ..................................................

44,000(max is FV) 12,000 3,000 43,000 16,000

$2,000 G Annual depreciation is ($72,000 – $12,000) ÷ 5 = $12,000 BV at time of sale = $72,000 – (2 x $12,000) = $48,000 Gain on sale = $50,000 – $48,000 = $2,000

*Ex. 11-79 Calculate depreciation and CCA Five identical vehicles which cost $500,000 (total) are acquired on April 1, 2014. Their estimated residual value is $20,000 and expected life is eight years. These assets are Class 10 with a maximum CCA rate of 30%. The company has a December 31 year end. Instructions Calculate the depreciation expense/CCA (to the nearest dollar) by each of the following methods: a) Straight-line for 2014 b) Double declining-balance for 2015 c) Maximum Capital cost allowance for 2015 Solution 11-79 a) ($500,000 – $20,000) ÷ 8 × 9 ÷ 12 = $45,000 b)

2014: 25% × $500,000 × 9 ÷ 12 = $93,750 2015: 25% × $406,250 = $101,562

2014: 30% × $500,000 × 1 ÷ 2 = $75,000 2015: 30% × $425,000 = $127,500

Depreciation, Impairment, and Disposition

11 - 31

Ex. 11-80 Rational entity impairment model Cougar Corp.'s balance sheet includes the following asset: Equipment ................................................ $95,000 Less: accumulated depreciation ............... (25,000) Book value (carrying amount)................... $70,000 After performing its annual review for impairment, Cougar obtains the following data: Asset’s value in use ................................. $58,000 Fair value less disposal costs ................... 62,000 Instructions Assuming Cougar uses the rational entity impairment model, a) Calculate the recoverable amount. b) Calculate the impairment loss. c) Prepare the entry to record the impairment loss. Solution 11-80 a) Recoverable amount: $62,000, the higher of the asset's value in use of $58,000 and its fair value less disposal costs of $62,000. b)

Impairment loss: Carrying amount......................................................... Recoverable amount .................................................. Impairment loss .......................................................... Journal entry: Loss on impairment .................................................... Accumulated impairment loss—equipment ..........

$70,000 $62,000 $8,000

8,000 8,000

Ex. 11-81 Impairment Assume the same information as in Ex. 11-79 above, except for the following: Cougar's review for impairment indicates the following: Asset’s value in use ................................................... Fair value less disposal costs .....................................

$64,000 $73,000

Instructions a) Calculate the recoverable amount. b) Calculate the impairment loss. Solution 11-81 a) Recoverable amount: $73,000, the higher of the asset's value in use of $64,000 and its fair value less disposal costs of $73,000. b)

$70,000 $73,000 none

Because the recoverable amount is higher than the asset's carrying amount, there is no Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

11 - 32

Test Bank for Intermediate Accounting, Tenth Canadian Edition

impairment loss.

*Ex. 11-82 Calculate depreciation and CCA A machine costing $400,000 is acquired on October 1, 2014. Its estimated residual value is $40,000 and its expected life is eight years. The company has a calendar year end. The asset is a Class 8 asset with a maximum CCA rate of 20%. Instructions Calculate depreciation expense for 2014 and 2015 by each of the following methods: a) Double declining-balance b) Capital cost allowance Solution 11-82 a) 2014: 25% × $400,000 × 3 ÷ 12 = $25,000 2015: 25% × $375,000 = $93,750 b)

2014: 20% × $400,000 × 1 ÷ 2 = $40,000 2015: 20% × $360,000 = $72,000

Depreciation, Impairment, and Disposition

11 - 33

PROBLEMS Pr. 11-83 Asset overhaul Swift Corporation is an international provider of freight services that follows IFRS. Its fleet of vehicles includes a truck that is carried in its books as "VC1-016." This truck was purchased two years ago for $150,000 and has been depreciated on a straight-line basis. By December 31, 2014, its book value (carrying value) is $97,000. As part of its commitment to safety and as required by its insurer, the company has a policy to overhaul its trucks after every 50,000 kms. The associated costs of the overhauls are tracked in separate accounts. At December 31, 2014 the balances for VC1-016 are as follows: Overhauls # 1 - 5: Accumulated Depreciation: ........................................ Overhaul # 6: Cost ........................................................................... Less accumulated depreciation: ................................. Book value .................................................................

$0 $20,000 (16,400) $3,600

On January 1, 2015, after the driver had reported problems with the truck's engine, a decision was made to do an early overhaul (i.e. 9,000 km prior to the next scheduled overhaul). The overhaul was completed on January 7, 2015 for $28,000 cash. Because of a slowdown in the economy, the truck only operated for 21,000 km for the remainder of 2015. Instructions Prepare the appropriate journal entries for 2015 relating to the truck's overhaul. Solution 11-83 Truck overhaul (VC1-016 #7) ........................................................ Cash ......................................................................................... To account for costs of January 2015 overhaul

28,000 28,000

Accumulated depreciation (VC1-016 #6) ....................................... 16,400 Loss on overhaul ........................................................................... 3,600 Truck overhaul (VC1-016 #6) ................................................... To remove costs relating to previous overhaul and recognize loss Depreciation expense - overhauls ................................................. Accumulated depreciation (VC1-016 #7) .................................. To record 2015 depreciation expense for current overhaul $28,000 ÷ 50,000 km x 21,000 km = $11,760

20,000

11,760 11,760

*Pr. 11-84 Calculate depreciation and CCA On July 2, 2014, Vicuna Inc. purchased equipment for $720,000. This equipment has an estimated useful life of six years and an estimated residual value of $30,000. Depreciation is Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

11 - 34

Test Bank for Intermediate Accounting, Tenth Canadian Edition

taken for the portion of the year the asset is used. The asset is a Class 8 asset with a maximum CCA rate of 20%. Vicuna has a December year end. Instructions a) Complete the form below by determining the depreciation expense/CCA and year-end book values/UCC for 2014 and 2015 using the 1. double declining-balance method. 2. capital cost allowance method (using maximum rate). Double Declining-Balance Method 2014 2015 Depreciation expense for year Accumulated depreciation Year-end book value Capital Cost Allowance Method 2014 2015 CCA for year End of year UCC Total CCA claimed b) Instead, assume Vicuna had used straight-line depreciation during 2014 and 2015. During 2016, the company determined that the equipment would be useful to the company for only one more year beyond 2016. Residual value is estimated at $40,000. Calculate the amount of depreciation expense for the 2016 income statement. Solution 11-84 a) Double Declining-Balance Method....................................... Depreciation expense for year ............................................. Accumulated depreciation, end of year ................................ Year-end book value ...........................................................

2014 $120,000 120,000 600,000

2015 $200,000 320,000 400,000

Capital Cost Allowance Method CCA for year........................................................................ End of year UCC ................................................................. Total CCA claimed...............................................................

2014 $ 72,000 648,000 72,000

2015 $129,600 518,400 201,600

Cost ..................................................................................... Depreciation ........................................................................ Residual .............................................................................. 2016 depreciation ................................................................

$720,000 (172,500) (40,000) $507,500 × 1/2 = $253,750

Pr. 11-85 Cost recovery impairment model, revision of depreciation Rhino Corporation is a manufacturer of automobile parts. Its capital assets include specialized equipment that is being used in the finishing stage of its manufacturing process. The equipment was purchased in 2014 and is being depreciated using the units-of-production method. By December 31, 2015, the book (carrying) value was $430,000 (after depreciation expense had been recorded). However, at that time, Rhino became aware of new technology that would make the equipment obsolete within the next five years. An appraisal puts the equipment's future undiscounted net cash flows at $390,000 and its fair value at $300,000. While considering its options for the eventual replacement, Rhino will continue using the equipment, but will change to straight-line depreciation.

Depreciation, Impairment, and Disposition

11 - 35

Instructions Assuming Rhino is a private Canadian corporation, a) Prepare the journal entry, if any, to record the impairment loss at December 31, 2015. b) Prepare the journal entries to record 2016 and 2017 depreciation. Solution 11-85 a) Recoverability test: Carrying value $430,000 – undiscounted net cash flows $390,000 = -40,000, therefore asset impaired. Loss on impairment ....................................................................... 130,000 Accumulated impairment losses—equipment ......................... 130,000 (Carrying value $430,000 – fair value $300,000 = $130,000 impairment loss) b) 2016 depreciation: Depreciation expense ................................................................... Accumulated depreciation-equipment..................................... ($300,000 ÷ 5 years = $60,000) 2017 Depreciation: Depreciation expense ................................................................... Accumulated depreciation-equipment..................................... ($300,000 ÷ 5 years = $60,000)

60,000 60,000

Pr. 11-86 Calculation of ratios Vulture Ltd. provides the following selected information for the calendars years 2014 and 2013: 2014 2013 Net revenues........................................................................ $320,000 Net income ........................................................................... 75,000 Accounts receivable ............................................................. 33,000 $26,000 Inventory .............................................................................. 61,000 55,000 Total assets.......................................................................... 210,000 176,000 Total liabilities ...................................................................... 84,000 74,000 Instructions For 2014, calculate the following ratios to two decimals: a) Asset turnover ratio b) Profit margin ratio c) Rate of return on assets Solution 11-86 a) Asset turnover ratio = net revenue ÷ average total assets Average total assets = ($210,000 + $176,000) ÷ 2 = $193,000 ATR = $320,000 ÷ $193,000 = 1.66 b) Profit margin ratio = net income ÷ net revenue x 100 PMR = $75,000 ÷ $320,000 x 100 = 23.44% c) Rate of return on assets = net income ÷ average total assets x 100 ROA = $75,000 ÷ $193,000 x 100 = 38.86% Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 12 GOODWILL AND OTHER INTANGIBLE ASSETS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

1 2 4 4 4 5 5 5

E M E M M M M M

33. 34. 35.

3,6 4 4

M M H

45. 46. 47.

3,5 4 5

M H M

54. 55. 56.

2,4-7 3 3,4,6,8

H M M

65.

3-5

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 9. 5 H 17. 6 10. 5 M 18. 6 11. 5 H 19. 7 12. 6 M 20. 7 13. 6 H 21. 7 14. 6 H 22. 8 15. 6 H 23. 8 16. 6 H 24. 8 Multiple Choice–Computational 36. 5 M *39. 11 37. 7 M *40. 11 38. 8 H *41. 11 Multiple Choice–CPA Adapted 48. 5 H 51. 6 49. 6 M 52. 7 50. 6 H 53. 8 Exercises 57. 3,5,6 H 60. 8 58. 3,7 H 61. 8 59. 4 H *62. 11 Problems 66. 4,7 M

M = Medium

LOD

Item

LOD

M M H H M H M M

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

8 8 8 8 8 8 8 11

M H M M H M H M

M M M

*42. *43. *44.

11 11 11

H H M

*63. *64.

11 11

H M

H M M H M H

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Item

Type

54.

33. 45.

MC MC

55. 56.

Ex Ex

3. 4.

MC MC

5. 34.

MC MC

6. 7. 8.

MC MC MC

9. 10. 11.

MC MC MC

12. 13. 14.

MC MC MC

15. 16. 17.

MC MC MC

19. 20.

MC MC

21. 37.

MC MC

22. 23. 24.

MC MC MC

25. 26. 27.

MC MC MC

*32. *39.

MC MC

*40. *41.

MC MC

Item Type Item Type Learning Objective 1

Item

Type

Item

Type

59. 65.

Ex Pr

66.

65.

56. 57.

Ex Ex

56. 60. 61.

Ex Ex Ex

*63. *64.

Ex Ex

Learning Objective 2

Note:

MC = Multiple Choice

Learning Objective 3 57. Ex 65. Pr 58. Ex Learning Objective 4 35. MC 54. Ex 46. MC 56. Ex Learning Objective 5 36. MC 48. MC 45. MC 54. Ex 47. MC 57. Ex Learning Objective 6 18. MC 50. MC 33. MC 51. MC 49. MC 54. Ex Learning Objective 7 52. MC 58. Ex 54. Ex 66. Pr Learning Objective 8 28. MC 31. MC 29. MC 38. MC 30. MC 53. MC Learning Objective 11 *42. MC *44. MC *43. MC *62. Ex Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Goodwill and Other Intangible Assets

12 - 3

CHAPTER STUDY OBJECTIVES 1. Understand the importance of intangible assets and goodwill from a business perspective. We have an economy that is increasingly dominated by information and service providers, and their major assets are often intangible in nature. Identifying and measuring intangible assets tends to be difficult, and as a result many intangibles are not captured on companies’ statements of financial position. However, intangible assets and goodwill remain critically important for companies, and are a key focus of standard setters in North America and internationally.

2. Define and describe the characteristics of intangible assets. Intangible assets have three characteristics: (1) they are identifiable, (2) they lack physical substance, and (3) they are nonmonetary in nature.

3. Identify and apply the recognition and measurement requirements for purchased intangible assets. A purchased intangible asset is recognized when it is probable that the entity will receive the expected future economic benefits and when its cost can be measured reliably. It is measured initially at cost. When several intangibles, or a combination of intangibles and other assets, are acquired in a business combination, the cost of each intangible asset is its fair value. When acquired in a business combination, the identifiable intangibles are recognized separately from the goodwill component.

4. Identify and apply the recognition and measurement requirements for internally developed intangible assets. No costs are capitalized unless they meet the general recognition criteria concerning future benefits and measurability. Costs incurred in the research phase of developing an intangible asset internally are expensed. Costs incurred in the development phase of a project are also expensed unless the entity can demonstrate that it meets six stringent criteria. These criteria are designed to provide evidence that the asset is technically and financially feasible and that the company has the intent and ability to generate future economic benefits from it. Under ASPE, entities have a choice whether to capitalize or expense costs that meet the six criteria.

5. Explain how intangible assets are accounted for after initial recognition. Under ASPE, intangible assets are accounted for using the cost model, whereas IFRS also allows the revaluation model to be used if the asset’s fair value is determined in an active market. This is not often used. An intangible with a finite or limited useful life is amortized over its useful life to the entity. Except in unusual and specific circumstances, the residual value is assumed to be zero. The amount to report for amortization expense should reflect the pattern in which the asset is consumed or used up if that pattern can be reliably determined. Otherwise a straight-line approach is used. An intangible with an indefinite life is not amortized until its life is determined to no longer be indefinite. All intangibles are tested for impairment.

6. Identify and explain the accounting for specific types of intangible assets. Major types of intangibles include the following: (1) marketing-related intangibles that are used in the marketing or promotion of products or services, (2) customer-related intangibles that result from interactions

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

with outside parties, (3) artistic-related intangibles that involve ownership rights to such items as plays and literary works, (4) contract related intangibles that represent the value of rights that arise from contractual arrangements, and (5) technology-related intangible assets that relate to innovations or technological advances.

7. Explain and account for impairment of limited life and indefinite-life intangible assets. Under ASPE, impairment is determined and applied by using the cost recovery impairment model. Impairment for limited-life intangible assets is based first on a recoverability test. If the carrying amount is higher than its net recoverable amount (undiscounted), then an impairment loss must be measured and recognized, based on the asset’s fair value. No reversals of such losses are per mitted. The procedures are the same as for property, plant, and equipment. Indefinite-life intangibles use only a impairment model is used. An intangible asset is impaired only if its carrying amount is higher than its recoverable amount. The recoverable amount is defined as the greater of the asset’s value in use and its fair value less costs to sell. The impairment loss is the difference between the carrying amount and the recoverable amount, if lower. The loss is reversed subsequently if economic conditions change and the recoverable amount increases. The same approach is used for both limited-life and indefinite-life intangible assets.

8. Explain the concept of goodwill and how it is measured and accounted for after acquisition. Goodwill is unique because, unlike all other assets, it can be identified only with the business as a whole. It is not an identifiable asset. Goodwill is recorded only when a business is purchased. To calculate goodwill in a 100% acquisition, the fair value of the identifiable assets that are acquired and liabilities that are assumed is compared with the fair value of the consideration transferred for the acquired business. The difference is goodwill. After acquisition, it is not amortized but is regularly assessed for impairment. The goodwill has to be assigned to a cash-generating group or reporting unit and the group is tested for impairment. Under ASPE, a goodwill impairment loss is recognized if the fair value of the asset group is lower than the group’s carrying amount, and the loss is equal to the difference. Under IFRS, there is a goodwill impairment loss if the recoverable amount of the cash generating unit is less than its carrying amount. The loss is equal to the difference and is applied to goodwill first. Under both, goodwill impairment losses are not reversed.

9. Identify the types of disclosure requirements for intangible assets and goodwill and explain the issues in analyzing these assets. Disclosures under ASPE are limited because users can access additional information. Under IFRS, significant details are required to be disclosed. The disclosures allow a reader to determine how amounts invested in classes of intangibles (and goodwill) have changed over the period, with substantial information provided when fair values are used, such as under the revaluation model and all impairment calculations. For intangibles that are not amortized, companies must indicate the amount of any impairment losses that have been recognized as well as information about the circumstances that led to the writedown. Goodwill must be separately reported, as are the major classes of intangible assets. Because it is difficult to measure intangibles, some resources, such as intellectual capital and other internally developed intangible assets, do not get captured on the statement of financial position. Other intangibles are recognized, but with a relatively high level of measurement uncertainty. For these reasons and because of recent changes in the accounting policy related to intangibles, care must be taken in the analysis of financial statement information related to earnings and total assets.

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10. Identify differences in accounting between ASPE and IFRS. There are few, but significant, differences between ASPE and IFRS regarding intangible assets and goodwill. One major difference relates to the accounting treatment for costs incurred in the development phase of internally generated intangible assets that meet the six stringent criteria for capitalization. Under ASPE, entities can choose a policy of whether to capitalize these costs or expense all costs associated with internally generated intangibles. Under IFRS, these costs are capitalized. The other major difference relates to the impairment models applied: the cost recovery model for ASPE, and the rational entity model for IFRS.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer b c d a a c d a d b c b d b c d a a b d a d a c d b a c d b d d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. *32.

Description Intangible assets and goodwill Characteristics of intangible assets Recognition of internally developed intangibles Amortization of laboratory building used in R & D Capitalization of certain R & D costs Use of revaluation model Definition of “indefinite life” Amortization method for intangibles Accounting for a change in amortization rate Post-acquisition accounting for intangibles – ASPE Post-acquisition accounting for intangibles – IFRS Accounting for computer software costs Patent amortization Legal fees associated with trademark infringement Accounting for internally developed trademark Example of artistic-related intangible Example of technology-related intangible Accounting for limited life franchises or licenses Impairment of intangibles under ASPE Impairment test for indefinite-life intangibles Rational entity impairment model Impairment of intangibles under IFRS Methods of accounting for goodwill Internally generated goodwill Accounting for purchased goodwill Definition of negative goodwill Goodwill impairment under ASPE Goodwill impairment under IFRS Reversal of goodwill impairment Treatment of goodwill impairment Negative goodwill Methods of measuring goodwill

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Computational Answer a d a d b b a b c c b b

No. 33. 34. 35. 36. 37. 38. *39. *40. *41. *42. *43. *44.

Description Calculate total intangible assets. Capitalization of research expense Calculate development costs. Calculate trademark amortization. Calculate amount of worthless patent to be written off. Proper accounting when fair value of net assets acquired exceeds cost. Calculate goodwill. Calculate goodwill. Calculate goodwill. Calculate goodwill. Calculate goodwill. Calculate goodwill.

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—CPA Adapted Answer c b b a c b d c d

No. 45. 46. 47. 48. 49. 50. 51. 52. 53.

Description Capitalization of legal fees Calculate R & D expense. Calculate amortization of a trademark. Calculate amortization of a trademark. Calculate patent costs to capitalize. Valuation of patent exchanged for an investment in shares Valuation of copyright exchanged for common shares Calculate impairment loss. Capitalization of goodwill costs

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E12-54 E12-55 E12-56 E12-57 E12-58 E12-59 E12-60 E12-61 *E12-62 *E12-63 *E12-64

Description Definitions Intangible assets theory Terminology Carrying value of patent Intangible asset impairment Criteria for capitalization of development costs Alternative treatments of goodwill after recognition Acquisition of tangible and intangible assets Calculation of goodwill Goodwill calculation Calculate goodwill.

PROBLEMS Item P12-65 P12-66

Description Intangible assets Journal entries for impairment of intangible assets

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT generally true of intangible assets and goodwill? a. Many major public companies have significant amounts of intangible assets and goodwill listed on their balance sheets. b. The major assets of today’s information and service providers are likely to be tangible. c. The major assets of today’s information and service providers are likely to be intangible. d. Since identifying and measuring intangibles and goodwill is often difficult, they are not always reported on the balance sheet.

2. Which of the following is NOT a characteristic of intangible assets? a. They must be individually identifiable. b. They are non-monetary in nature. c. They are monetary in nature. d. They lack physical substance.

3. When determining whether an internally developed intangible asset should be recognized, the process of generating the intangible is usually broken down into the a. research and financing elements. b. acquisition and disposal stages. c. exploitation and disposal stages. d. research and development phases.

4. If a company constructs a laboratory building to be used as a research and development facility, the cost of the laboratory building is matched against earnings as a. amortization deducted as part of research and development costs. b. research and development expense in the period(s) of construction. c. amortization or immediate write-off, depending on company policy. d. an expense at such time as productive research and development has been obtained from the facility.

5. Which of the following research and development related costs should be capitalized and amortized over current and future periods? a. research and development general laboratory building which can be put to alternative uses in the future b. inventory used for a specific research project c. administrative salaries allocated to research and development d. research findings purchased from another company to aid a particular research project currently in process

6. The reason that the revaluation model is NOT widely used for measuring intangible assets after initial recognition is that a. it is not allowed under IFRS. b. the cost method is easier to use.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. it can be applied only to intangible assets with a fair value determined in an active market. d. it requires an extensive internal investigation to determine fair value. 7. An “indefinite life” for an intangible asset means that a. the asset will last forever. b. unlimited amortization may be recorded for the asset. c. amortization is only recorded if future economic benefits can be determined. d. there appears to be no foreseeable limit to how long the asset will generate positive future cash flows. 8. If the pattern in which an intangible asset’s benefits will be used up CANNOT be determined, the amortization method most likely to be used is a. straight-line. b. capital cost allowance. c. units of production. d. double declining-balance.

9. A change in the amortization rate for an intangible asset should be accounted for as a a. change in accounting principle. b. change in reporting entity. c. correction of an error. d. change in accounting estimate.

10. Under ASPE, which of the following statements best describes the accounting for intangible assets after acquisition? a. They may be accounted for under the cost model or the revaluation model. b. They should be accounted for under the cost model. c. They should be accounted for under the revaluation model. d. They must be amortized over a very short period, usually less than five years.

11. Under IFRS, which of the following statements best describes the accounting for intangible assets after acquisition? a. They may be accounted for under either the cost model or the revaluation model. b. They should be accounted for under the cost model. c. They should be accounted for under the revaluation model if an active market exists for the asset. d. They should always be accounted for under the revaluation model.

12. The proper accounting for the costs incurred in creating computer software products that are to be sold, leased, or otherwise marketed to external parties, is to a. capitalize all costs until the software is sold to external parties. b. charge research and development expense when incurred until technological feasibility has been established for the product. c. charge research and development expense only if the computer software has alternative future uses.

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d. capitalize all costs as incurred until a detailed program design or working model is created.

13. The cost of purchasing patent rights for a product that might otherwise have seriously competed with one of the purchaser's patented products should be a. expensed in the current period. b. amortized over the legal life of the purchased patent. c. added to factory overhead and allocated to production of the purchaser's product. d. amortized over the remaining estimated life of the original patent covering the product whose market would have been impaired by competition from the newly patented product.

14. This year, Bentine Ltd. went to court and successfully defended its trade-marked product, "Hot Gum," from infringement by a competitor. Legal costs of this defence should be charged to a. Trademarks and amortized over the legal life of the trademark. b. Trademarks and amortized over the same period of time as the “Hot Gum” trademark. c. Legal Expense and amortized over five years or less. d. Legal Expense of the period.

15. If a trademark is developed by the enterprise itself, the costs should be a. capitalized but not amortized. b. capitalized only if future benefits are reasonably assured. c. capitalized, but only from the point in time when all six capitalization criteria are met in the development phase. d. capitalized as soon as the development phase starts.

16. A copyright is an example of a(n) a. customer-related intangible asset. b. marketing-related intangible asset. c. contract-based intangible asset. d. artistic-related intangible asset.

17. A patent is an example of a(n) a. technology-based intangible asset. b. marketing-related intangible asset. c. contract-based intangible asset. d. artistic-related intangible asset.

18. A franchise or licence with a limited life is a. amortized over the lesser of its legal or useful life. b. expensed. c. not amortized. d. always amortized over its legal life.

19. Under ASPE, to determine if there is an impairment loss, compare the a. fair value of the identifiable assets to the book value of the assets.

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b. fair value of the reporting unit to the carrying value of the reporting unit. c. imputed current fair value of the assets with the carrying value of the assets. d. imputed carrying value of the assets with the fair value of the assets.

20. Which of the following is the impairment test for indefinite-life intangibles? a. recoverability test and then fair value test b. fair value test and then recoverability test c recoverability test d. fair value test

21. Which of the following is correct regarding the rational entity impairment model? a. For limited-life intangibles, IFRS requires that the rational entity impairment model be applied. b. For limited-life intangibles, ASPE requires that the rational entity impairment model be applied. c. For indefinite–life intangibles, ASPE requires that the rational entity impairment model be applied. d. Neither ASPE nor IFRS allow the use of the rational entity impairment model.

22. Under IFRS, to determine if there is an impairment loss, compare the a. fair value of the identifiable assets to the book value of the assets. b. fair value of the reporting unit to the carrying value of the reporting unit. c. imputed current fair value of goodwill with the carrying value of goodwill. d. carrying amount of the CGU with the recoverable amount.

23. Goodwill may be a. capitalized only when purchased. b. capitalized either when purchased or created internally. c. capitalized only when created internally. d. written off directly to retained earnings.

24. Internally generated goodwill a. is not possible. b. may be capitalized or expensed. c. is not capitalized. d. is capitalized but not amortized.

25. Purchased goodwill should be a. expensed as soon as possible against retained earnings. b. expensed as soon as possible to other comprehensive income. c. amortized over the period benefited, but not more than 40 years. d. not expensed or amortized, but rather reduced only if impairment occurs.

26. Negative goodwill arises when

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a. the book value of identifiable net assets acquired exceeds the purchase price. b. the fair value of identifiable net assets acquired exceeds the purchase price. c. the fair value of identifiable net assets acquired is less than the purchase price. d. the fair value of identifiable net assets acquired exceeds the book value.

27. Under ASPE, which of the following statements best describes when goodwill should be tested for impairment? a. Goodwill should be tested for impairment when events or changes in circumstances indicate that impairment may have occurred. b. Goodwill should be tested annually for impairment regardless of the circumstances. c. Goodwill should be tested for impairment annually and whenever events or changes in circumstance indicate that impairment may have occurred. d. Goodwill should only be tested for impairment when the company follows a policy to amortize its goodwill.

28. Under IFRS, which of the following statements best describes when goodwill should be tested for impairment? a. Goodwill should be tested for impairment when events or changes in circumstance indicate that impairment may have occurred. b. Goodwill should be tested annually for impairment regardless of the circumstances. c. Goodwill should be tested for impairment annually and whenever events or changes in circumstance indicate that impairment may have occurred. d. Goodwill should only be tested for impairment when the company follows a policy to amortize its goodwill.

29. Which of the following statements best describes when previously recognized goodwill impairment may be reversed? a. Reversals are permitted under both ASPE and IFRS. b. Reversals are permitted under ASPE but not IFRS. c. Reversals are permitted under IFRS but not ASPE. d. Reversals are not permitted under either IFRS or ASPE.

30. Goodwill was purchased when a business was acquired. When it is determined that the goodwill is impaired, the credit is usually made to a. the Goodwill account. b. an Accumulated Impairment Loss account. c. a Deferred Credit account. d. a shareholders' equity account.

31. If the fair value of the net assets acquired in a business combination is greater than the purchase price, the difference is called a. organizational costs. b. contributed surplus. c. purchased goodwill. d. negative goodwill or bargain purchase.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*32. Which of the following is NOT a method of calculating goodwill? a. excess earnings approach b. total earnings approach c. discounted free cash flow method d. undiscounted free cash flow method

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Multiple Choice Answers—Conceptual Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

b c d a a c

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

d a d b c b

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

d b c d a a

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

b d a d a c

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

d b a c d b

31. *32.

d d

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 33. At December 31, 2014, Duluth Corp.’s general ledger includes the following account balances: Copyrights ..................................................................................... $ 50,000 Deposits with advertising agency (will be used to promote goodwill) 32,000 Discount on bonds payable ........................................................... 72,700 Excess of cost over fair value of identifiable net assets of acquired subsidiary ....................................................................... 578,000 Trademarks ................................................................................... 102,000 In the preparation of Duluth’s balance sheet as of December 31, 2014, what should be reported as total intangible assets? a. $152,000 b. $730,000 c. $762,000 d. $802,700

34. In 2014, Laredo Corporation incurred research costs as follows: Materials and supplies................................................................... Personnel ...................................................................................... Indirect costs—allocated ...............................................................

$120,000 130,000 160,000 $410,000 These costs relate to a product that Laredo expects to market in 2015. It is estimated that these costs will be recouped by December 31, 2017. How much of these costs could be capitalized in 2014? a. $410,000 b. $250,000 c. $160,000 d. $0

35. Albany Inc. incurred the following costs during the year ended December 31, 2014: Laboratory research aimed at discovery of new knowledge .......... $240,000 Design of new products involving new technology......................... 87,000 Testing of new products ................................................................ 58,000 Construction of research and development facilities ...................... 360,000 Assuming the 6 specific conditions have been demonstrated, the total amount to be classified as development costs (either deferred or capitalized) in 2014 is a. $145,000. b. $240,000. c. $327,000. d. $600,000.

36. On January 2, 2014, Sacramento Corp. bought a trademark from Francisco Inc. for $150,000. An independent research company estimated that the remaining useful life of the trademark was 30 years. At this time, the trademark’s net book value in Francisco’s records was $210,000. Because the trademark had a demonstrated limited life beyond 20 years, Sacramento decided to

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amortize the trademark over the maximum period, straight-line with no residual. In Sacramento’s (calendar) 2014 income statement, what amount should be reported as amortization expense for this trademark? a. $7,500 b. $7,000 c. $6,000 d. $5,000

37. In January, 2009, Tampa Corp. purchased a patent for a new consumer product for $900,000. At the time of purchase, the patent was valid for fifteen years. Due to the competitive nature of the product, however, the patent was estimated to have a useful life of only ten years. During 2014, the product was permanently removed from the market because of a potential health hazard. What amount should Tampa recognize as an impairment loss for calendar 2014, assuming amortization has been recorded annually using the straight-line method with no residual value? a. $600,000 b. $450,000 c. $90,000 d. $60,000

38. During 2014, Spokane Ltd. purchased the net assets of Tacoma Corp. for $635,000. On the date of the transaction, Tacoma reported $200,000 in liabilities. As well, the fair value of Tacoma’s assets were: Current assets ............................................................................... $ 360,000 Noncurrent assets ......................................................................... 840,000 $1,200,000 How should the difference between the fair value of the net assets acquired and the cost be accounted for by Spokane? a. The difference should be credited to retained earnings. b. The difference should be recognized as a gain in net income. c. The noncurrent assets should be reduced appropriately. d. The difference should be prorated between the current and the noncurrent assets.

Use the following information for questions *39–*40. Casper Corp. is planning to acquire a controlling interest in the outstanding shares of Frosty Inc. for $9.2 million in cash.

*39. Assuming the fair value of Frosty's net assets is $10.2 million, and Casper acquires a 75% share, goodwill can be calculated as a. $1,550,000. b. $1,243,000. c. $1,000,000. d. $750,000.

*40. Assuming the fair value of Frosty's net assets is $12.5 million, and Casper acquires a 75% share, goodwill can be calculated as

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a. $375,000. b. $175,000 negative. c. $175,000. d. $ 0.

*41. Frosty Corp.'s average annual net income is $75,000 above the average for Frosty's industry. Casper is interested in purchased Frosty. Assuming Casper estimates goodwill by capitalizing excess earnings at 14%, the estimated goodwill (to the nearest dollar) is a. $1,050,000. b. $954,333. c. $535,714. d. $ 0.

*42. The owners of Dallas Electronics Store are contemplating selling the business. The cumulative earnings for the past 5 years totalled $900,000, including a gain on discontinued operations of $30,000. The annual earnings based on an average rate of return on investment for this industry would have been $138,000. If excess earnings are to be capitalized at 15%, then implied goodwill should be a. $210,000. b. $280,000. c. $240,000. d. $870,000.

Use the following information for questions *43–*44. Jeremiah Inc. is being targeted for acquisition by Argo Corporation. As an analyst for Argo, you are asked to determine the goodwill that, pending various assumptions, may be inherent in this potential transaction. The available information relating to Jeremiah includes the following: Current net assets: $5.1 million Expected return on net assets for industry: 10% Reported net income for the previous six consecutive years: Year 2009 2010 2011

Amount $710,000 $680,000 $980,000

Year 2012 2013 2014

Amount $745,000 $815,000 $835,000

Net income for 2011 included a $200,000 gain from the sale of a discontinued operation.

*43. Estimated goodwill by capitalizing average excess earnings at 14% is a. $2,029,762. b. $1,791,667. c. $1,654,331. d. $ 760,833.

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*44. Assuming that excess earnings are expected to continue for 8 years, and ignoring the time value of money, estimated goodwill is a. $2,273,000. b. $2,006,667. c. $1,854,333. d. $1,531,733

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Multiple Choice Answers—Computational Item

Ans.

33. 34. 35.

a d a

Item

36. 37. 38.

Ans.

d b b

Item

*39. *40. *41.

Ans.

a b c

Item

*42. *43. *44.

Ans.

c b b

DERIVATIONS—Computational No. Answer 33. a 34. d 35. a 36. d 37. b

Derivation $50,000 + $102,000 = $152,000 $0. Research costs must be expensed $87,000 + $58,000 = $145,000 $150,000 / 30 = $5,000 ($900,000 ÷ 10) × 5 = $450,000 amortization already recorded carrying value is $900,000 – $450,000 = $450,000 impairment is $0 – $450,000 = $450,000 Conceptual $9,200,000 – (75% x $10,200,000) = $1,550,000 $9,200,000 – (75% x $12,500,000) = $175,000 negative $75,000 / 0.14 = $535,714 $900,000 – $30,000

38. *39. *40. *41.

b a b c

*42.

(———–––——————) – $138,000 = $36,000

5 $36,000 ———— = $240,000. .15 b $710,000 + $680,000 + $980,000 + $745,000 + $815,000 + $835,000 = $4,765,000 [($4,765,000 – $200,000) ÷ 6] – ($5,100,000 × .10) = $250,833 $250,833 ÷ .14 = $1,791,667 $250,833 x 8 = $2,006,667

*43.

*44.

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MULTIPLE CHOICE—CPA Adapted 45. Which of the following legal fees should be capitalized? Legal fees to Legal fees to successfully obtain a franchise defend a trademark a. No No b. No Yes c. Yes Yes d. Yes No

46. During 2014, Pomona Inc. incurred the following costs: Research Expense for process alternatives .................................. $360,000 Routine design of tools, jigs, moulds, and dies .............................. 250,000 Modification of the formulation of a process .................................. 610,000 Development services performed by Chicago Corp. for Pomona .. 325,000 Assuming the 6 specific conditions have been demonstrated, in 2014, Pomona Corp. would report development costs of a. $1,545,000. b. $1,295,000. c. $935,000. d. $610,000.

47. On January 1, 2014, Boston Corp. bought a trademark from Yarmouth Corp. for $160,000. An independent consultant retained by Boston estimated that the remaining useful life is 50 years. The trademark’s carrying value on Yarmouth’s books was $61,000. Boston decided to write off the trademark over the maximum period allowed. How much should be amortized for the year ended December 31, 2014? a. $1,220 b. $3,200 c. $4,000 d. $8,000

48. On January 1, 2010, Richmond Corp. purchased a trademark for $400,000, which had an estimated useful life of 16 years. In January 2014, Richmond paid $60,000 for legal fees in a successful defence of the trademark. The amortization expense for this asset for calendar 2014, should be a. $30,000. b. $28,750. c. $25,000. d. $0.

49. Bremerton Corp. incurred $160,000 of basic research and $50,000 of development costs to develop a product for which a patent was granted on January 2, 2009. Legal fees and other costs associated with registration of the patent totalled $60,000. On March 31, 2014, Bremerton paid

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$90,000 for legal fees in a successful defence of the patent. The total amount capitalized for the patent through March 31, 2014 should be a. $360,000. b. $270,000. c. $200,000. d. $150,000.

50. On June 30, 2014, Helena Ltd. exchanged 3,000 Butte Corp. common shares for a patent owned by Montana Corp. The Butte shares were acquired in 2012 for $160,000. At the exchange date, Butte common shares have a fair value of $90 per share, and the patent had a carrying value of $320,000 on Montana’s books. Helena should record the patent at a. $320,000. b. $270,000. c. $180,000. d. $160,000.

51. On May 5, 2014, Miami Corp. exchanged 5,000 of its common shares for a copyright owned by Lauderdale Ltd. At this date, Miami’s common shares were quoted at $28 per share, and the copyright had a carrying value of $130,000 on Lauderdale’s books. Miami should record the copyright at a. $110,000. b. $120,000. c. $130,000. d. $140,000.

52. On January 2, 2011, Fresno Corp. purchased a patent for a new consumer product for $45,000. At the time of purchase, the patent was valid for fifteen years. Due to the competitive nature of the product, however, the patent was estimated to have a useful life of only ten years. During 2014, the product was permanently removed from the market because of a potential health hazard. What amount should Fresno recognize as an impairment loss for calendar 2014, assuming amortization has been recorded annually using the straight-line method with no residual value? a. $4,500. b. $27,000. c. $31,500. d. $36,000.

53. Which of the following costs of goodwill should be capitalized? Costs of goodwill from a business combination accounted Costs of developing for as a purchase goodwill internally a. No No b. No Yes c. Yes Yes d. Yes No

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Multiple Choice Answers—CPA Adapted Item

Ans.

45. 46.

c b

Item

47. 48.

Ans.

b a

Item

49. 50.

Ans.

c b

Item

51. 52.

Ans.

d c

Item

53.

Ans.

Item

Ans.

DERIVATIONS—CPA Adapted No. Answer 45. c 46. b 47. b 48. a 49. c 50. b 51.

52.

53.

Derivation Conceptual $360,000 + $610,000 + $325,000 = $1,295,000 $160,000 / 50 = $3,200 ($400,000 ÷ 16) + ($60,000 ÷ 12) = $30,000 $60,000 + $90,000 + $50,000 = $200,000 $3,000 × $90 = $270,000, since do not have a reliable fair value of patent received 5,000 x $28 = $140,000, since do not have a reliable fair value of copyright received ($45,000 ÷ 10) × 3 = $13,500 amortization already recorded carrying value is $45,000 – $13,500 = $31,500 impairment is $0 – $31,500 = $31,500 Conceptual

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 12-54 Definitions Provide clear, concise answers for the following: 1. What are intangible assets? 2. How are research costs accounted for? 3. How are development costs accounted for? 4. What are the two models that are used to measure intangible assets after initial acquisition? 5. What are the factors that should be considered when determining the useful life of limited life intangible assets? 6. What are the major categories of intangible assets? 7. What are the two models that are used to account for the impairment of intangible assets? Solution 12-54 1. Intangible assets are assets that are individually identifiable, lack physical substance, and are non-monetary in nature. 2.

Research costs do not, by definition, meet the criteria for recognition as an asset. As a result, they must be recognized as expenses when they are incurred.

Development costs may be recognized as intangible assets, provided that future economic benefits can be demonstrated. That demonstration includes the satisfaction of six specific conditions.

The models are the cost model and the revaluation model.

Factors to be considered are the expected use of the asset; legal, contractual or regulatory provisions; potential obsolescence, demand, competition and other economic factors; and the expected expenditures for its maintenance.

The major categories are marketing-related, customer-related, artistic-related, contract-based and technology-based intangible assets.

The two models are the cost recovery impairment model and the rational entity impairment model. The first is used for ASPE and the latter is used in IFRS.

Ex. 12-55 Intangible assets theory It has been argued on the grounds of conservatism that all intangible assets should be written off immediately after acquisition. Discuss the accounting arguments against this treatment. Solution 12-55 Intangible assets may have future revenue producing ability, like tangible assets. The costs, therefore, should be capitalized, deferred, and matched as closely as possible against those revenues. Definite-life intangible assets should be amortized over the lesser of their useful and legal lives; indefinite-life intangibles are not amortized. Both types of intangibles should be tested regularly for impairment.

Goodwill and Other Intangible Assets

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Ex. 12-56 Terminology In the space provided at right, write the word or phrase that is defined or indicated. 1.

In a business combination, the difference between the fair value of the consideration given and the fair values assigned to the identifiable net assets.

1. ______________________________

When identifiable net assets are acquired at a price that is below their fair value.

A lease that includes terms that are more favourable than the current market terms for a comparable lease.

Planned investigation undertaken with the hope of gaining new scientific or technical knowledge and understanding.

Translation of research findings or other knowledge into a plan or design for new or substantially improved materials, products, processes, systems or services.

A database including customer names, contact information, order history, and demographic information

An exclusive right that is granted for the life of the creator plus fifty years.

Solution 12-56 1. Goodwill 2.

Negative goodwill or bargain purchase

A favourable lease

Research

Development

Customer list

7. Copyright

Ex. 12-57 Carrying value of patent On July 1, 2011, Bermuda Corp. purchased a patent from Antigua Ltd. for $60,000. On July 1, 2014, Bermuda paid $12,000 for successful litigation in defence of the patent. Bermuda estimates

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

that the useful life of the patent will be 15 years from the date of acquisition. Instructions Prepare a calculation of the carrying value of the patent at December 31, 2014. Label all calculations. Solution 12-57 Cost of patent................................................................................ Amortization Jul 1/11 to Jul 1/14 ($60,000  15) × 3...................... Carrying value at Jul 1/14.............................................................. Add cost of successful defence ..................................................... Carrying value ............................................................................... Amortization Jul 1 to Dec 31/14 [$60,000  (15 – 3)] × 1/2 ............ Carrying value at Dec 31/14 ..........................................................

$60,000 (12,000) 48,000 12,000 60,000 (2,500) $57,500

Ex. 12-58 Intangible asset impairment Trinidad Inc. is a private corporation following ASPE. On Jan 2, 2014 they purchased a limited-life licence for $50,000. This licence has a ten year life, and is not renewable. Straight-line amortization will be used. At December 31, 2015, Trinidad estimates that the undiscounted net cash flows of this license is $38,000, and the fair value (discounted net future cash flows) of this licence is $32,000. Instructions a. Calculate the amount of impairment (if any) for this asset. b. Prepare the adjusting entry required to reflect the impairment. Solution 12-58 a. Carrying value at Dec 31/15 = $50,000 – [($50,000/10) x 2years] = $40,000 Recoverability test: $40,000 – $38,000 = $2,000. Therefore, the asset is impaired. Impairment is $40,000 – $32,000 = $8,000 b.

AJE required at Dec 31/15 Impairment Loss—Licence ............................................................ Accumulated Impairment Losses, Licence..............................

8,000 8,000

Ex. 12-59 Criteria for capitalization of development costs List the criteria that must be met before development costs of a project may be capitalized. Solution 12-59 The six criteria that must be met are: 1. Technical feasibility of completing the intangible asset, 2. The entity’s intention to complete it for use or sale, 3. The entity’s ability to use or sell it, 4. Availability of technical, financial, and other resources needed to complete, use or sell it, 5. The way in which the future economic benefits will be received; including the existence of a market for the asset if it will be sold, or its usefulness to the entity if it will be used internally, 6. The ability to reliably measure the costs associated with and attributed to the intangible asset

Goodwill and Other Intangible Assets

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during its development.

Ex. 12-60 Alternative treatments of goodwill after recognition Once goodwill has been recognized in the accounts there has been much disagreement over how it should be treated in subsequent periods. Discuss the alternative treatment approaches. Solution 12-60 1. Charge goodwill off immediately to shareholders’ equity. Goodwill is not an asset that is separable from the business itself and therefore should not be recognized as a separate asset. In addition, immediate expensing would be consistent with the expensing of costs of internally generated goodwill. As well, there is no rational method to amortize goodwill, due to the many uncertainties involved; therefore, financial statements will be more reliable if it is expensed. 2.

Amortize goodwill over its useful life. Goodwill at the time of purchase erodes in value over time and therefore it should be charged to income over the estimated period in which it is expected to benefit the business.

Retain goodwill indefinitely at cost (i.e., do not amortize), unless impairment occurs. Current and future expenses help to maintain existing goodwill; therefore, it can have an indefinite life. Amortization of goodwill is entirely arbitrary and leads to distortions of net income.

Ex. 12-61 Acquisition of tangible and intangible assets Jamaica Manufacturing Corp. decided to expand further by purchasing the net assets of Kingston Corp. Kingston’s statement of financial position at December 31, 2014 is: KINGSTON CORP. Statement of Financial Position December 31, 2014 Assets Cash ......................................... $ 210,000 Receivables .............................. 450,000 Inventory ................................... 275,000 Plant assets (net) ...................... 1,025,000 Total assets .............................. $1,960,000

Liabilities and equities Accounts payable .................. $ 325,000 Common shares .................... 800,000 Retained earnings ................. 835,000 Total equities ......................... $1,960,000

An appraisal, agreed to by both parties, indicated that the fair value of the inventory was $320,000 and the fair value of the plant assets was $1,225,000. The fair value of the receivables and payables is equal to the amount reported on the balance sheet. The agreed purchase price was $3 million, and this amount was paid in cash to the owners of Kingston Corp. Instructions Calculate the amount of goodwill (if any) implied in the purchase price of $3 million. Show calculations. Solution 12-61 Purchase price ..................................................................................... Less tangible net assets acquired:

$3,000,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash ............................................................................................. $210,000 Receivables (FV)........................................................................... 450,000 Inventory (FV) ............................................................................... 320,000 Plant assets (FV)........................................................................... 1,225,000 Less accounts payable (FV) .......................................................... (325,000) Total fair market value of tangible net assets acquired .................. 1,880,000 Implied Goodwill................................................................................... $1,120,000

*Ex. 12-62 Calculation of goodwill Grenada Corp. expects excess earnings of $48,000 for each of the next eight years. Assume half of the excess is earned at the end of each six months. Calculate the estimated goodwill if it is based on the present value of excess earnings discounted at 10%, compounded semi-annually. *Solution 12-62 Present value of $24,000 for 16 periods at 5%; 10.83777 × $24,000 = $260,106. OR 16 N 5 I 24000 PMT CPT PV = $260,106

*Ex. 12-63 Goodwill calculation The net assets of Hispaniola Ltd., excluding goodwill, have a total fair value of $4 million, and earnings for the last five years total $2.2 million. Included in the latter figure are nonrecurring gains and losses of $200,000 and $140,000 respectively, as well as sales commissions of $25,000. A 10% return on identifiable net assets is considered normal for the industry and annual excess earnings are to be capitalized at 16% in arriving at goodwill in developing a sales price for the business. Instructions Calculate the company's goodwill. Label all calculations. *Solution 12-63 Goodwill is $175,000. Earnings for 5 years ................................................................. Less nonrecurring gains ........................................................... Add nonrecurring losses........................................................... Adjusted 5-year total earnings ..................................................

$2,200,000 200,000 2,000,000 140,000 $2,140,000

Average earnings ($2,140,000 ÷ 5) .......................................... Normal earnings ($4,000,000  .10) ......................................... Excess annual earnings ...........................................................

$428,000 400,000 $ 28,000

Excess earnings capitalized at 16% ($28,000 ÷ .16) ................

$175,000

*Ex. 12-64 Calculation of goodwill The owners of Paraguay Corp. are planning to sell the business. The cumulative earnings for the past five years are $600,000 including nonrecurring losses of $100,000. The annual earnings based on an average rate of return for this industry would be $80,000. If excess earnings are to be

Goodwill and Other Intangible Assets

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capitalized at 12%, what is the implied goodwill? *Solution 12-64 ($600,000 + $100,000) ÷ 5 = $140,000 Average earnings ....................................................... $ 140,000 Normal earnings ......................................................... 80,000 Excess earnings $ 60,000 Goodwill ($60,000 ÷.12) .............................................

$500,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 12-65 Intangible assets The following transactions involving intangible assets of Falkland Corporation occurred on or near December 31, 2014. Complete the chart below by writing the journal entr(ies) needed at that date to record the transaction, and at December 31, 2015 to record any resultant amortization. If no entry is required at a particular date, write "none needed." On Date of Transaction 1.

Falkland paid Jericho Company $200,000 for the exclusive right to market a particular product, using the Jericho name and logo in promotional material. The franchise runs for as long as Falkland is in business. Falkland decided to amortize the franchise over 25 years.

Falkland spent $300,000 developing a new manufacturing process and has applied for a patent. It believes that its application will be successful and that the process will be successfully implemented and used for 10 years.

In January, 2015, Falkland's application for a patent (#2 above) was granted. Legal and registration costs incurred were $35,000. The patent runs for 17 years from the grant date. The manufacturing process will be useful to Falkland for 10 years.

Falkland incurred $90,000 in successfully defending another of its patents in an infringement suit. The patent expires during December, 2015.

Falkland incurred $200,000 in an unsuccessful patent defence. As a result of the adverse verdict, the patent, with a remaining unamortized cost of $99,000, is deemed worthless.

Falkland paid Mexico Laboratories $52,000 for research work performed by Mexico under contract for Falkland.

Solution 12-65 On Date of Transaction 1. Franchise ............. 200,000

On December 31, 2015

On December 31, 2015 1. Franchise Amort. Exp.8,000

Goodwill and Other Intangible Assets

Cash ............. 2.

Deferred ....... Devel. Costs......... 300,000 Cash.............. ...................... Patents................. 35,000 Cash..............

200,000

300,000

35,000

Patents................. 90,000 Cash..............

90,000

Legal Fees Exp. ... 200,000 Cash..............

200,000

Loss on Impair. of Patent .................. 99,000 Acc impairment losses

99,000

Research Expense 52,000 Cash..............

52,000

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Acc Amortization Franchise 8,000 2. Devel. Cost Amortization Expense 30,000 Deferred Devel. Costs 30,000 3. Patent Amortization Expense ........ 3,500 Acc Amortization Patents

3,500

4. Patent Amortization Expense ........ 22,500 Acc Amortization Patents 22,500 5. “None needed.”

6. "None needed."

Pr. 12-66 Journal entries for impairment of intangible assets Patagonia Corp., a large, privately held company is preparing its year-end entries. As senior accountant, you have been asked to prepare the entries related to the company's intangible assets. Patagonia currently carries the following intangible assets* on its balance sheet: Trade name $125,000 net of accumulated amortization of $75,000 Patent $126,000 net of accumulated amortization of $54,000 Other intangibles $340,000 no amortization recorded Trademark $120,000 net of accumulated amortization of $30,000 $711,000 *Current year amortization has already been recorded. The following additional information is available: After recent negative press releases relating to the technology that underlies the patent, the company has carried out a recoverability test that indicates that the patent's carrying value is higher than its undiscounted future net cash flows. The patent's fair value has now been estimated at $84,000. The item classified as “Other intangibles” relates to research costs that the company incurred in the current year. According to a statement from the company's President, "the costs were incurred with the intention to gain new knowledge. At the moment we don't know exactly how to use this information, but we are confident that eventually we will be able to use it."

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Instructions Based on the information provided, prepare all journal entries that are required to adjust Patagonia's records as would be required under ASPE. Solution 12-66 To record impairment loss on patent: Impairment loss, patent ................................................................. Accumulated impairment losses, patent ................................. $126,000 – $84,000 = $42,000

42,000 42,000

To expense research costs that had been incorrectly capitalized: Research expense ........................................................................ 340,000 Other intangible assets ........................................................... 340,000 According to the information provided, these costs appear to be research costs, rather than development costs (that might qualify for capitalization). Research costs, by definition, do not meet the criteria that are required to recognize these costs as an asset. As a result, they should be expensed.

Goodwill and Other Intangible Assets

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CHAPTER 13 NON-FINANCIAL AND CURRENT LIABILITIES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

2 2 2 3 3 3 3 3 3

E E M E M M E M M

37. 38. 39. 40. 41. 42.

3 3 3 3 3 3

E H M M H M

61. 62. 63.

3 3 3

M M M

72. 73.

3 3

M M

80. 81. 82.

2 3 3

E M H

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 10. 3 E 19. 4 11. 3 M 20. 4 12. 3 E 21. 4 13. 3 M 22. 5 14. 3 E 23. 5 15. 3,7 M 24. 5 16. 4 M 25. 7 17. 4 M 26. 7 18. 4 M 27. 7 Multiple Choice–Computational 43. 3 H 49. 5 44. 3 M 50. 5 45. 4 M 51. 6 46. 4 M 52. 7 47. 4 H 53. 7 48. 4 H 54. 7 Multiple Choice–CPA Adapted 64. 3 E 67. 5 65. 4 M 68. 6 66. 4 M 69. 6 Exercises 74. 4 M 76. 5 75. 4 H 77. 7 Problems 83. 4 M 86. 7 84. 5,8 H 87. 7 85. 7 H 88. 8

M = Medium

LOD

Item

LOD

H M M M E M M M M

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

8 8 8 9 9 9 10 10 10

M M M M M M E M H

M M M M H H

55. 56. 57. 58. 59. 60.

7 8 8 9 9 9

M M M M E H

M M M

70. 71.

7 8

H M

M H

78. 79.

7 8

H M

M H M

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

4. 5. 6. 7. 8.

MC MC MC MC MC

9. 10. 11. 12. 13.

MC MC MC MC MC

16. 17. 18.

MC MC MC

19. 20. 21.

MC MC MC

22. 23.

MC MC

24. 49.

MC MC

51.

68.

15. 25. 26.

MC MC MC

27. 52. 53.

MC MC MC

28. 29.

MC MC

30. 56.

MC MC

31.

32.

34.

35.

MC = Multiple Choice

Item Type Item Type Learning Objective 2 3. MC 80. Pr Learning Objective 3 14. MC 40. MC 15. MC 41. MC 37. MC 42. MC 38. MC 43. MC 39. MC 44. MC Learning Objective 4 45. MC 48. MC 46. MC 65. MC 47. MC 66. MC Learning Objective 5 50. MC 76. Ex 67. MC 84. Pr Learning Objective 6 69. MC Learning Objective 7 54. MC 77. Ex 55. MC 78. Ex 70. MC 85. Pr Learning Objective 8 57. MC 79. Ex 71. MC 84. Pr Learning Objective 9 33. MC 58. MC Learning Objective 10 36. MC Ex = Exercise

Item

Type

Item

Type

61. 62. 63. 64. 72.

MC MC MC MC Ex

73. 81. 82.

Ex Pr Pr

74. 75. 83.

Ex Ex Pr

86. 87.

Pr Pr

88.

59.

60.

Pr = Problem

Non-Financial and Current Liabilities

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CHAPTER STUDY OBJECTIVES 1. Understand the importance of non-financial and current liabilities from a business perspective. Cash flow management is a key control factor for most businesses. Taking advantage of supplier discounts for prompt payment is one step companies can take. Control of expenses and related accounts payable can improve the efficiency of a business, and can be particularly important during economic downturns.

2. Define liabilities, distinguish financial liabilities from other liabilities, and identify how they are measured. Liabilities are defined as present obligations of an entity arising from past transactions or events that are settled through a transfer of economic resources in the future. They must be enforceable on the entity. Financial liabilities are a subset of liabilities. They are contractual obligations to deliver cash or other financial assets to another party, or to exchange financial instruments with another party under conditions that are potentially unfavourable. Financial liabilities are initially recognized at fair value, and subsequently either at amortized cost or fair value. ASPE does not specify how non-financial liabilities are measured. However, unearned revenues are generally measured at the fair value of the goods or services to be delivered in the future, while others are measured at the best estimate of the resources needed to settle the obligation. Under IFRS, non-financial liabilities other than unearned revenues are measured at the best estimate of the amount the entity would rationally pay at the date of the statement of financial position to settle the present obligation.

3. Define current liabilities and identify and account for common types of current liabilities. Current liabilities are obligations that are payable within one year from the date of the statement of financial position or within the operating cycle if the cycle is longer than a year. IFRS also includes liabilities held for trading and any obligation where the entity does not have an unconditional right to defer settlement beyond 12 months after the date of the statement of financial position. There are several types of current liabilities. The most common are accounts and notes payable, and payroll-related obligations.

4. Identify and account for the major types of employee-related liabilities. Employeerelated liabilities include (1) payroll deductions, (2) compensated absences, and (3) profitsharing and bonus agreements. Payroll deductions are amounts that are withheld from employees and result in an obligation to the government or other party. The employer’s matching contributions are also included in this obligation. Compensated absences earned by employees are company obligations that are recognized as employees earn an entitlement to them, as long as they can be reasonably measured. Bonuses based on income are accrued as an expense and liability as the income is earned.

5. Explain the recognition, measurement, and disclosure requirements for decommissioning and restoration obligations. A decommissioning, restoration, or asset retirement obligation (ARO) is an estimate of the costs a company is obliged to incur when it retires certain assets. It is recorded as a liability and is usually long-term in nature. Under ASPE, only legal obligations are recognized. They are measured at the best estimate of the cost to settle them at the date of the statement of financial position, and the associated cost is included

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

as part of the cost of property, plant, and equipment. Under IFRS, both legal and constructive obligations are recognized. They are measured at the amount the entity would rationally pay to be relieved of the obligation, and are capitalized as part of PP&E or to inventory, if due to production activities. Over time, the liability is increased for the time value of money and the asset costs are amortized to expense. Entities disclose information about the nature of the obligation and how it is measured, with more disclosures required under IFRS than ASPE.

6. Explain the issues and account for unearned revenues. When an entity receives proceeds in advance or for multiple deliverables, unearned revenue is recognized to the extent the entity has not yet performed. This is measured at the fair value of the remaining goods or services that will be delivered. When costs remain to be incurred in revenue transactions where the revenue is considered earned and has been recognized, estimated liabilities and expenses are recognized at the best estimate of the application of the matching concept.

7. Explain the issues and account for product guarantees and other customer program obligations. Historically, an expense approach has been used to account for the outstanding liability, but some recent standards have moved toward the revenue approach. Under the expense approach, the outstanding liability is measured at the cost of the economic resources needed to meet the obligation. The assumption is that along with the liability that is required to be recognized at the reporting date, the associated expense needs to be measured and matched with the revenues of the period. Under the revenue approach, the outstanding liability is measured at the value of the obligation. The proceeds received for any goods or services yet to be delivered or performed are considered to be unearned at the point of sale. Until the revenue is earned, the obligation—the liability—is reported at its sales or fair value. The liability is then reduced as the revenue is earned.

8. Explain and account for contingencies and uncertain commitments, and identify the accounting and reporting requirements for guarantees and commitments. Under existing standards, a loss is accrued and a liability recognized if (1) information that is available before the issuance of the financial statements shows that it is likely (or more likely than not under IFRS) that a liability has been incurred at the date of the financial statements, and (2) the loss amount can be reasonably estimated (under IFRS, it would be a rare situation where this could not be done). An alternative approach likely to be required in new standards being developed by the IASB is described in the Looking Ahead section of the chapter. Guarantees in general are accounted for similarly to contingencies. Commitments, or contractual obligations, do not usually result in a liability at the date of the statement of financial position. Information about specific types of outstanding commitments is reported at the date of the statement of financial position.

9. Indicate how non-financial and current liabilities are presented and analyzed. Current liability accounts are commonly presented as the first classification in the liability section of the statement of financial position, although under IFRS, a common presentation is to present current assets and liabilities at the bottom of the statement. Within the current liability section, the accounts may be listed in order of their maturity or in order of their liquidation preference. IFRS requires information about and reconciliations of any provisions. Additional information is provided so that there is enough to meet the requirement of full disclosure. Information about unrecognized loss contingencies is reported in notes to the financial statements, including their

Non-Financial and Current Liabilities

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nature and estimates of possible losses. Commitments at year end that are significant in size, risk, or time are disclosed in the notes to the financial statements, with significantly more information required under IFRS. Three common ratios used to analyze liquidity are the current, acid-test, and days payables outstanding ratios.

10. Identify differences in accounting between IFRS and ASPE and what changes are expected in the near future. Private enterprise and international standards are substantially the same. However, there are some classification differences. ASPE does not address “provisions,” and there are differences related to which decommissioning and restoration liabilities are recognized and how the costs are capitalized, and how the probability and measurement criteria are applied to contingencies. In addition, requires considerably more disclosure. Looking ahead, revisions to the existing standards are being proposed by the IASB and FASB that will likely be applied, at least in part, under CICA Handbook, Part II in the future. The major changes relate to the recognition and measurement standards for non-financial liabilities.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c c b a d c b c d a b c a b d c b c b d c d c a c d b c a d c d c b c d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.

Description Essential characteristics of liabilities Constructive obligation Recognition and accounting for financial liabilities Classification of notes payable Zero-interest-bearing notes Refinancing of long-term debts Identify item that is not a current liability. Identify the current liability. Classification of stock dividends distributable Goods and Services Tax Identify current liability. Accounting for GST Provincial Sales Tax Corporation income tax Current liabilities in general - determine false statement Determine employer’s payroll costs Accumulating rights to benefits Accrual of liability for compensated absences Non-accumulating rights to benefits Methods of calculating employee bonuses Definition of a provision Recognition of an asset retirement obligation Recognition of an asset retirement obligation Recording accretion expense for ARO Revenue approach for product guarantees Determine false statement regarding warranties Accounting for premiums and coupons Recognition of contingencies (ASPE) Recognition of contingencies (IFRS) Accrual of contingent liability Disclosure of commitments Acid-test ratio elements Days payable outstanding elements Essential characteristics of liabilities Proposed amendments regarding provisions and contingencies IFRS re customer loyalty programs

Non-Financial and Current Liabilities

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MULTIPLE CHOICE—Computational Answer b d b d b c d c b b c b d b c a a c a b d c d a

No. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

Description Adjusting entry for zero-interest-bearing note Journal entry for payment of interest-bearing note Determine amount of short-term debt to be reported. Determine amount of short-term debt to be reported. Calculate accounts receivable including sales taxes. Calculate cost of purchase for own use. Payment of GST Adjusting entry for corporate income tax Calculate payroll tax expense. Calculate vacation pay expense to be reported. Calculate accrued vacation pay liability. Calculate net pay. Entry for asset retirement obligation Entry for asset retirement obligation accretion Adjusting entry for unearned revenue Expense approach to warranty Revenue approach to warranty Calculate warranty liability (expense approach). Calculate liability for unredeemed coupons. Determine amount to accrue as a loss contingency. Determine amount to accrue as a gain contingency. Calculate quick (acid-test) ratio. Calculate current ratio. Calculate days payables outstanding.

MULTIPLE CHOICE—CPA Adapted Answer a d c c a b b b b c d

No. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

Description Knowledge of accounts payable Determine amount of short-term debt to be reported. Calculate accrued interest payable. Calculate HST collected. Calculate accrued salaries payable. Accrual of payroll taxes Calculate asset retirement obligation. Determine current and long-term portions of debt. Calculate unearned service contract revenue. Calculate liability from unredeemed trading stamps. Determine range of loss accrual.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E13-72 E13-73 E13-74 E13-75 E13-76 E13-77 E13-78 E13-79

Description Notes payable Sales taxes Payroll entries Compensated absences Asset retirement obligation Premiums Premiums Contingent liabilities

PROBLEMS Item P13-80 P13-81 P13-82 P13-83 P13-84 P13-85 P13-86 P13-87 P13-88

Description Common types of current liabilities Accounts and notes payable Refinancing of short-term debt Employee related liabilities Asset retirement obligation Premiums Warranties Unredeemed coupons Contingences

Non-Financial and Current Liabilities

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MULTIPLE CHOICE—Conceptual 1. According to the existing IFRS and the CICA Handbook Part II guidelines, which of the following is NOT an essential characteristic of a liability? a. It embodies a duty or responsibility. b. The transaction or event that obliges the entity has occurred. c. The obligation is enforceable on the obligor entity. d. The entity has little or no discretion to avoid the duty.

2. A constructive obligation arises when a. the entity is legally obligated to honour the obligation. b. the entity makes an unconditional promise to pay money in the future. c. past or present company practice reveals the entity acknowledges a potential economic burden. d. the entity has a conditional obligation which becomes unconditional if an uncertain future event occurs.

3. Which of the following statements is NOT true about recognition and subsequent accounting for financial liabilities? a. They are initially recognized at their fair value. b. After acquisition, they continue to be accounted for at fair value. c. After acquisition, they are generally accounted for at amortized cost. d. Short term liabilities, such as accounts payable, are usually recorded at their maturity value. 4. Among Oslo Corp.’s short-term obligations, on its most recent statement of financial position date, are notes payable totalling $250,000 with the Provincial Bank. These are 90-day notes, renewable for another 90-day period. These notes should be classified on Oslo’s statement of financial position as a. current liabilities. b. deferred charges. c. long-term liabilities. d. shareholders’ equity.

5. Regarding zero-interest-bearing notes, a. they do not have an interest component. b. the debtor receives the future value of the note and pays back the present value. c. any interest is never recognized until the note is repaid. d. the debtor receives the present value of the note and pays back the future value.

6. Under IFRS, even if the entity plans to refinance long term debt, the current portion must be reported as a current liability UNLESS a. long term financing has been completed after the statement of financial position date, but before the financial statements are released.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b. management intends to refinance the debt on a long-term basis. c. at statement of financial position date, the entity expects to refinance under an existing agreement for at least a year, and the decision is solely at its discretion. d. management intends to discharge the debt by issuing shares.

7. Which of the following should NOT be included in the current liabilities section of the statement of financial position? a. trade accounts payable b. current portion of long term debt to be retired by non-current assets c. short-term zero-interest-bearing notes payable d. a liability due on demand (callable debt)

8. Which of the following is a current liability? a. preferred dividends in arrears b. stock dividends distributable c. preferred cash dividends payable d. stock splits

9. Stock dividends distributable should be classified on the a. income statement as an expense. b. statement of financial position as an asset. c. statement of financial position as a liability. d. statement of financial position as an item of shareholders' equity.

10. Goods and Services Tax (GST) a. is a value added tax. b. is a sales tax charged by each province on all taxable goods. c. in some provinces, is an income tax. d. must be collected by all businesses in Canada.

11. Which of the following may be classified as a current liability? a. stock dividends distributable b. accounts receivable credit balances c. losses expected to be incurred within the next twelve months in excess of the company's insurance coverage d. tenant’s rent deposit not returnable until the end of a long-term lease

12. Accounting for GST includes a. crediting GST Payable to record GST paid on inventory for resale. b. crediting GST Recoverable to record GST collected from customers. c. debiting GST Recoverable to record GST paid to suppliers. d. debiting GST Payable to record GST collected from customers.

13. Regarding Provincial Sales Tax (PST)

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a. the purchaser includes any PST paid in the cost of the goods or services. b. all PST paid is recorded in a “PST Expense” account. c. all PST paid is recorded in a “PST Recoverable” account. d. for statement of financial position presentation, a PST registrant “nets” any PST paid against any PST collected from customers.

14. Corporation income taxes payable a. must always be approved by an external auditor. b. are reviewed and approved by Canada Revenue Agency (CRA). c. also apply to proprietorships and partnerships. d. are always the same under GAAP and Canadian tax laws.

15. Which of the following statements is FALSE? a. Under IFRS, a company may exclude a short-term obligation from current liabilities if, at statement of financial position date, the entity expects to refinance under an existing agreement for at least a year, and the decision is solely at its discretion. b. Cash dividends should be recorded as a liability when they are declared by the board of directors. c. Under the cash basis method, warranty costs are charged to expense as they are paid. d. Federal income taxes withheld from employees' payroll cheques should be recorded as a long-term liability. 16. Which of the following are included in the employer's “Payroll Tax Expense”? a. employee income tax deducted, employer portion of CPP/QPP and EI b. employer portion of CPP/QPP and EI, union dues c. employer portion of CPP/QPP and EI only d. employer portion of EI, union dues, and employee income tax deducted

17. Accumulating rights to benefits (for employees) a. are rarely mandated by provincial labour law. b. include vested rights that do not depend on the employee’s continued service. c. are rights that do not accrue with employee service. d. are not accrued as an expense in the period earned.

18. A liability for compensated absences such as vacations, for which it is expected that employees will be paid, should a. be accrued during the period when the compensated time is expected to be used by employees. b. be accrued during the period following vesting. c. be accrued during the period when earned. d. not be accrued unless a written contractual obligation exists.

19. Non-accumulating rights to benefits, such as parental leave, are generally accounted for by a. the full accrual method. b. the event accrual method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. the cash method. d. financial statement note disclosure only.

20. Which of the following is generally NOT used as a basis for calculating bonuses or profit sharing amounts? a. a percentage of the employees’ regular pay rates b. the company’s pre-tax income c. productivity increases d. gross sales

21. Under IFRS, a provision is a. a special fund set aside to pay long-term debt. b. unearned revenue. c. a liability of uncertain timing or amount. d. an allowance for future dividends to be paid.

22. At the time of recognition of an asset retirement obligation, the present value should be a. recorded as a separate long-term asset and as an asset retirement obligation. b. expensed and recorded as an asset retirement obligation. c. expensed to “Asset Retirement Expense” in the period actually paid. d. added to the related asset cost and recorded as an asset retirement obligation.

23. Under ASPE, an asset retirement obligation should be recognized when a. an asset is impaired and is available for sale. b. operation of an asset has resulted in an additional obligation such as the cost of cleaning up an oil spill. c. there is a legal obligation to restore the site of the asset at the end of its useful life. d. the company has an obligation to purchase a long-lived asset.

24. Which of the following statements is INCORRECT regarding the recording of the related increase or accretion in the carrying amount of an asset retirement obligation (ARO)? a. Under ASPE, it is recognized as interest expense. b. Under ASPE, it is recognized as an operating expense (but not as interest expense). c. Under IFRS, it is recognized as a borrowing cost. d. The amount should be calculated using the same discount (interest rate) as was used to calculate the initial present value of the ARO.

25. Using the revenue approach of accounting for product guarantees and warranty obligations a. the liability is measured at the estimated cost of meeting the obligation. b. there is no effect on future income. c. the liability is measured at the value of the services to be provided. d. the liability is measured at the value of the services to be provided, but there is no effect on future income.

Non-Financial and Current Liabilities

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26. Which of the following statements is INCORRECT concerning warranties? a. Using the expense approach, the warranty is provided with the product or service with no additional fee. b. Where warranty costs are immaterial or when the warranty period is quite short, the warranty costs may be accounted for using the cash basis. c. Using the revenue approach, the warranty is a separate deliverable from the related product or service. d. The revenue approach must be used for income tax purposes.

27. The current (commonly used) accounting treatment for premiums and coupons requires that the costs should a. be recorded at the maximum possible redemption cost in the year of the related sales. b. be recorded at the total estimated redemption cost in the year of the related sales. c. be recorded in the year(s) that the redemption is expected to occur. d. not be recorded at all.

28. Under ASPE, a contingent liability is recognized if a. it is certain that funds are available to settle the contingency. b. an asset may have been impaired. c. the amount of the loss can be reasonably estimated and it is likely that an asset has been impaired or a liability incurred as of the financial statement date. d. it is likely that an asset has been impaired or a liability incurred even though the amount of the loss cannot be reasonably estimated.

29. Under current IFRS requirements, a provision is recognized if a. the amount of the loss can be reliably measured and it is probable that an asset has been impaired or a liability incurred as of the financial statement date. b. the amount of the loss cannot be measured reliably but it is probable that an asset has been impaired or a liability incurred as of the financial statement date. c. it relates to a lawsuit commenced after the statement of financial position date, the outcome of which can be reliably measured. d. it relates to an asset recognized as impaired after the statement of financial position date.

30. Which of the following may NOT be accrued as a contingent liability? a. threat of expropriation of assets b. pending or threatened litigation c. guarantees of indebtedness of other. d. potential income tax refunds

31. Which of the following commitments would NOT require disclosure in the financial statement notes? a. major property, plant and equipment expenditures b. payments under non-cancellable operating leases c. large purchases of materials in the normal course of business d. commitments involving significant risk

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

32. The numerator of the acid-test ratio consists of a. total current assets. b. cash and marketable securities. c. cash and net receivables. d. cash, marketable securities, and net receivables.

33. The denominator of the days payable outstanding ratio can be a. average daily sales. b. average trade accounts payable. c. average daily cost of goods sold. d. average trade accounts receivable.

34. According to the IASB current proposed definition, which of the following is NOT an essential characteristic of a liability? a. It exists in the present time. b. There is certainty about the amount of future outflows. c. The obligation is enforceable on the obligor entity. d. It represents an economic burden or obligation.

35. According to the Exposure Draft of Proposed Amendments to IAS 37, Provisions, Contingent Liabilities and Contingent Assets a. only conditional obligations are recorded. b. liabilities must have measurement certainty. c. the term “contingent liabilities” is eliminated. d. a conditional obligation related to an unconditional obligation is not recognized.

36. What are the current International Financial Reporting Standards regarding customer loyalty programs (such as frequent flyer points)? a. They are recognized only in the financial statement notes. b. They are recognized only when customers redeem their points. c. They are not explicitly addressed. d. The current proceeds are to be split between the original transaction and the award credits (as unearned revenue).

Non-Financial and Current Liabilities

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MULTIPLE CHOICE ANSWERS—Conceptual Item

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

Ans.

c c b a d c

Item

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

Ans.

b c d a b c

Item

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

Ans.

a b d c b c

Item

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

Ans.

b d c d c a

Item

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

Ans.

c d b c a d

Item

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

Ans.

c d c b c d

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 37. On November 1, 2014, Best Corp. signed a three-month, zero-interest-bearing note for the purchase of $80,000 of inventory. The maturity value of the note was $81,200, based on the bank’s discount rate of 6%. The adjusting entry prepared on December 31, 2014 in connection with this note will include a a. debit to Note Payable for $800. b. credit to Note Payable for $800. c. debit to Interest Expense for $1,200. d. credit to Interest Expense for $800.

38. On December 1, 2014, Corby Ltd. borrowed $270,000 from their bank, by signing a fourmonth, 7% interest bearing note. Assuming Corby has a December 31 year end and does NOT use reversing entries, the journal entry to record payment of this note on April 1, 2015 will include a a. credit to Note Payable of $270,000. b. debit to Interest Expense of $6,300. c. debit to Interest Payable of $4,725. d. debit to Interest Payable of $1,575.

39. On February 10, 2014, after issuance of its financial statements for calendar 2013, Diogenes Corp. entered into a financing agreement with Gigantic Bank, allowing Diogenes Corp. to borrow up to $6,000,000 at any time through 2016. Amounts borrowed under the agreement bear interest at 2% above the bank's prime interest rate and mature two years from the date of the loan. Diogenes presently has $2,250,000 of notes payable with Provincial Bank maturing March 15, 2015. The company intends to borrow $3,750,000 under the agreement with Gigantic and pay off the notes payable to Provincial. The agreement with Gigantic also requires Diogenes to maintain a working capital level of $9,000,000 and prohibits the payment of dividends on common shares without prior approval by Gigantic. From the above information only, the total short-term debt of Diogenes Corp. on the December 31, 2013 statement of financial position is a. $0. b. $2,250,000. c. $3,000,000. d. $6,000,000.

40. On December 31, 2014, Street Ltd. has $2,000,000 in short-term notes payable due on February 14, 2015. On January 10, 2015, Street arranged a line of credit with Regal Bank, which allows Street to borrow up to $1,500,000 at 1% above the prime rate for three years. On February 2, 2015, Street borrowed $1,200,000 from Regal Bank and used $500,000 additional cash to liquidate $1,700,000 of the short-term notes payable. Assuming Street adheres to IFRS, the amount of the short-term notes payable that should be reported as current liabilities on Street’s December 31, 2014 statement of financial position (to be issued on March 5, 2015) is a. $0. b. $300,000. c. $1,200,000.

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d. $2,000,000.

41. Ye Olde Shoppe operates in a province with a 6% PST. The store must also collect 5% GST on all sales. For the month of May, Ye Olde Shoppe sold $90,000 worth of goods to customers, 60% of which were cash sales and the balance being on account. Based on the above information, what is the total debit to Accounts Receivable for the month of May? a. $59,940 b. $39,960 c. $37,800 d. $36,000

42. Zircon Ltd., a GST registrant, buys $4,500 worth of Office Supplies for their own use. The purchase is subject to 8% PST and 5% GST. What amount will be debited to the Office Supplies account as a result of this transaction? a. $4,500 b. $4,725 c. $4,860 d. $5,085 43. At December 31, 2014, Manganese Corp.’s records show the following balances, all of which are normal: PST Payable, $625; GST Payable, $600; GST Recoverable, $488. In January 2015, Manganese pays the Federal Government the net amount owing regarding GST owing from December. The journal entry to record this payment will include a a. debit to GST Payable of $112. b. credit to Cash of $600. c. credit to GST Payable of $600. d. credit to GST Recoverable of $488.

44. Aluminum Ltd. has made a total of $23,250 in instalments for corporate income tax for calendar 2014, all of which have been debited to Current Income Tax Expense. At year end, Dec 31, 2014, the accountant has calculated that the corporation’s actual tax liability is only $21,500. What is the correct adjusting entry to reflect this fact? a. Dr Current Income Tax Expense $1,750, Cr Income Taxes Payable $1,750 b. Dr Income Taxes Payable, $1,750, Cr Current Income Tax Expense $1,750 c. Dr Income Taxes Receivable $1,750, Cr Current Income Tax Expense $1,750 d. Dr Current Income Tax Expense $21,500, Cr Income Taxes Payable $21,500

45. The total payroll of Carbon Company for the month of October was $240,000, all subject to CPP deductions of 4.95% and EI deductions of 1.83%. As well, $60,000 in federal income taxes and $6,000 of union dues were withheld. The employer matches the employee deductions and contributes 1.4 times the employee EI deductions. What amount should Carbon record as employer payroll tax expense for October? a. $16,272.00 b. $18,028.80 c. $24,028.80 d. $78,028.80

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Use the following information for questions 46–47. Silver Ltd. has 35 employees who work 8-hour days and are paid hourly. On January 1, 2014, the company began a program of granting its employees 10 days paid vacation each year. Vacation days earned in 2014 may be taken starting on January 1, 2015. Information relative to these employees is as follows: Hourly Vacation Days Earned Vacation Days Used Year Wages by Each Employee by Each Employee 2014 $12.90 10 0 2015 13.50 10 8 2016 14.25 10 10 Silver has chosen to accrue the liability for compensated absences (vacation pay) at the current rates of pay in effect when the vacation pay is earned. 46. What is the amount of vacation pay expense that should be reported on Silver’s income statement for 2014? a. $37,800 b. $36,120 c. $34,440 d. $ 0

47. What is the amount of the Vacation Wages Payable that should be reported at December 31, 2016? a. $39,900 b. $45,360 c. $47,460 d. $47,880 48. Information regarding Oxygen Inc.’s payroll for the period ending March 22 follows: Gross salaries and wages ........................ $100,000 CPP rate .................................................. 4.95% EI rate ...................................................... 1.83% Employee income tax ............................... deducted $20,000 Company pension deducted ..................... 5% of gross salaries and wages Union dues deducted ............................... $ 800 Assume 100% of the gross salaries and wages are subject to CPP and EI. Therefore, the NET pay for this period is a. $66,690. b. $67,420 c. $68,220. d. $ 72,420.

Use the following information for questions 49–50. Antimony Inc. developed a new gold mine during 2014, and is required by provincial law to

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restore the site to its previous condition once mining operations are completed. The company estimates that the mine will close in 20 years and that the land restoration will cost $5,000,000. Antimony uses a 6% discount rate.

49. To the nearest dollar, the entry to record the asset retirement obligation is a. Restoration Expense ................................................................ 93,541 Asset Retirement Obligation ............................................. 93,541 b. Restoration Expense ................................................................ 250,000 Asset Retirement Obligation .............................................. 250,000 c. Gold Mine ................................................................................. 5,000,000 Asset Retirement Obligation .............................................. 5,000,000 d. Gold Mine ................................................................................. 1,559,000 Asset Retirement Obligation .............................................. 1,559,000

50. To the nearest dollar, the adjusting entry to record accretion at the end of year one is a. Accretion Expense .................................................................... 250,000 Asset Retirement Obligation .............................................. 250,000 b. Accretion Expense .................................................................... 93,540 Asset Retirement Obligation .............................................. 93,540 c. Gold Mine ................................................................................. 93,540 Asset Retirement Obligation .............................................. 93,540 d. Interest Expense....................................................................... 93,540 Asset Retirement Obligation .............................................. 93,540

51. On Dec 12, 2014, Ivory Coast, CGA, received $5,000 from a customer as an advance payment for accounting work to be done. The payment was credited to Accounting Revenue. Thirty percent of the work was performed in December 2014, with the rest to be done in January 2015, at which time the customer will be billed. The required adjusting entry at December 31, 2014 (year end) is a. Dr Unearned Revenue $1,500, Cr Accounting Revenue $1,500. b. Dr Accounting Revenue $1,500, Cr Unearned Revenue $1,500. c. Dr Accounting Revenue $3,500, Cr Unearned Revenue $3,500. d. Dr Unearned Revenue $3,500, Cr Accounting Revenue $3,500.

52. Platinum Corp. uses the expense approach to account for warranties. They sell a used car for $30,000 on Oct 25, 2014, with a one year warranty covering parts and labour. Warranty expense is estimated at 2% of the selling price, and the appropriate adjusting entry is recorded at Dec 31, 2014. On March 12, 2015, the car is returned for warranty repairs. This cost Platinum $200 in parts and $120 in labour. When recording the March 12, 2015 transaction, Platinum would debit Warranty Expense with a. Zero. b. $120. c. $200. d. $320.

53. Potassium Corp. uses the revenue approach to account for warranties. During 2014, the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

company sold $500,000 worth of products, all of which carried a two year warranty (included in the price). It was estimated that 2% of the selling price represented the warranty portion, and that 60% of this related to 2014, and 40% to 2015. Assuming that Potassium incurred costs of $3,700 to service the warranties in 2015, what is the net warranty revenue (revenue minus warranty costs) for 2015? a. $300 b. $1,300 c. $3,700 d. $4,000

54. In 2014, Hydrogen Corp. began selling a new line of products that carry a two-year warranty against defects. Based upon past experience with other products, the estimated warranty costs related to dollar sales are as follows: First year of warranty 2% Second year of warranty 5% Sales and actual warranty expenditures for 2014 and 2015 are presented below: 2014 2015 Sales $450,000 $600,000 Actual warranty expenditures 15,000 30,000 Hydrogen uses the expense approach to account for warranties. What is the estimated warranty liability at the end of 2015? a. $73,500 b. $43,500 c. $28,500 d. $12,000

55. Krypton Foods distributes coupons to consumers which may be presented, on or before a stated expiry date, to grocery stores for discounts on certain Krypton products. The stores are reimbursed when they send the coupons in to Krypton. In Krypton's experience, only about 50% of these coupons are redeemed. During 2014, Krypton issued two separate series of coupons as follows: Coupon Amounts Reimbursed Issued On Total Value Expiry Date as of Dec 31/14 Jan 1/14 $250,000 Jun 30/14 $118,000 Jul 1/14 360,000 Dec 31/14 150,000 Krypton’s only journal entries for 2014 recorded debits to coupon expense, and credits to cash of $268,000. Their December 31, 2014 statement of financial position should include a liability for unredeemed coupons of a. $0. b. $30,000. c. $62,000. d. $180,000.

56. Asbestos Corp. is being sued for illness caused to local residents as a result of negligence on the company's part in permitting the local residents to be exposed to highly toxic chemicals. Asbestos's lawyer states that it is likely the corporation will lose the suit and be found liable for a judgement which may cost Asbestos anywhere from $300,000 to $1,500,000. However, the lawyer states that the most likely cost is $900,000. As a result of the above facts, using ASPE,

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Asbestos should accrue a. a loss contingency of $300,000 and disclose an additional contingency of up to $1,200,000. b. a loss contingency of $900,000 and disclose an additional contingency of up to $600,000. c. a loss contingency of $900,000 but not disclose any additional contingency. d. no loss contingency but disclose a contingency of $300,000 to $1,500,000.

57. At January 1, 2014, Neon Corp. owned a machine that had cost $100,000. The accumulated depreciation to date was $60,000, estimated residual value was $6,000, and fair value was $160,000. On January 4, 2014, this machine suffered major damage due to Argon Corp.’s actions and was written off as worthless. In October 2014, a court awarded damages of $160,000 against Argon in favour of Neon. At December 31, 2014, the final outcome of this case was awaiting appeal and was, therefore, uncertain. However, in the opinion of Neon's attorney, Argon's appeal will be denied. At December 31, 2014, what amount should Neon accrue for this gain contingency? a. $160,000 b. $130,000 c. $100,000 d. $0

58. Presented below is information available for Radon Corp.: Current Assets Cash.................................................. $ 8,000 Marketable securities ........................ 150,000 Accounts receivable .......................... 122,000 Inventories......................................... 220,000 Prepaid expenses.............................. 60,000 Total current assets .................... $560,000 Total current liabilities are $100,000. To two decimals, Radon’s acid-test ratio is a. 5.60. b. 5.30. c. 2.80. d. .36.

59. Lee Kim Inc.'s most recent statement of financial position includes Cash ........................................................ $7,500 Accounts receivable ................................. 10,000 Inventory .................................................. 13,300 Plant and equipment (net) ........................ 73,700 Accounts payable ..................................... 14,000 Long term bonds payable ......................... 50,000 Common shares ....................................... 20,000 Retained earnings .................................... 20,500 To two decimals, Lee Kim Inc. has a current ratio of a. .27. b. .48. c. 1.63.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. 2.20.

60. Helium Corp. provides the following information for 2014 and 2015: ........................................................ 2014 2015 Current assets ................................. $23,000 $27,000 Accounts payable ............................ 9,000 10,000 Other current liabilities..................... 5,000 4,000 Non-current liabilities ....................... 50,000 62,000 Sales ............................................... 125,000 135,000 Cost of goods sold .......................... 75,000 79,600 To one decimal, Helium’s days payable outstanding for 2015 is a. 43.6 days. b. 46.2 days. c. 47.2 days. d. 48.7 days.

Non-Financial and Current Liabilities

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

37. 38. 39. 40.

b d b d

Item

41. 42. 43. 44.

Ans.

b c d c

Item

45. 46. 47. 48.

Ans.

b b c b

Item

49. 50. 51. 52.

Ans.

d b c a

Item

53. 54. 55. 56.

Ans.

a c a b

Item

57. 58. 59. 60.

Ans.

d c d a

DERIVATIONS—Computational No. Answer 37. b 38. d 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55.

b d b c d c b b c b d b c a a c a

56. 57. 58.

b d c

59.

60.

Derivation $80,000 x 6% x 2 ÷ 12 = $800 Interest payable that would have been recorded at Dec 31/14 $278,000 x 7% x 1 ÷ 12 = $1,575. $2,250,000 (no agreement in place at year end) $2,000,000 (no agreement in place at year end) $90,000 x 40% x 1.11 = $39,960 $4,500 x 1.08 = $4,860 To clear GST Recoverable account $23,250 – $21,500 = $1,750 overpaid = Income Taxes Receivable ($240,000 × 4.95%) + ($240,000 × 1.83% × 1.4) = $18,028.80 $12.90 × 8 × 10 × 35 = $36,120 ($14.25 × 8 × 10 × 35) + ($13.50 × 8 × 2 × 35) = $47,460 $100,000 – (100,000 x (.0495 + .0183 + .05)) – $20,000 – $800 = $67,420 20 N 6 I 5000000 FV CPT PV => $1,559,000 $1,559,000 x 6% = $93,540 Remove 70% of revenue and transfer to liability Debit is to the liability account, not the expense acct $500,000 x 2% x 40% = $4,000 – $3,700 costs = $300 [$450,000 + $600,000 × .07] – $15,000 – $30,000 = $28,500 ($360,000 × .5) – $150,000 = $30,000 8000 + $150,000 + $122,000 $900,000 and $600,000 $0, gain contingencies are not accrued ————————————— = 2.80 $100,000 7,500 + 10,000 + 13,300. = 2.20 14,000 (10,000 + 9,000) ÷ 2 = 43.6 days 79,600 ÷ 365

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 61. Which of the following is generally associated with current liabilities classified as accounts payable? Periodic Payment Secured of Interest by Collateral a. No No b. No Yes c. Yes No d. Yes Yes 62. Included in Harrison Inc.’s account balances at December 31, 2014, were the following: 4% note payable issued October 1, 2014, maturing September 30, 2015 $250,000 6% note payable issued April 1, 2014, payable in six equal annual instalments of $100,000 beginning April 1, 2015 600,000 Harrison’s December 31, 2014 financial statements were to be issued on March 31, 2015. On January 15, 2015, the entire $600,000 balance of the 6% note was refinanced by issuance of a long-term note to be repaid in 2015. In addition, on March 10, 2015, Harrison made arrangements to refinance the 4% note on a long-term basis. Under IFRS, on the December 31, 2014 statement of financial position, the amount of the notes payable that Harrison should classify as current liabilities is a. $0. b. $100,000. c. $250,000. d. $350,000.

63. On September 1, 2014, Coffee Ltd. issued a $1,800,000, 12% note to Humungous Bank, payable in three equal annual principal payments of $600,000. On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2015. At December 31, 2015, Coffee should record accrued interest payable of a. $72,000. b. $66,000. c. $48,000. d. $44,000.

64. Jordan Corp. operates in Ontario, selling a variety of goods. For most of these goods, Jordan must charge 13% HST, for some they only have to charge 5% HST; while a very few are tax exempt. During June of this year, the company reported sales of $200,000, on which 70% were charged 13% HST, 25% were charged only 5% HST, and the rest were tax exempt sales. The total amount of HST collected in June was a. $10,000. b. $18,200. c. $20,700. d. $26,000.

Non-Financial and Current Liabilities

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65. Browning Company's salaried employees are paid biweekly. Information relating to salaries for the calendar year 2014 is as follows: Accrued salaries payable ......................... 91,000 Salaries expense for 2014 ........................ 910,000 Salaries paid during 2014 (gross) ............. 875,000 At December 31, 2014, what amount should Browning report for accrued salaries payable? a. $126,000 b. $120,000 c. $91,000 d. $35,000

66. Willow Corp.'s payroll for the period ended October 31, 2014 is summarized as follows: Amount of Wages Subject Department Total Income Tax to Payroll Taxes Payroll Wages Withheld CPP/QPP EI Factory $ 75,000 $10,000 $66,000 $22,000 Sales 22,000 3,000 16,000 2,000 Office 18,000 2,000 8,000 — $115,000 $15,000 $90,000 $24,000 Assume the following payroll tax rates: CPP/QPP for employer and employee 4.95% each Employment Insurance 1.83% for employee 1.4 times employee premium for employer To the nearest dollar, what amount should Willow accrue as its share of payroll taxes in its October 31, 2014 statement of financial position? a. $ 4,894 b. $ 5,070 c. $ 6,102 d. $20,070

67. On April 30, 2014, Canuck Oil Corp. purchased an oil tanker depot for $1,200,000 cash. The company expects to operate this depot for eight years, at which time they will be legally required to dismantle the structure and remove the underground storage tanks. Canuck Oil estimates this asset retirement obligation (ARO) will cost $200,000. Assuming a 5% discount rate, to the nearest dollar, the amount to be recorded as the ARO is a. $ 25,000. b. $135,368. c. $150,000. d. $295,491.

68. On January 1, 2014, Wick Ltd. leased a building to Candle Corp. for a ten-year term at an annual rental of $90,000. At the inception of the lease, Wick received $360,000 covering the first two years rent of $180,000 and a security deposit of $180,000. This deposit will NOT be returned to Candle upon expiration of the lease but will be applied to payment of rent for the last two years of the lease. What portion of the $360,000 should be shown as a current and longterm liability, respectively, in Wick's December 31, 2014 statement of financial position? Current Liability Long-term Liability

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a. b. c. d.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

$ 0 $ 90,000 $180,000 $180,000

$360,000 $180,000 $180,000 $ 90,000

69. Woodwards Store sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to unearned service contract revenues. This account had a balance of $600,000 at December 31, 2013 before year-end adjustment. Service contract costs are charged as incurred to the service contract expense account, which had a balance of $150,000 at December 31, 2013. Outstanding service contracts at December 31, 2013 expire as follows: During 2014 During 2015 During 2016 $125,000 $200,000 $90,000 What amount should be reported as unearned service contract revenues in Woodwards’ December 31, 2013 statement of financial position? a. $450,000 b. $415,000 c. $300,000 d. $275,000

70. Jackpine Trading Stamp Co. records trading stamp revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Jackpine's past experience indicates that only 75% of the stamps sold to licensees will be redeemed. Jackpine's liability for stamp redemptions was $3,000,000 at December 31, 2014. Additional information for 2014 is as follows: Stamp revenue from stamps sold to licensees ..................... $2,000,000 Cost of redemptions ............................................................. 1,350,000 If all the stamps sold in 2014 were presented for redemption in 2015, the redemption cost would be $1,000,000. What amount should Jackpine report as a liability for stamp redemptions at December 31, 2014? a. $3,750,000 b. $2,650,000 c. $2,400,000 d. $1,650,000

71. Harriet Ltd. has a likely loss that can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. Under ASPE, the loss accrual should be a. zero. b. the maximum of the range. c. the mean of the range. d. the minimum of the range.

Non-Financial and Current Liabilities

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MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

61. 62.

a d

Item

63. 64.

Ans.

c c

Item

65. 66.

Ans.

a b

Item

67. 68.

Ans.

b b

Item

69. 70.

Ans.

Item

Ans.

b c

71.

DERIVATIONS—CPA Adapted No. Answer 61. a 62. 63. 64. 65. 66. 67. 68. 69. 70.

d c c a b b b b c

71.

Derivation Conceptual—accounts payable generally are zero-interest-bearing and unsecured. 250,000 + 100,000 = $350,000 ($1,800,000 – $600,000) × .12 × 4 ÷ 12 = $48,000 ($200,000 x 13% x 70%) + ($200,000 x 5% x 25%) = $20,700 $910,000 + $91,000 – $875,000 = $126,000 ($90,000 × .0495) + ($24,000 × .0183 × 1.4) = $5,070 8 N 5 I/Y 200000 FV CPT PV => $135,368 $90,000 (50% to be earned in 2015) and $180,000 (security deposit) $125,000 + $200,000 + $90,000 = $415,000 $3,000,000 + ($2,000,000 × 75%) – $1,350,000 – ($1,000,000 x 75%) = $2,400,000 Conceptual

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 13-72 Notes payable On August 31, 2014, Kamloops Corp. paid the Regal Bank part of an outstanding $300,000 long-term 10% note payable obtained one year earlier (August 31, 2013), by paying $180,000 plus $18,000 interest. In order to do this, Kamloops used $51,211 cash and signed a new oneyear, zero-interest-bearing $160,000 note discounted at 9% by Regal (i.e. the bank issued a note at a discount designed to provide a 9% return over the one year period). Instructions a.

Prepare the entry to record the refinancing.

Prepare the adjusting entry at December 31, 2014 in connection with the new zero-interestbearing note.

Solution 13-72 a.

Notes Payable....................................................................................

180,000

Interest Expense................................................................................

18,000

Notes Payable ($160,000/1.09)................................................

146,789

Cash...........................................................................................

51,211

Interest Expense ($146,789 x 9% x 4 ÷ 12)............................................ Notes Payable.............................................................................

4,403.67 4,403.67

Ex.13-73 Sales taxes For the month of November, Parry Sound Sales Ltd. recorded $280,000 in sales, 40% of which were on account (terms N30), and 60% of which were cash sales. The company is required to charge 6% PST and 5% GST on all sales. Instructions Prepare one journal entry to record the company’s sales for November. Solution 13-73 Accounts Receivable (280,000 x 1.11 x 40%) ............................... Cash (280,000 x 1.11 x 60%) ........................................................

124,320 186,480

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Non-Financial and Current Liabilities

Sales Revenue ....................................................................... GST Payable (280,000 x 5%) ................................................. PST Payable (280,000 x 6%) .................................................

280,000 14,000 16,800

Ex. 13-74 Payroll entries The total payroll of Lyndon Inc. was $230,000. Income taxes withheld were $55,000. The EI rate is 1.83% for the employee and 1.4 times the employee premium for the employer. The CPP/QPP contributions are 4.95% for both the employee and employer. Instructions (Round all values to the nearest dollar, if necessary) a. Prepare the journal entry for the wages and salaries paid. b. Prepare the entry to record the employer payroll taxes. Solution 13-74 a. Wages and Salaries Expense ....................................................... 230,000 Employee Income Tax Deductions Payable ........................... EI Payable ($230,000 x 1.83%) .............................................. CPP/QPP Payable ($230,000 x 4.95%) .................................. Cash....................................................................................... b.

Payroll Tax Expense ..................................................................... EI Payable ($4,209 × 1.4) ....................................................... CPP/QPP Contributions Payable ............................................

55,000 4,209 11,385 159,406

17,278 5,893 11,385

Ex. 13-75 Compensated absences Sycamore Ltd. began operations on January 2, 2014. The company employs 15 people who work 8-hour days. Each employee earns 10 paid vacation days annually. Vacation days may be taken after January 10 of the year following the year in which they are earned. The average hourly wage rate was $12.00 in 2014 and $12.75 in 2015. The average number of vacation days used by each employee in 2015 was 9. Sycamore accrues the cost of compensated absences at rates of pay in effect when earned. Instructions Prepare journal entries to record the transactions related to paid vacation days during 2014 and 2015. Solution 13-75 2014 Wages Expense ............................................................................ Vacation Wages Payable ....................................................... 1 15 × 8 × $12.00 × 10 = $14,400.

2015 Wages Expense ............................................................................ Vacation Wages Payable .............................................................. Cash.......................................................................................

Wages Expense ............................................................................

14,400 14,400

810 12,960 3

13,770

15,300

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Vacation Wages Payable ....................................................... $14,400 ÷ 10 × 9 = $12,960 3 15 × 8 × $12.75 × 9 = $13,770 4 $15 × 8 x $12.75 x 10 = $15,300

15,300

Ex.13-76 Asset Retirement Obligation Tin Mines International Ltd. discovered a new iron ore deposit, the Grouse Mine, and began production on January 1, 2014. The province requires mining companies to return the land to its natural state at the end of mining activity. Tin Mines International estimates that it will operate the mine for 25 years, at which time it will cost $25,000,000 for the land restoration project. Tin Mines International uses an 8% discount rate, and follows ASPE. Instructions a. Record any obligation for land restoration at January 1, 2014. b. Record any entry required related to this obligation at December 31, 2014. Solution 13-76 a. January 1, 2014 Grouse Mine ................................................................................. 3,650,500 Asset Retirement Obligation ................................................... 3,650,500 25 N 8 I 25000000 FV CPT PV => $3,650,500 b.

December 31, 2014 Accretion Expense ........................................................................ Asset Retirement Obligation ...................................................

292,000 292,000

$3,650,500 x 8% = 292,000

Ex. 13-77 Premiums Modern Music gives its customers coupons which are redeemable for a poster plus a Hens and Chicks DVD. One coupon is issued for each dollar of sales. On presentation of 100 coupons and $5.00 cash, the customer receives the poster and DVD. Modern estimates that 80% of the coupons will be presented for redemption. Sales for Year One were $1,050,000, and 510,000 coupons were redeemed. Sales for Year Two were $1,260,000, and 1,275,000 coupons were redeemed. Modern bought 30,000 posters at $2.00 each, and 30,000 DVDs at $5.50 each. Instructions Prepare the following entries for both years, assuming all the coupons expected to be redeemed from Year One were redeemed by the end of Year Two. Entry Year One Year Two —————————————————————————————————————————— a. To record coupons redeemed —————————————————————————————————————————— b. To record estimated liability —————————————————————————————————————————— Solution 13-77

Non-Financial and Current Liabilities

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Entry Year One Year Two —————————————————————————————————————————— a. Estimated Liability for Premiums 8,250 Premium Expense [(510,000 ÷ 100) x ($7.50 – $5)] 12,750 *23,625 Cash (510,000 ÷ 100) × $5 25,500 **63,750 Inventory of Premium Posters and DVDs 38,250 95,625 *[(1,275,000 ÷ 100) x (7.50 – $5)] – 8,250 **(1,275,000 ÷ 100) x $5 ————————————————————————————————————— b. Premium Expense *8,250 1,575 Estimated Liability for Premiums 8,250 1,575 *[(1,050,000 x .80) – 510,000] ÷ 100 × $2.50

Ex. 13-78 Premiums Fido Corp. includes one coupon in each bag of dog food it sells. In return for three coupons, customers receive a dog toy that the company purchases for $1.20 each. Fido's experience indicates that 60% of the coupons will be redeemed. During 2014, 100,000 bags of dog food were sold, 12,000 toys were purchased, and 45,000 coupons were redeemed. During 2015, 120,000 bags of dog food were sold, 16,000 toys were purchased, and 60,000 coupons were redeemed. Instructions Determine the premium expense to be reported in the income statement and the estimated liability for premiums on the statement of financial position for 2014 and 2015. Solution 13-78 Premium expense Estimated liability for premiums (1) (2) (3) (4)

2014 $24,000 (1) 6,000 (2)

2015 $28,800 (3) 10,800 (4)

100,000 × .6 = 60,000; 60,000 ÷ 3 = 20,000; 20,000 × $1.20 = $24,000 45,000 ÷ 3 = 15,000; 20,000 – 15,000 = 5,000; 5,000 × $1.20 = $6,000 120,000 × .6 = 72,000; 72,000 ÷ 3 = 24,000; 24,000 × $1.20 = $28,800 60,000 ÷ 3 = 20,000; 5,000 + 24,000 – 20,000 = 9,000; 9,000 × $1.20 = $10,800

Ex. 13-79 Contingent liabilities Below are three independent situations: 1. In August, 2014, a worker was injured in the factory in an accident partially the result of his own negligence. The worker has sued his employer, Prince Corp., for $500,000. Prince’s legal counsel believes it is possible that the outcome of the suit will be unfavourable and that the settlement would cost the company from $150,000 to $400,000. 2. On October 4, 2014, a lawsuit for breach of contract seeking damages of $2,400,000 was filed by an author against Queen Corp. Queen's legal counsel believes that an unfavourable outcome is more likely than not. A reliable measurement of the award to the plaintiff is between $600,000 and $1,800,000. 3. King Ltd. is involved in a pending court case. King's lawyers believe it is likely that King will be awarded damages of $700,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Instructions Discuss the proper accounting treatment, including any required disclosures, for each situation. Give the rationale for your answers. Assume all companies involved use IFRS. Solution 13-79 1. Prince should disclose, in the notes to the financial statements, the existence of a possible contingent liability related to the law suit. The note should indicate the range of the possible loss. The contingent liability should not be accrued because the loss is only possible, not probable (as required by IFRS). 2. The likely award should be accrued by a debit to an estimated loss account and a credit to an estimated liability using the expected value method. Queen should disclose the following in the notes to the financial statements: the amount of the suit, the nature of the contingency, the reason for the accrual, and the range of the possible loss. The accrual is made because it is more likely than not (probable) that a liability has been incurred and the amount of the loss can be measured reliably. 3. King should not record the gain contingency until it is realized. Usually, gain contingencies are neither accrued nor disclosed. The $700,000 gain contingency should be disclosed only if the likelihood that it will be realized is very high.

Non-Financial and Current Liabilities

13- 33

PROBLEMS Pr 13-80 Common types of current liabilities Define and identify common types of current liabilities and how they are valued. Solution 13-80 Current liabilities are obligations due within one year or the operating cycle where this is longer than one year from the statement of financial position date. The liquidation of a current liability is reasonably expected to require the use of current assets or the creation of other current liabilities. Theoretically, liabilities should be measured at the present value of the future outlay of cash required to liquidate them. In practice, current liabilities other than borrowings are usually recorded in accounting records and reported in financial statements at their full maturity value. There are several types of current liabilities, the most common being accounts and notes payable, sales taxes payable, and payroll related obligations.

Pr. 13-81 Accounts and Notes Payable Below are selected transactions of Blackbird Ltd. for 2014: 1. On May 10, the company purchased goods from Jay Corp. for $60,000, terms 2/10, n/30. Purchases and accounts payable are recorded at net amounts. The invoice was paid on May 18. 2. On June 1, the company purchased equipment for $180,000 from Seagull Ltd., paying $60,000 in cash and giving a one-year, 8% note for the balance. 3. On September 30, the company borrowed $162,000 from the Second National Bank by signing a one year, zero-interest-bearing note for $180,000. The bank’s discount rate was 10%. Instructions a. Prepare the journal entries necessary to record the transactions above using appropriate dates. b. Prepare the adjusting entries necessary at December 31, 2014 in order to properly report interest expense related to the above transactions. c. Indicate the manner in which the above transactions should be reflected in the Current Liabilities section of Blackbird's December 31, 2014 statement of financial position. Solution 13-81 a. May 10, 2014 Purchases/Inventory ($60,000 x 98%)........................................... Accounts Payable................................................................... May 18, 2014 Accounts Payable ......................................................................... Cash....................................................................................... June 1, 2014 Equipment ..................................................................................... Cash....................................................................................... Notes Payable ........................................................................

58,800 58,800

180,000 60,000 120,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

September 30, 2014 Cash ............................................................................................. Notes Payable ........................................................................ b.

162,000 162,000

Interest Expense ........................................................................... Interest Payable ($120,000 × 8% × 7 ÷ 12) ............................

5,600

Interest Expense ........................................................................... Notes Payable ($162,000 x 10% x 3 ÷ 12)..............................

4,050

Current Liabilities Interest payable............................................................................. Note payable—Seagull Ltd. ........................................................... Note payable—Second Provincial Bank (162,000 + 4,050) ...........

5,600

4,050

$ 5,600 120,000 166,050 $291,650

Pr. 13-82 Refinancing of short-term debt At their last year end, December 31, 2014, the liabilities outstanding of Copper Corp. included the following: 1. Cash dividends on common shares, $100,000, payable on January 15, 2015 2. Note payable to Manitoba Bank, $850,000, due January 20, 2015 3. Serial bonds, $2,000,000, of which $500,000 matures during 2015 4. Note payable to Ontario Bank, $200,000, due January 27, 2015 The following transactions occurred early in 2015: January 15: The cash dividends were paid. January 20: The note payable to Manitoba Bank was paid. January 25: Copper entered into a financing agreement with Saskatchewan Bank, enabling it to borrow up to $1,000,000 at any time through the end of 2014. Amounts borrowed under the agreement would bear interest at 1% above the bank's prime rate and would mature 3 years from the date of the loan. The corporation immediately borrowed $800,000 to replace the cash used in paying its January 20 note to Manitoba Bank. January 26: 40,000 common shares were issued for $300,000. $200,000 of the proceeds was used to pay off the note payable to Ontario Bank. February 1: The financial statements for 2014 were issued. Instructions Prepare a partial statement of financial position for Copper Corp., showing the manner in which the above liabilities should be presented at December 31, 2014 under IFRS. The liabilities should be properly classified between current and long-term, and any appropriate note disclosure should be included. Solution 13-82 Current liabilities: Dividends payable on common shares .......................................... $ 100,000 Notes payable—Manitoba Bank .................................................... 850,000 Note payable—Ontario Bank—Note 1 ........................................... 200,000

Non-Financial and Current Liabilities

Currently maturing portion of serial bonds ..................................... Total current liabilities .............................................................

13- 35

500,000 $1,650,000

Long-term debt: Serial bonds not maturing currently ............................................... 1,500,000 Total long-term debt ............................................................... 1,500,000 Total liabilities ...................................................................................... $3,150,000 Note 1: On January 26, 2015, the corporation issued 40,000 common shares and received proceeds totalling $300,000, of which $200,000 was used to liquidate a note payable that matured on January 27, 2015.

Pr. 13-83 Employee related liabilities Identify and account for the major types of employee-related liabilities Solution 13-83 Employee-related liabilities include (1) payroll deductions, (2) compensated absences and (3) bonus agreements. Payroll deductions are amounts withheld from employees along with the employer’s required contributions that have not yet been remitted to the government. Compensated absences earned by employees are company obligations that should be recognized as the employees earn the entitlement to them, provided they can be reasonably measured. Bonuses based on income should be accrued as an expense and liability as the income is earned.

Pr. 13-84 Asset Retirement Obligation Extraction Friendly Ltd. (EFL) specializes in extracting ore. It prides itself for following high environmental standards in the extraction process. On January 1, 2010, EFL purchased the rights to use a parcel of land from the province of New Brunswick. The rights cost $15,000,000 and allowed the company to extract ore for five years, i.e., until Dec 31, 2014. EFL expects to extract the ore evenly over the contract period. At the end of the contract, EFL has one year to clean up and restore the land. EFL estimates this will cost $2,000,000. EFL uses a discounted cash flow method to calculate the fair value of this obligation and believes that 8% is the appropriate discount rate. EFL uses straight-line depreciation method. EFL uses the calendar year as its fiscal year and follows IFRS. As a helpful suggestion, students may want to draw a timeline of events before solving the questions given below. Instructions (Round all values to the nearest dollar.) a. Prepare the journal entries to be recorded on January 1, 2010. b. Prepare the journal entries to be recorded on December 31, 2010. Show the amounts and accounts to be reported on the classified statement of financial position at December 31, 2010. c. Prepare the journal entries to be recorded on December 31, 2014. Show the amounts and accounts reported on the classified statement of financial position at December 31, 2014. d. After 2014, EFL was supposed to clean up and restore the land. Even though the company spent a considerable amount of money on restoration, it was sued by the province of New Brunswick for not following the contract’s requirements. On February 3, 2016, judgment

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

was rendered against EFL for $3,000,000. The company claims that because the language in the contract was misleading regarding the restoration costs, it plans to appeal the judgment and expects the ruling to be reduced to anywhere between $1,000,000 and $2,000,000, with $1,500,000 being the probable amount. EFL has not yet released its 2015 financial statements. Discuss how EFL should report this matter on its financial statements for the year ended December 31, 2015. Solution 13-84 a. To record the purchase of the rights and the ARO: January 1, 2010 Extraction rights ............................................................................ 15,000,000 Cash....................................................................................... 15,000,000 Extraction rights ............................................................................ 1,361,160 Asset retirement obligation ..................................................... 1,361,160 5N 8 I

2000000 FV CPT PV => 1,361,160

To depreciate the extraction rights over 5 years and also record accretion (interest) expense on the obligation. December 31, 2010 Depreciation expense ................................................................... 3,272,232 ((15,000,000+1,361,160) ÷ 5) Accumulated depreciation ...................................................... 3,272,232 Interest expense** ......................................................................... (1,361,160 x 8%) Asset retirement obligation .....................................................

108,893 108,893

** If the company were using ASPE, the debit is to Accretion Expense Statement of financial position amounts: Account Amount Extraction rights net of accumulated depreciation 13,088,928* Asset retirement obligation 1,470,053**

Classification Long-term assets Long-term liabilities

*15,000,000 + 1,361,160 – 3,272,232 = 13,088,928 **1,361,160 + 108,893 = 1,470,053 c. For the depreciation of the extraction rights, the journal entry is the same every year. December 31, 2014 Depreciation expense ................................................................... 3,272,233 Accumulated depreciation ...................................................... 3,272,233 For the accretion (interest) costs, first you need to find the carrying value of the ARO at January 1, 2014 and then to calculate the expense. Since the carrying value at January 1, 2014 is $1,851,851, the interest expense is 1,851,851 x 8% = 148,149. Interest expense............................................................................ Asset retirement obligation .....................................................

148,149 148,149

Non-Financial and Current Liabilities

Statement of financial position amounts: Account Amount Extraction rights net of accumulated depreciation 0 Asset retirement obligation 2,000,000

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Classification

Current liabilities

Since by the end of 2014 the liability is due to be discharged within a year, it should be classified as a current liability. d. This is a somewhat complicated situation. Clearly EFL is expecting a contingent loss of anywhere between $1,500,000 and $3,000,000. However, a $3,000,000 judgment has already been rendered against them, while the reduction in the loss is uncertain. There are two legitimate approaches to this issue. The first approach is to record a loss of $1,500,000 for 2015 (since this amount is deemed probable) and to provide full disclosure in the notes about the ruling and the expected appeal. The second approach is that the firm has incurred a contingent loss of $3,000,000 and expects a contingent gain of $1,500,000. Because losses are recorded immediately and contingent gains are not, then EFL should record a loss of $3,000,000 for 2015 and provide full disclosure on the possible contingent gain.

Pr. 13-85 Premiums Creamy Candy Company offers a coffee mug as a premium for every ten 50-cent candy bar wrappers presented by customers together with $1.00. The purchase price of each mug to the company is 90 cents; in addition it costs 60 cents to mail each mug. The results of the premium plan for the years 2014 and 2015 are as follows (assume all purchases and sales are for cash): 2014 2015 Coffee mugs purchased .............................................................. 480,000 400,000 Candy bars sold .......................................................................... 3,750,000 4,500,000 Wrappers redeemed ................................................................... 1,900,000 2,800,000 2014 wrappers expected to be redeemed in 2015....................... 1,300,000 2015 wrappers expected to be redeemed in 2016....................... 1,800,000 Instructions a. Prepare the general journal entries that should be made in 2014 and 2015 related to the above plan by Creamy Candy. b. Indicate the account names, amounts, and classifications of the items related to the premium plan that would appear on the statement of financial position and income statement at the end of 2014 and 2015. Solution 13-85 a. 2014 Inventory of Premium Mugs (480,000 × $.90 = $432,000) ............. Cash.......................................................................................

432,000 432,000

Cash ............................................................................................. 1,875,000 Sales (3,750,000 × $.50 = $1,875,000) .................................. 1,875,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash [1,900,000 ÷ 10 = 190,000 × ($1.00 – $.60) = $76,000] ....... Premium Expense ......................................................................... Inventory of Premium Mugs (190,000 × $.90 = $171,000) ......

76,000 95,000

Premium Expense (1,300,000 ÷ 10 = 130,000 × $.50 = $65,000).. Estimated Liability for Premiums ............................................

65,000

2015 Inventory of Premium Mugs (400,000 × $.90 = $360,000) ............. Cash.......................................................................................

171,000

65,000

360,000 360,000

Cash ............................................................................................. 2,250,000 Sales (4,500,000 × $.50 = $2,250,000) .................................. 2,250,000

Cash [2,800,000 ÷ 10 = 280,000 × ($1.00 – $.60) = $112,000] ..... Estimated Liability for Premiums ................................................... Premium Expense ......................................................................... Inventory of Premium Mugs (280,000 × $.90 = $252,000) ......

112,000 65,000 75,000

Premium Expense ......................................................................... Estimated Liability for Premiums ............................................ (1,800,000 ÷ 10 = 180,000 × $.50 = $90,000)

90,000

252,000

90,000

Statement of financial position Name Inventory of Premium Mugs Estimated Liability for Premiums

Classification Current Asset Current Liability

2014 $261,000 65,000

2015 $369,000 90,000

Income Statement Name Premium Expense

Classification Operating Expense

2014 160,000

2015 165,000

Pr. 13-86 Warranties Alaska Computer Company sells computers for $2,000 each, which includes a 3-year warranty that requires the company to perform periodic services and to replace defective parts. During 2014, Alaska sold 500 computers on account. Based on past experience, the company has estimated the total 3-year warranty costs at $80 for parts and $100 for labour. (Assume sales all occur at December 31, 2014.) In 2015, Alaska Computer Company incurred actual warranty costs relative to 2014 computer sales of $10,000 for parts and $12,000 for labour. Instructions a. Using the expense warranty approach, prepare the entries to reflect the above transactions (accrual method) for 2014 and 2015. b. Using the cash basis method, what are the Warranty Expense balances for 2014 and 2015? c. The transactions of part a. create what balance under current liabilities in the 2014 statement of financial position?

Non-Financial and Current Liabilities

13- 39

Solution 13-86 a. 2014 Accounts Receivable ..................................................................... 1,000,000 Sales ...................................................................................... 1,000,000 Warranty Expense 500 x ($80 + $100) .......................................... Estimated Liability Under Warranties ...................................... 2015 Estimated Liability Under Warranties............................................. Inventory ................................................................................ Accrued Payroll ......................................................................

90,000 90,000

22,000 10,000 12,000

2014 $0 2015 $20,000

2014 Current Liabilities—Estimated Liability Under Warranties $30,000 (The remainder of the $90,000 liability is a long-term liability.)

Pr. 13-87 Unredeemed coupons During 2014, Red Deer Corp. sold 200,000 tickets for hockey games for $60 each under a new sales promotion program. Each ticket contains one coupon. Any person who presents 2 coupons can receive a ticket to an Edmonton Flames football game for only $2. Red Deer pays $8.00 per football ticket and at the beginning of 2014 had purchased 80,000 tickets (any tickets not used in 2014 can be used in 2015). The company estimates that 60% of the coupons will be redeemed even though only 50,000 coupons had been processed during 2014. Instructions a. What amount should Red Deer report as a liability for unredeemed coupons on December 31, 2014? b. What amount of expense will Red Deer report on its 2014 income statement as a result of the promotional program? c. Prepare any necessary 2014 journal entries related to the promotion program. d. Explain how the accounting treatment for this promotion is treated under IFRS. Solution 13-87 a. The number of coupons expected to be processed is 200,000 x 60% = 120,000. In 2014, 50,000 coupons were processed, so 70,000 more are expected to be processed and accordingly 35,000 tickets to be purchased. The additional net cost per ticket is $6 and therefore the liability for unredeemed coupons at December 31, 2014 should be 35,000 x 6 = $210,000. b.

Promotion expense = (120,000) ÷ 2 x 6 = 360,000.

c. Inventory of Premium Tickets (80,000 x $8) .................................. Cash.......................................................................................

640,000 640,000

Cash (200,000 x $60) .................................................................... 12,000,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Sales ......................................................................................

12,000,000

Estimated Liability for Premiums ................................................... Cash (50,000 ÷ 2 x $2) .................................................................. Inventory of Premium Tickets (50,000 ÷ 2 x $8)......................

150,000 50,000

Premium Expense ......................................................................... Estimated Liability for Premiums ............................................

360,000

200,000

360,000

d. Under IFRS, this promotion would be considered a multiple deliverables arrangement. Red Deer is selling two separate products (the hockey tickets and the football tickets), with the selling price of the hockey tickets inflated to encourage the ticket purchasers to also purchase football tickets. Therefore some of the revenue from the sale of each hockey ticket should be deferred and allocated to the delivery of the football tickets. An estimated amount should be deferred to 2015 when the remaining coupons will be redeemed.

Pr. 13-88 Contingencies You have been hired by Yew Corp. to advise them on how to reflect the events below in their financial statements for the year ended December 31, 2014 under ASPE. Event 1: The Division A employees union has been negotiating a new contract with Yew Corp. The union is requesting a 5% wage increase retroactive for two years. Yew’s management has offered the union a 2% wage increase retroactive for one year. While the negotiations are still ongoing, the company believes that an agreement will soon be reached for a 4% wage increase retroactive for one year, but there is no guarantee that this will be the outcome of the negotiations. Event 2: The Division B employees union is also negotiating a new contract with Yew Corp. However, these negotiations are proving to be very tough. So far there has not been much progress and management is pessimistic about a quick resolution. The company is concerned that during 2015 the Division B employees will decide to go on strike; in fact, Yew considers it very likely. At this point it is difficult to assess the economic consequences of the potential strike. Event 3: Towards the end of 2014, a fire destroyed one of Yew’s plants. The damage is estimated to be $8,000,000 and the company’s insurance policy has maximum coverage of $15,000,000 for this. The deductible on the policy is $300,000. The company is concerned that the insurance premium ($200,000 in 2014) will double in 2015. Instructions For each of the above events, state the accounting treatment you believe is most appropriate. Be specific, and give your rationale. Solution 13-88 Event 1: The event is more likely than not to happen and the cost can be reasonably estimated. Yew Corp. should accrue an additional expense for 2014 based on the most likely outcome of a 4% wage increase retroactive for one year. In the notes to the financial statements, they should provide the range for the potential expense (2-5%, 1-2 years). Event 2: If Yew Corp. considers this to be a contingent liability, note disclosure only would be appropriate, since the event is likely to happen but cannot be reasonably estimated. If they do not, then no disclosure is required.

Non-Financial and Current Liabilities

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Event 3: The $300,000 deductible payment should be accrued in 2014 as a loss from fire. While the premium is likely to increase and can be reasonably measured, the cost relates to future periods and therefore no expense should be accrued for 2014. Full disclosure of the event and of the expected cost increase for next year is appropriate, unless the amount is immaterial. Alternatives the company could consider: 1. Shop around for a better deal on insurance. 2. Avoid the potential premium increase by choosing to self-insure.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 14 LONG-TERM FINANCIAL LIABILITIES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item LO LOD Item LO Multiple Choice–Conceptual 9. 2 M 17. 2 10. 2 M 18. 2 11. 2 M 19. 3 12. 2 M 20. 3 13. 2 E 21. 3 14. 2 E 22. 3 15. 2 M 23. 3 16. 2 M 24. 3 Multiple Choice–Computational 36. 2 M 41. 3 37. 2 M 42. 3 38. 2 H 43. 3 39. 3 H 44. 3 40. 3 H 45. 3 Multiple Choice–CPA Adapted 52. 2 M 55. 3 53. 3 H 56. 3 54. 3 M 57. 3 Exercises 62. 2 M 66. 3 63. 2 M 67. 3 64. 2,3 H 68. 3 65. 2,3 M 69. 3 Problems 74. 2 M 76. 2,3 75. 2 M 77. 2,3

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

1 1 1 1 1 2 2 2

E E E E E E M M

31. 32. 33. 34. 35.

2 2 2 2 2

M M M M M

49. 50. 51.

2 2 2

M M M

58. 59. 60. 61.

1 1,2,6 2 2

E M M M

72. 73.

1,2,4,6 2

H M

Note:

E = Easy

M = Medium

LOD

Item

LOD

H M M M M M H E

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

3 5 6 6 6 6

M E E M M M

M M M M M

46. 47. 48.

3 6 6

M M H

M H M E

70. 71.

3 3

H M

H H

78. 79.

2,3 3

H M

M M H

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Item

Type

1. 2.

MC MC

3. 4.

MC MC

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

MC MC MC MC MC MC MC

13. 14. 15. 16. 17. 18. 31.

MC MC MC MC MC MC MC

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

MC MC MC MC MC MC

25. 39. 40. 41. 42. 43.

MC MC MC MC MC MC

72.

26.

27. 28.

MC MC

Item Type Item Type Learning Objective 1 5. MC 59. Ex 58. Ex 72. Pr Learning Objective 2 32. MC 49. MC 33. MC 50. MC 34. MC 51. MC 35. MC 52. MC 36. MC 59. Ex 37. MC 60. Ex 38. MC 61. Ex Learning Objective 3 44. MC 56. MC 45. MC 57. MC 46. MC 64. Ex 53. MC 65. Ex 54. MC 66. Ex 55. MC 67. Ex Learning Objective 4

Item

Type

Item

Type

62. 63. 64. 65. 72. 73. 74.

Ex Ex Ex Ex Pr Pr Pr

75. 76. 77. 78.

Pr Pr Pr Pr

68. 69. 70. 71. 76. 77.

Ex Ex Ex Ex Pr Pr

78. 79.

Pr Pr

Learning Objective 5

Note:

29. 30.

MC MC

MC = Multiple Choice

Learning Objective 6 47. MC 59. Ex 48. MC 72. Pr Ex = Exercise

Pr = Problem

Long-Term Financial Liabilities

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CHAPTER STUDY OBJECTIVES 1. Understand the nature of long-term debt financing arrangements. Incurring long-term debt is often a formal procedure. Corporation bylaws usually require the approval of the board of directors and the shareholders before bonds can be issued or other long-term debt arrangements can be contracted. Generally, long-term debt has various covenants or restrictions. The covenants and other terms of the agreement between the borrower and the lender are stated in the bond indenture or note agreement. Notes are similar in substance to bonds but do not trade as readily in capital markets, if at all. The variety of types of bonds and notes is a result of attempts to attract capital from different investors and risk takers and to satisfy the issuers’ cash flow needs. External credit rating agencies rate bonds and assign a credit rating based on the riskiness. The credit rating helps investors decide whether to invest in a particular bond. Companies sometimes extinguish debt early using a defeasance arrangement. In a defeasance arrangement, funds are deposited into a trust and the trust continues to make the regularly scheduled payments until maturity. By using debt financing, companies can maximize income through the use of leverage. Capitalintensive industries often have higher levels of debt. Continued access to low-cost debt is important for maximizing shareholder value.

2. Understand how long-term debt is measured and accounted for. The investment community values a bond at the present value of its future cash flows, which consist of interest and principal. The rate that is used to calculate the present value of these cash flows is the interest rate that provides an acceptable return on an investment that matches the issuer’s risk characteristics. The interest rate written in the terms of the bond indenture and ordinarily appearing on the bond certificate is the stated, coupon, or nominal rate. This rate, which is set by the issuer of the bonds, is expressed as a percentage of the bond’s face value, which is also called the par value, principal amount, or maturity value. If the rate used by the buyers differs from the stated rate, the bond’s present value calculated by the buyers will differ from the bond’s face value. The difference between the bond’s face value and the present value is either a discount or a premium. Long-term debt is measured at fair value on initial recognition, including transaction costs where the instruments will subsequently be valued at amortized cost. Subsequently, the instruments are measured at amortized cost or, in certain limited situations, fair value, under the fair value option. The discount (premium) is amortized and charged (credited) to interest expense over the period of time that the bonds are outstanding. IFRS requires the effective interest method; however, ASPE allows a choice and often smaller private entities use the straight-line method. Bonds and notes may be issued with zero interest or for a non-monetary consideration. Measurement of the bonds and the consideration must reflect the underlying substance of the transaction. In particular, reasonable interest rates must be imputed. The fair value of the debt and of the non-monetary consideration should be used to value the transaction.

3. Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings. At the time of reacquisition, the unamortized premium or discount and any costs of issue that apply to the debt must be amortized up to the reacquisition date. The amount that is paid on extinguishment or redemption before maturity, including any call premium and expense of reacquisition, is the reacquisition price. On any

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

specified date, the debt’s net carrying amount is the amount that is payable at maturity, adjusted for unamortized premium or discount and the cost of issuance. Any excess of the net carrying amount over the reacquisition price is a gain from extinguishment, whereas the excess of the reacquisition price over the net carrying amount is a loss from extinguishment. Legal defeasance results in derecognition of the liability. In-substance defeasance does not. Where debt is settled by exchanging the old debt with new debt (generally in troubled debt situations), it is treated as a settlement where the terms of the agreements are substantially different, including a size test, and where the new debt is with a new lender. If not treated as a settlement, it is treated as a modification of the old debt and a new interest rate is imputed. Off–balance sheet financing is an attempt to borrow funds in such a way that the obligations are not recorded. One type of off–balance sheet financing involves the use of certain variable interest entities. Accounting standard setters are studying this area with the objective of coming up with a new definition of what constitutes the reporting entity.

4. Explain how long-term debt is presented on the statement of financial position. Companies that have large amounts and many issues of long-term debt often report only one amount in the SFP and support this with comments and schedules in the accompanying notes. Long-term debt that matures within one year should be reported as a current liability, unless it will be retired without using current assets. If the debt is to be refinanced, converted into shares, or retired from a bond retirement fund, it should continue to be reported as noncurrent and accompanied by a note explaining the method to be used in its liquidation unless certain conditions are met.

5. Identify disclosure requirements. Note disclosures are significant and generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security as well as other details.

6. Calculate and interpret key ratios related to solvency and liquidity. Debt to total assets and times interest earned are two ratios that provide information about debt-paying ability and long-term solvency.

7. Identify major differences in accounting standards between IFRS and ASPE, and what changes are expected in the near future. IFRS and ASPE are largely converged as they relate to long-term debt. Small differences relate to whether the debt is presented as current or noncurrent and in measurement. For example, ASPE has measurement standards for relatedparty transactions. The standard setters are working on several large projects, including the conceptual framework and financial instruments with the characteristics of equity.

Long-Term Financial Liabilities

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MULTIPLE CHOICE—Conceptual Answer a b d b c d b a b d c d b d c b d d a c d b c a d b c a. d b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Description Liability identification Restrictions in restricted covenants Bond vocabulary Bond vocabulary Bond vocabulary Rate of interest earned by bondholders Bond premium and interest rates Interest and discount amortization Effective interest amortization method Impact of effective interest method Bonds issued between interest dates Bonds issued between interest dates Valuation of bonds Bond face value Callable bonds Notes with zero interest or non-monetary consideration Fair value option Note issued for property, goods, or services Debt refunding Modification of terms in troubled debt restructuring Gain/loss on troubled debt restructuring Gain/loss on troubled debt restructuring Creditor's calculations for modification of terms In-substance defeasance Off balance sheet financing Long-term debt disclosures Times interest earned ratio Debt to total assets ratio Times interest earned ratio Debt to total assets ratio

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Answer a b a b c a c a b a c b b b d b d c

No. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48.

Description Calculate the present value of bond principal. Calculate the present value of bond interest. Calculate the issue price of bonds. Interest expense using effective interest method Interest expense using effective interest method Interest on noninterest-bearing note Interest on instalment note payable Calculate balance of note payable. Calculate gain on retirement of bonds. Calculate gain or loss on retirement of bonds. Calculate loss on retirement of bonds. Bond retirement with call premium Calculate loss on retirement of bonds. Transfer of equipment in debt restructure Recognizing gain on debt restructure Interest and troubled debt restructuring Calculate times interest earned ratio. Calculate debt to total assets ratio.

MULTIPLE CHOICE—CPA Adapted Answer c b c b b a b c d

No. 49. 50. 51. 52. 53. 54. 55. 56. 57.

Description Calculate proceeds from bond issue. Calculate balance in bonds payable account. Calculate balance in bonds payable account. Calculate bond interest expense. Calculate loss on retirement of bonds. Calculate loss on retirement of bonds. Calculate gain or loss on retirement of bonds. Calculate gain or loss on retirement of bonds. Classification of gains from troubled debt restructuring

Long-Term Financial Liabilities

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EXERCISES Item E14-58 E14-59 E14-60 E14-61 E14-62 E14-63 E14-64 E14-65 E14-66 E14-67 E14-68 E14-69 E14-70 E14-71

Description Underwriting for bond issues Terms related to long-term debt Amortization of discount or premium Bond issue price and discount amortization Note issued for cash and other rights Note issued for non-cash consideration Entries for bonds payable Sale and subsequent buyback of bonds Retirement of bonds Early extinguishment of debt Accounting for a troubled debt settlement Accounting procedures for bond redemptions Accounting for troubled debt restructuring Accounting for troubled debt

PROBLEMS Item P14-72 P14-73 P14-74 P14-75 P14-76 P14-77 P14-78 P14-79

Description Bond accounting, ratios, debt covenants Bond interest and discount amortization Bond interest and discount amortization Fair value option Entries for bonds payable Entries for bonds payable Accounting for bond issuance and retirement Accounting for a troubled debt settlement

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT generally classified as a long-term liability? a. stock dividends distributable b. pension liabilities c. mortgages payable d. lease liabilities

2. Restrictions included in restricted covenants do NOT generally include a. working capital restrictions. b. limits on executive compensation. c. dividend restrictions. d. limitations on incurring additional debt.

3. A contract representing the covenants and other terms of the agreement between the issuer of bonds and the lender is known as a a. bond debenture. b. long term note payable. c. registered bond. d. bond indenture.

4. The term used for bonds that are backed by collateral is a. convertible bonds. b. debenture bonds. c. secured bonds. d. callable bonds.

5. Bonds frequently used by schools and municipalities that mature in instalments are called a. convertible bonds. b. revenue bonds. c. serial bonds. d. callable bonds.

6. The rate of interest actually earned by bondholders is called the a. stated rate. b. coupon rate. c. dividend rate. d. effective yield or market rate.

7. Mars Corp. issued ten year bonds with a maturity value of $400,000. If the bonds were issued at a premium, this indicates that a. the market rate was higher than the stated rate. b. the stated rate was higher than the market rate.

Long-Term Financial Liabilities

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c. the market and stated rates were the same. d. no relationship exists between the two rates.

8. If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will be a. higher than it would have been had the effective interest method of amortization been used. b. less than it would have been had the effective interest method of amortization been used. c. the same as it would have been had the effective interest method of amortization been used. d. less than the stated rate of interest.

9. Using the effective interest method of bond discount or premium amortization, the periodic interest expense is equal to the a. stated rate multiplied by the face value of the bonds. b. market rate multiplied by the beginning-of-period carrying value of the bonds. c. stated rate multiplied by the beginning-of-period carrying value of the bonds. d. market rate multiplied by the face value of the bonds.

10. When the effective interest method is used to amortize bond premium or discount, the periodic amortization will a. increase if the bonds were issued at a discount. b. decrease if the bonds were issued at a premium. c. increase if the bonds were issued at a premium. d. increase if the bonds were issued at either a discount or a premium.

11. If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a a. debit to Interest Payable. b. credit to Interest Receivable. c. credit to Interest Expense. d. credit to Unearned Interest.

12. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be a. decreased by accrued interest from June 1 to November 1. b. decreased by accrued interest from May 1 to June 1. c. increased by accrued interest from June 1 to November 1. d. increased by accrued interest from May 1 to June 1.

13. How should a long term bond initially be valued? a. at the future value of the future cash flows b. at the present value of the future cash flows c. at the present value of the interest to be paid

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. at the maturity value of the bond 14. A bond’s face value is also called a. the par value or the present value. b. the principal amount or the present value. c. the future value or the maturity value. d. the par value or the maturity value.

15. A ten-year bond was issued in 2014 at a discount with a call provision to retire the bonds. When the bond issuer exercised the call provision on an interest date in 2016, the carrying value of the bond was less than the call price. The amount of bond liability removed from the accounts in 2016 would be the a. call price. b. maturity value. c. carrying value. d. face amount plus unamortized discount.

16. If a long-term note is issued with zero interest or for non-monetary consideration, a. the debtor must first try to value the non-monetary asset(s) involved in the transaction. b. a reasonable interest rate must be imputed. c. the debtor always tries to create a gain with such a transaction. d. the note is a non-monetary liability.

17. When valuing financial instruments at fair value (the fair value option), a. ASPE allows this option only for certain financial instruments. b. IFRS allows this for all financial instruments. c. IFRS requires that this option be used only where fair value does not result in more relevant information. d. IFRS requires that non-performance risk be included in the fair value measurement.

18. When a note payable is issued for property, goods, or services, the present value of the note should preferably be measured by a. the present value of the property, goods or services. b. the fair value of the property, goods, or services. c. the fair value of the debt instrument. d. the present value of the debt instrument.

19. If a debt refunding is viewed as a modification or renegotiation, then a. a new effective interest rate is calculated. b. a gain or loss is recorded. c. there is no change in the accounting for the debt. d. the old debt is derecognized.

20. In a troubled debt restructuring in which the debt is continued with modified terms and the

Long-Term Financial Liabilities

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carrying amount of the debt is less than the total future cash flows, a. an extraordinary gain should be recognized by the debtor. b. a gain should be recognized by the debtor. c. a new effective interest rate must be calculated. d. no interest expense or revenue should be recognized in the future.

21. A troubled debt restructuring will generally result in a a. loss by the debtor and a gain by the creditor. b. loss by both the debtor and the creditor. c. gain by both the debtor and the creditor. d. gain by the debtor and a loss by the creditor.

22. In a troubled debt restructuring in which the debt is settled by a transfer of assets with a fair market value less the carrying amount of the debt, the debtor would a. not recognize a gain or loss on the settlement. b. recognize a gain on the settlement. c. recognize a loss on the settlement. d. only record a memo in the general ledger.

23. In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should a. calculate a new effective interest rate. b. not recognize a loss. c. calculate its loss using the historical effective rate of the loan. d. calculate its loss using the current effective rate of the loan.

24. When the debtor sets aside money in a trust such that the investment and any return will be sufficient to pay the principal and the interest to the creditor, but the creditor does NOT release the company from the primary obligation to settle the debt, this type of arrangement is known as a. in-substance defeasance. b. in-substance refunding. c. substantive repayment. d. legal defeasance. 25. Which of the following arrangements would NOT represent a possible example of “offbalance-sheet financing”? a. non-consolidated subsidiaries b. variable interest entities c. operating leases d. capital or financing leases

26. Note disclosures for long-term debt generally include all of the following EXCEPT a. assets pledged as security. b. names of specific creditors. c. restrictions imposed by creditors.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. call provisions and conversion privileges.

27. The times interest earned ratio is calculated by dividing a. net income by interest expense. b. income before taxes by interest expense. c. income before income taxes and interest expense by interest expense. d. net income and interest expense by interest expense.

28. The debt to total assets ratio is calculated by dividing a. total liabilities by total assets. b. long-term liabilities by total assets. c. current liabilities by total assets. d. total assets by total liabilities.

29. The times interest earned ratio measures a. the amount of interest expense related to long term debt. b. the percentage of total assets financed by creditors. c. the profitability of an enterprise. d. an enterprise’s ability to meet interest payments as they come due.

30. The debt to total assets earned ratio measures a. the amount of debt related to interest expense. b. the percentage of total assets financed by creditors. c. the likelihood an enterprise will default on its obligations. d. the profitability of an enterprise.

Long-Term Financial Liabilities

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MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

a b d b c

6. 7. 8. 9. 10.

d b a b d

11. 12. 13. 14. 15.

c d b d c

16. 17. 18. 19. 20.

b d d a c

21. 22. 23. 24. 25.

d b c a d

26. 27. 28. 29. 30.

b c a d b

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Use the following information for questions 31–33. On January 1, 2014, Satin Corp. issued eight-year 6% bonds with a face value of $500,000, with interest payable semi-annually on June 30 and December 31. The bonds were sold to yield 8%. Table values are: Present value of 1 for 8 periods at 6% .627 Present value of 1 for 8 periods at 8% .540 Present value of 1 for 16 periods at 3% .623 Present value of 1 for 16 periods at 4% .534 Present value of annuity for 8 periods at 6% 6.210 Present value of annuity for 8 periods at 8% 5.747 Present value of annuity for 16 periods at 3% 12.561 Present value of annuity for 16 periods at 4% 11.652

31. The present value of the principal is a. $267,000. b. $270,000. c. $311,500. d. $313,500.

32. The present value of the interest is a. $172,410. b. $174,780. c. $186,300. d. $188,415.

33. The issue price of the bonds is a. $441,780. b. $442,410. c. $444,780. d. $499,800.

34. On January 1, 2014, Lace Ltd. sold five year, 12% bonds with a face value of $500,000. Interest will be paid semi-annually on June 30 and December 31. The bonds were sold for $538,500 to yield 10%. Using the effective interest method of amortization of bond discount or premium, interest expense for 2014 is a. $50,000. b. $53,696. c. $53,850. d. $60,000.

35. On January 2, 2014, Muslin Ltd. sold five year, 8% bonds with a face value of $900,000.

Long-Term Financial Liabilities

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Interest will be paid semi-annually on June 30 and December 31. The bonds were sold for $830,400 to yield 10%. Using the effective interest method of amortization of bond discount or premium, interest expense for 2014 is a. $72,000. b. $83,040. c. $83,316. d. $90,000.

36. On January 1, 2014, Susan Hong lent $60,104 to Ben Bachu. A zero-interest-bearing note (face amount, $80,000) was exchanged solely for cash; no other rights or privileges were exchanged. The note is to be repaid on December 31, 2016. The market rate of interest for a loan of this type is 10%. To the nearest dollar, and using the effective interest method, how much interest revenue should Ms. Hong recognize in 2014? a. $ 6,010 b. $ 8,000 c. $18,030 d. $24,000

37. On January 1, 2014, Alvin Corp. sold property to Marvin Ltd., for which Alvin had originally paid $570,000. There was no established exchange price for this property. Marvin gave Alvin a $900,000, zero-interest-bearing note, payable in three equal annual instalments of $300,000, with the first payment due December 31, 2014. The note also has no ready market. The market rate of interest for a note of this type is 10%. The present value of a $900,000 note payable in three equal annual instalments of $300,000 at 10% is $746,056. To the nearest dollar, and using the effective interest method, how much interest revenue should Alvin recognize in 2014? a. $ 0 b. $30,000 c. $74,606 d. $90,000

38. On January 1, 2014, Queen Ltd. sold property to King Company. There was no established exchange price for the property, and King gave Queen a $3,000,000, zero-interest-bearing note payable in five equal annual instalments of $600,000, with the first payment due December 31, 2014. The market rate of interest for a note of this type is 9%. The present value of the note at 9% was $2,333,791 at January 1, 2014. What should be the balance of the Note Payable to Queen Ltd. account on King’s December 31, 2014 adjusted trial balance, assuming that the note is recorded at net and the effective interest method is used? (round to the nearest dollar, if necessary) a. $1,943,832 b. $2,333,791 c. $2,400,000 d. $3,000,000

39. The December 31, 2014, statement of financial position of Cotton Corporation includes the following: 9% bonds payable due December 31, 2023 $718,900 The bonds have a face value of $700,000, and were issued on December 31, 2013, at 103, with

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

interest payable on July 1 and December 31 of each year. Cotton uses straight-line amortization to amortize bond premium or discount. On March 1, 2015, Cotton retired $280,000 of these bonds at 98 plus accrued interest. Ignoring income taxes, what should Cotton record as a gain on retirement of these bonds? a. $ 7,560 b. $13,020 c. $13,160 d. $14,000

40. On January 1, 2014, Linen Corp. issued $450,000 (face value), 10%, ten-year bonds at 103. The bonds are callable at 105. Linen has recorded amortization of the bond premium by the straight-line method. On December 31, 2020, Linen repurchased $100,000 of the bonds in the open market at 96. Bond interest expense and premium amortization have been recorded for 2020. Ignoring income taxes, what is the loss or gain arising from this reacquisition? a. a gain of $4,900 b. a loss of $4,900 c. a gain of $6,100 d. a loss of $6,100

41. At December 31, 2014, the 10% bonds payable of Paisley Inc. had a carrying value of $760,000. The bonds, which had a face value of $800,000, were issued at a discount to yield 12%. The amortization of the bond discount had been recorded using the effective interest method. Interest was being paid on January 1 and July 1 of each year. The July 1, 2015 interest payment and discount amortization had been correctly recorded. On July 2, 2015, Paisley retired the bonds at 102. Ignoring income taxes, what is the loss that should be recorded on the early retirement of the bonds? a. $16,000 b. $44,800 c. $50,400 d. $56,000

42. Suede Corp. called an outstanding bond obligation four years before maturity. At that time there was an unamortized discount of $150,000. To extinguish this debt, Suede had to pay a call premium of $75,000. Ignoring income tax considerations, how should these amounts be treated for accounting purposes? a. Amortize $225,000 over four years. b. Record a $225,000 loss in the year of extinguishment. c. Record a $75,000 loss in the year of extinguishment and amortize $150,000 over four years. d. Either amortize $225,000 over four years or record a $225,000 loss immediately, whichever management selects.

43. At December 31, 2014, the 12% bonds payable of Leather Corp. had a carrying value of $312,000. The bonds, which had a face value of $300,000, were issued at a premium to yield 10%. Leather uses the effective interest method of amortization of bond premium. Interest is paid on June 30 and December 31. On June 30, 2015, Leather retired the bonds at 104 plus

Long-Term Financial Liabilities

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accrued interest. The loss on retirement, ignoring taxes, is a. $ 0. b. $ 2,400. c. $ 3,720. d. $12,000.

Use the following information for questions 44–46. On December 31, 2014, Diaz Corp. is in financial difficulty and cannot pay a $900,000 note with $90,000 accrued interest payable to Cameron Ltd., which is now due. Cameron agrees to accept from Diaz equipment that has a fair value of $435,000, an original cost of $720,000, and accumulated depreciation of $345,000. Cameron also forgives the accrued interest, extends the maturity date to December 31, 2017, reduces the face amount of the note to $375,000, and reduces the interest rate to 6%, with interest payable at the end of each year.

44. Diaz should recognize a gain or loss on the transfer of the equipment of a. $0. b. $60,000 gain. c. $90,000 gain. d. $285,000 loss.

45. Diaz should recognize a gain on the partial settlement and restructure of the debt of a. $0. b. $22,500. c. $112,500. d. $180,000.

46. Diaz should record interest expense for 2017 of a. $0. b. $22,500. c. $45,000. d. $67,500. 47. Continental Company’s 2014 financial statements contain the following selected data: Income tax expense $80,000 Interest expense 20,000 Net income 160,000 Continental’s times interest earned for 2014 is a. 8 times. b. 11 times. c. 12 times. d. 13 times.

48. Granger Ltd. reported the following information on their most recent statement of financial position:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Current assets $200,000 Total assets 797,000 Current liabilities 160,000 Total equity 350,000 To the nearest percent, what is Granger’s debt to total assets? a. 20% b. 44% c. 56% d. 80%

14- 19

Long-Term Financial Liabilities

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

31. 32. 33.

a b a

34. 35. 36.

b c a

37. 38. 39.

c a b

40. 41. 42.

a c b

43. 44. 45.

b b d

46. 47. 48.

b d c

DERIVATIONS—Computational No. Answer 31. a 32. b 33. a 34. b

35.

36. 37. 38.

a c a

39.

40.

41.

42. 43.

b b

44. 45. 46. 47.

b d b d

Derivation $500,000 × .534 = $267,000 ($500,000 × .03) × 11.652 = $174,780 $267,000 + $174,780 = $441,780 Interest June 30 $538,500 x .05 = $26,925 Amortization of premium $30,000 – $26,925 = $3,075 CV is now $538,500 – $3,075 = $535,425 Interest Dec 31 $535,425 × .05 = $26,771 Total interest for 2014 $53,696 Interest June 30 $830,400 × .05 = $41,520 Amortization of discount $41,520 - $36,000 = $5,520 CV is now $830,400 + $5,520 = $835,920 Interest Dec 31 $835,920 × .05 = 41,796 Total interest for 2014 $83,316 $60,104 × .10 = $6,010 $746,056 × .10 = $74,606 Interest portion of Dec 31 pmt = $2,333,791 x 9% = $210,041; therefore principal reduction is $600,000 – $210,041 = $389,959, and carrying value of note is $2,333,791 – $389,959 = $1,943,832.   $18,900 2    × .4 = $287,420 (CV of retired bonds) $718,900 −  6   18  $287,420 – ($280,000 × .98) = $13,020 [($450,000 x 1.03) – ($13,500 × 7/10)] x 100/450 = $100,900 (CV of retired bonds) $100,900 – ($100,000 × .96) = $4,900 gain ($760,000 × 1.06) – ($800,000 × .05) = $765,600 (CV of bonds) $765,600 – ($800,000 × 1.02) = $50,400 $150,000 + $75,000 = $225,000 loss ($312,000 – [($300,000 x .06) – ($312,000 × .05)] = $309,600 (CV of bonds) ($300,000 × 1.04) – $309,600 = $2,400 $435,000 – ($720,000 – $345,000) = $60,000 ($900,000 + $90,000) – ($435,000 + $375,000) = $180,000 $375,000 × .06 = $22,500 ($160,000 + $80,000 + $20,000) ÷ $20,000 = 13 times

14- 20

48.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Total liabilities = $797,000 – $350,000 = $447,000 Debt to total assets = $447,000 ÷ $797,000 x 100 = 56%

Long-Term Financial Liabilities

14- 21

MULTIPLE CHOICE—CPA Adapted 49. On July 1, 2014, Salmon Corp. issued $600,000, 8% bonds at 99 plus accrued interest. The bonds are dated April 1, 2014 and mature on April 1, 2024. Interest is payable semi-annually on April 1 and October 1. How much did Salmon receive from the bond issuance? a. $594,000 b. $600,000 c. $606,000 d. $618,000

50. On January 1, 2014, Varden Ltd. issued $4,000,000, 10% bonds, which mature on January 1, 2024. The bonds were issued for $4,540,000 to yield 8%. Varden uses the effective interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2014, the adjusted balance in the Bonds Payable account should be a. $4,540,000. b. $4,503,200. c. $4,486,000. d. $4,000,000.

51. On July 1, 2014, Pike Inc. issued $500,000, 9% bonds, which mature on July 1, 2024. The bonds were issued for $469,500 to yield 10%. Pike uses the effective interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2016, the adjusted balance in the Bonds Payable account should be a. $500,000. b. $493,900. c. $473,595. d. $471,450.

52. On January 1, 2014, Trout Corp. sold $500,000, 10% bonds for $442,648 to yield 12%. Interest is payable semi-annually on January 1 and July 1. Trout uses the effective interest method of amortizing bond discount. What amount should Trout report as interest expense for the six months ended June 30, 2014? a. $30,000 b. $26,559 c. $25,000 d. $22,133

53. On January 1, 2014, Bass Inc. redeemed its 15-year, $900,000 par value bonds at 102. They were originally issued on January 1, 2002 at 98 with a maturity date of January 1, 2017. Bass amortizes bond discounts and premiums using the straight-line method. Ignoring income taxes, what amount of loss should Bass recognize on the redemption of these bonds? a. $32,400 b. $21,600 c. $18,000 d. $14,400

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

54. On its December 31, 2014 statement of financial position, Codfish Ltd. reported bonds payable of $1,000,000. The bonds had been issued at par. On January 2, 2015, Codfish retired one half of the outstanding bonds at 103 plus a call premium of $35,000. Ignoring income taxes, what amount should Codfish report on its 2015 income statement as loss on extinguishment of debt? a. $50,000 b. $35,000 c. $15,000 d. $0

55. On January 1, 2014, Halibut Corp. issued $1,000,000, 10% bonds for $1,040,000. These bonds were to mature on January 1, 2024 but were callable at 101 any time after December 31, 2014. Interest was payable semi-annually on July 1 and January 1. On July 1, 2019, Halibut called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Ignoring income taxes, Halibut's gain or loss in 2019 on this early extinguishment of debt was a. $8,000 loss. b. $8,000 gain. c. $10,000 loss. d. $12,000 gain.

56. On July 1, 2014, Tilapia Corp. had outstanding 8%, $1,000,000, 15-year bonds maturing on June 30, 2024. Interest is payable semi-annually on June 30 and December 31. Assume all appropriate entries had been prepared and posted at June 30, 2014. The carrying value of the bond at June 30, 2014 was $965,000. At this time, Tilapia purchased all the bonds at 94 and retired them. What is the gain or loss on this early extinguishment of debt? a. $60,000 gain b. $35,000 loss c. $25,000 gain d. $25,000 loss

57. Pineapple owes Dole a $600,000, 12%, three-year note dated December 31, 2012. Pineapple has been experiencing financial difficulties, and still owes accrued interest of $72,000 on this note at December 31, 2014. Under a troubled debt restructuring, on December 31, 2014, Dole agrees to settle the note plus the accrued interest for land that Pineapple owns, which has a fair value of $540,000. Pineapple's original cost of the land is $435,000. Ignoring income taxes, on its 2014 income statement, what should Pineapple report as a result of the troubled debt restructuring? Gain on Gain on Disposition of Land Restructuring of Debt a. $237,000 $0 b. $165,000 $0 c. $105,000 $60,000 d. $105,000 $132,000

Long-Term Financial Liabilities

14- 23

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

49. 50.

c b

51. 52.

c b

53. 54.

b a

55. 56.

b c

57.

DERIVATIONS—CPA Adapted No. Answer 49. c 50. b 51.

52. 53. 54. 55. 56. 57.

b b a b c d

Derivation ($600,000 × .99) + ($600,000 × .08 × 3 ÷ 12) = $606,000 Amortization of premium $400,000 – ($4,540,000 × .08)] = $36,800 CV is $4,540,000 – $36,800 = $4,503,200 2014–2015: CV is $469,500 + [($469,500 × .1) – $45,000] = $471,450 2015–2016: CV is $471,450 + [($471,450 x .1) – $45,000) = $473,595 $442,648 × .06 = $26,559 ($900,000 × 1.02) – [ $882,000 + ($18,000 x 12 ÷ 15)] = $21,600 [($500,000 x 1.03) + $35,000)] – [($1,000,000 × ½] = $50,000 [$1,040,000 – ($40,000 x 11/20)] – ($1,000,000 × 1.01) = $8,000 $965,000 – ($1,000,000 x .94 = $25,000 gain $540,000 – $435,000 = $105,000 ($600,000 + $72,000) – $540,000 = $132,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 14-58 Underwriting for bond issues Explain the difference between firm underwriting and best efforts underwriting. Solution 14-58 With firm underwriting, an investment bank or brokerage will underwrite a bond issue by guaranteeing a specified amount to the bond issuer. Thus the broker assumes the risk of selling the bonds for whatever they can get. On the other hand, with best efforts underwriting, the agent (broker) will sell the bond issue for a commission that will be deducted from the sale proceeds.

Ex. 14-59 Terms related to long-term debt Place the letter of the best matching phrase before each term.

a. b. c. d. e. f. g. h. i. j. k. l. m.

1. Debenture

6. Debt to total assets ratio

2. Bearer bonds

7. Term bonds

3. Income bonds

8. Leverage

4. Carrying value

9. Callable bonds

5. Stated rate

10. Market rate

Bonds that mature on a single date. Rate set by party issuing the bonds which appears on the bond indenture. Bonds that pay no interest unless the issuer is profitable. Rate of interest actually earned by the bondholders. Results when bonds are sold below par. The practice of using other peoples’ money to maximize returns to shareholders. Bonds not recorded in the holder’s name; can be easily transferred from one party to another. Give the issuer the right to call in and retire bonds before maturity. Maturity value of bonds less any discount or plus any premium at any given date. Ratio of current assets to current liabilities. Unsecured debt instruments not backed by collateral. Measures the percentage of total assets provided by creditors. Indicates the company’s ability to meet interest payments as they come due.

Solution 14-59 1. k 2.

Long-Term Financial Liabilities

10.

14- 25

Ex. 14-60 Amortization of discount or premium On May 1, 2014, Salinas Industries Ltd. issued $2,000,000, 8% bonds and received cash proceeds of $1,774,526. The bonds pay interest semi-annually on May 1 and November 1. The maturity date on these bonds is November 1, 2026. Salinas uses the effective interest method of amortizing bond discounts and premiums. The bonds were sold to yield an effective interest rate of 10%. Instructions Calculate the total dollar amount of discount or premium amortization during the first year that these bonds were outstanding. Show calculations and round values to the nearest dollar. Solution 14-60 Date May 1/14 Nov 1/14 May 1/15 Total

Interest Expense

$88,726 89,163

Cash Paid

$80,000 80,000

Discount Amortization

$ 8,726 9,163 $17,889

Carrying Value of Bonds $1,774,526 1,783,252 1,792,415

Ex. 14-61 Bond issue price and discount amortization On January 1, 2014, Oxnard Corp. issued ten-year, 10% bonds with a face value of $500,000, with interest payable semi-annually on June 30 and December 31. At the time, the market rate was 12%. Instructions a. Use your calculator to calculate the issue price of the bonds. Round the answer to the nearest dollar. b. Independent of your solution to part a., assume that the issue price was $442,000. Prepare the amortization table for 2014. Round values to the nearest dollar. Solution 14-61 a. N 20 %i 6

FV 500,000 PMT 25000

CPT PV => $442,650

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Date

Cash Paid

Interest Expense

Discount Amortized

Jan 1/14 Jun 30/14 $25,000 Dec 31/14 25,000

$26,520 26,611

$1,520 1,611

Carrying Value of Bonds $442,000 443,520 445,131

Ex. 14-62 Note issued for cash and other rights Rebecca Land Corp. issued a 5-year, zero-interest-bearing note with a $1,000,000 face value to Lindsay Inc. for $1,000,000 cash. Rebecca also gave Lindsay the right to use a parcel of land for equipment storage for 5 years. Interest rates for notes of this type were 8% at the time of issue. Instructions Prepare the journal entries to record the issuance of the note by (1) Rebecca and (2) Lindsay. Use your calculator and round values to the nearest dollar. Solution 14-62 Rebecca Cash ............................................................................................. 1,000,000 Notes Payable ........................................................................ Unearned Revenue (Rent) .....................................................

*680,583 319,417

Lindsay Notes Receivable .......................................................................... Prepaid Rent ................................................................................. Cash.......................................................................................

1,000,000

* N 5 %i 8

1000000 FV

*680,583 319,417

CPT PV => 680,583

Ex. 14-63 Note issued for non-cash consideration On July 1, 2014, Modesto Holdings Ltd. issued a $50,000 face value note due June 30, 2017 with a stated interest rate of 4% to Modern Consultants in return for consulting services provided in 2014. The value of the consulting services is not readily determinable and the note is not readily marketable. On the basis of a credit analysis, a reasonable imputed interest rate would be 12%. Instructions Prepare the journal entry to record the issuance of the note by Modesto. Use your calculator and round values to the nearest dollar. Solution 14-63 Operating (consulting) Expense .................................. Notes Payable ........................................................................ N 3 %i 12

40,393 40,393

FV 50000 PMT 2000 (50,000 x 4%) CPT PV => 40,393

Ex. 14-64 Entries for bonds payable

14- 27

Long-Term Financial Liabilities

Prepare journal entries to record the following transactions related to Chico Ltd.’s long-term bonds: a. On April 1, 2014, Chico issued $600,000, 9% bonds (dated January 1, 2014) for $645,442 including accrued interest. Interest is payable annually on January 1, and the bonds mature on January 1, 2024. b. On July 1, 2016, Chico retired 30% of the bonds at 102 plus accrued interest. Chico uses straight-line amortization. Solution 14-64 a. Cash ............................................................................................. Bonds Payable ....................................................................... Interest Expense ($600,000 × 9% × 3 ÷ 12) ........................... b.

645,442 631,942 13,500

Interest Expense ........................................................................... Bonds Payable ($31,942 × 30% × 6 ÷ 117) ................................... Cash ($600,000 x 30% × 9% × 6 ÷ 12) ...................................

7,609 491

Bonds Payable .............................................................................. Cash ($600,000 x 30% x 1.02) ............................................... Gain on Redemption of Bonds................................................

*187,371

8,100

183,600 3,771

*$180,000 plus unamortized Premium of ($31,942 x 30% x 90 ÷ 117 = $7,371) = $187,371

Ex. 14-65 Sale and subsequent buyback of bonds On July 1, 2014, Davis Corp. issued $800,000 par value, 10%, 10-year bonds, with interest payable semi-annually on January 1 and July 1. The bonds were issued for $908,722. On January 2, 2016, Davis offered to buy back the bonds at 103. Forty percent of the bondholders accepted the offer. Davis uses the effective interest method of amortizing premium or discount. Instructions a. Prepare the journal entry to record the bond issuance. b. Prepare the adjusting entry at December 31, 2014, the end of the fiscal year. c. Prepare the entry for the interest payment on January 1, 2015. d. Prepare the entry to record the retirement of the bonds on January 2, 2016. Round all values to the nearest dollar. Solution 14-65 First you need to solve for the yield, which is 8%. PV 908722 N 20 PMT (40000) CPT %i => 8%

Date Jul 1/14 Jan 1/15 Jul 1/15 Jan 1/16

Interest Payment

Interest Expense

Premium Amortization

40,000 40,000 40,000

36,349 36,203 36,051

3,651 3,797 3,949

Carrying Value 908,722 905,071 901,274 897,325

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash…………………………………………………… ....................... Bonds Payable .......................................................................

908,722

Interest Expense ........................................................................... Bonds Payable .............................................................................. Interest Payable ..................................................................... (Interest expense: $908,722 × 8% × ½ = $36,349)

36,349 3,651

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

40,000

Bonds Payable (897,325 x 40%)……. ........................................... Cash....................................................................................... Gain on Redemption of Bonds................................................

358,930

908,722

40,000

329,600 29,330

Bond retirement price = 800,000 x 1.03 x 40% = 329,600

Ex. 14-66 Retirement of bonds On December 31, 2013, LaBrea Corp.’s statement of financial position included the following: 7.5% bonds payable, due December 31, 2021 $576,000 The bonds have a face value of $600,000, and were issued on December 31, 2011 at 95. Interest is payable semi-annually on June 30 and December 31. LaBrea uses straight-line amortization. On April 1, 2014, LaBrea retired 20% of these bonds at 101 plus accrued interest. Instructions Prepare journal entries to record the retirement. Show calculations and round values to the nearest dollar. Solution 14-66 Interest Expense ........................................................................... Cash ($600,000 × 20% x 7.5% × 3 ÷ 12) ................................ Bonds Payable ($30,000 × 20% × 3 ÷ 120) ............................ Bonds Payable .............................................................................. Loss on Redemption of Bonds ...................................................... Cash.......................................................................................

2,400 2,250 150 *115,350 5,850 121,200

*$120,000 less unamortized discount of ($30,000 x 20% x 93 ÷ 120 = $4,650) = $115,350

Ex. 14-67 Early extinguishment of debt On August 1, 2012, Fresno Inc. sold 8%, five year bonds with a maturity value of $2,000,000 for $1,964,000. Interest on the bonds is payable semi-annually on August 1 and February 1. The bonds are callable at 104 at any time after August 1, 2014. By October 1, 2014, the market rate of interest has declined, and the market price of Fresno's bonds has increased to 102. The company decides to refund the bonds by selling a new 6% bond issue to mature in five years. Fresno begins to reacquire its 8% bonds in the market and is able to purchase $600,000 worth

Long-Term Financial Liabilities

14- 29

at 102. The remainder of the outstanding bonds are acquired by exercising the bond call feature. Instructions Calculate Fresno’s total gain or loss in reacquiring the 8% bonds. Assume the company uses straight-line amortization. Show calculations. Solution 14-67 Reacquisition price: $600,000 × 1.02 = $1,400,000 × 1.04 = Less carrying value: Face value Unamortized discount ($36,000 × 34 ÷ 60) = 20,400 Loss on redemption

$612,000 1,456,000

$2,068,000

2,000,000 1,979,600 $

88,400

Ex. 14-68 Accounting for a troubled debt settlement At December 31, 2014, Oscar Ltd. owes Wilde Corp. for a $300,000 note payable, plus accrued interest of $27,000. Oscar is now in financial difficulty and cannot repay Wilde. To settle the debt, Wilde agrees to accept from Oscar equipment with a fair value of $285,000, an original cost of $420,000, and accumulated depreciation to date of $98,000. Instructions a. Calculate the gain or loss to Oscar on the settlement of the debt. b. Calculate the gain or loss to Oscar on the transfer of the equipment. c. Prepare the journal entry on Oscar's books to record the settlement of the debt. d. Prepare the journal entry on Wilde's books to record the settlement of the receivable. Solution 14-68 a. Note payable Interest payable Carrying value of debt Fair value of equipment Gain on settlement of debt

$300,000 27,000 327,000 285,000 $ 42,000

Cost Accumulated depreciation Book value Fair value of equipment Loss on disposal of equipment

$420,000 98,000 322,000 285,000 $ 37,000

Notes Payable ............................................................................... Interest Payable ............................................................................ Accumulated Depreciation ............................................................ Loss on Disposal of Equipment ..................................................... Equipment .............................................................................. Gain on Settlement of Debt ....................................................

300,000 27,000 98,000 37,000 420,000 42,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Equipment ..................................................................................... Loss on Settlement of Debt ........................................................... Notes Receivable ................................................................... Interest Receivable ................................................................

285,000 42,000 300,000 27,000

Ex. 14-69 Accounting procedures for bond redemptions Describe the accounting procedures for the early redemption of bonds. Solution 14-69 At the time of redemption, any unamortized premium or discount must be amortized up to the reacquisition date. The amount paid on early redemption, including any call premium and expense of reacquisition, is the reacquisition price. Any excess of the carrying value over the reacquisition price is a gain from redemption, while any excess of the reacquisition price over the carrying value is a loss from redemption.

Ex. 14-70 Accounting for a troubled debt restructuring On December 31, 2014, Riverside Inc. is in financial difficulty and cannot pay a $350,000 note (with $35,000 accrued interest payable) to Stockton Corp. Stockton agrees to forgive the accrued interest, extend the maturity date to December 31, 2016, and reduce the interest rate to 4%. The present value of the restructured cash flows is $299,500. Instructions Prepare entries for the following: a. the restructure on Riverside's books b. the payment of interest on December 31, 2015 c. the restructure on Stockton’s books. Solution 14-70 a. Old debt: PV = $350,000 + $35,000 = $385,000 New debt: PV (given) = $299,500 The new debt differs by more than 10%: $85,500 ÷ $385,000 = 22.2% Notes Payable (old)....................................................................... Interest Payable ............................................................................ Notes Payable (new) .............................................................. Gain on Restructuring ............................................................ b.

350,000 35,000 299,500 85,500

Imputed interest rate FV 350000 PV 299500 PMT (14000) ($350,000 x 4%) CPT %i => 12.61% Interest Expense ($299,500 × 12.61%) ......................................... Cash....................................................................................... Notes Payable ........................................................................

37,767

Loss on Restructuring ................................................................... Notes Receivable ................................................................... Interest Receivable.................................................................

85,500

14,000 23,767

50,500 35,000

Long-Term Financial Liabilities

14- 31

Ex. 14-71 Accounting for troubled debt a. What are the general rules for measuring and recognizing gain or loss by the debtor on a settlement of troubled debt, which includes the transfer of noncash assets? b. What are the general rules for measuring and recognizing a gain and for recording future payments by the debtor in a troubled debt restructuring? Solution 14-71 a. If the settlement of debt includes the transfer of noncash assets, a gain is measured by the debtor as the difference between the fair value of the assets transferred and the carrying amount of the debt, including accrued interest. The debtor also recognizes a gain or loss on the disposal of assets as the difference between the fair value of the assets transferred and their book value. b.

If the carrying amount of the payable is greater than the discounted total future cash flows, based on currently prevailing interest rates, the gain is measured as the difference between the carrying amount and the discounted future cash flows. The gain is separately classified in the income statement and the nature of the restructuring is disclosed if the amount of the gain is material. The same treatment is given if a loss results. Future payments are used to reduce the principal and record interest expense.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 14-72 Bond accounting, ratios, debt covenants Superior Equipment Corporation is a public Canadian company manufacturing high-precision equipment. On January 1, 2011, Superior issued a 12%, $10,000,000 bond, maturing in ten years. At January 1, 2014, the bond had a carrying value of $9,300,000. Interest is payable semi-annually on June 30 and December 31. The company uses the straight-line method of amortizing any bond premium or discount. The bond carries covenants that call for the firm’s debt to total assets ratio to be no higher than 50% and their times interest earned ratio to be at least 2. You are the CEO of Superior. You have been on the job for a year after the previous CEO was fired for missing earnings targets. You are a McGill University grad with a major in Accounting. Superior’s business is cyclical and the last two years have been tough. In recent months however, there have been signs of recovery in the industry, and many distributors have placed large orders for Superior’s equipment. Delivery of the equipment is expected in 2015 and 2016. You are under pressure from the Board of Directors to show improvement in the bottom line. It is now November 30, 2014, and you have just met with the company’s CFO, Ms. Grimm. In preparation for the coming year end on December 31, 2014, she has prepared forecasted financial statements, but has not included the effects of the $10,000,000 bond issue. Below is a summary of those statements: Income Statement Sales COGS Gross profit Operating expenses Operating income before interest expense Bond interest expense Income before income tax Income tax (35%) Net income Statement of financial position Current assets Non-current assets Total assets

14,700,000 22,000,000 36,700,000

Current liabilities Bonds payable Shareholders’ equity Total liabilities and equity

9,000,000 ? ? 36,700,000

$ 28,000,000 20,000,000 8,000,000 5,465,000 2,535,000 ? ? ? ?

Additional information:

Long-Term Financial Liabilities

1. 2.

14- 33

Except for the bond, the company did not incur any other interest expense. The last time entries were recorded for the bond was at the end of the third quarter (September 30, 2014), when adjusting entries were prepared.

Instructions a. Prepare the journal entries related to the bond payable for the last quarter of 2014. The entries should reflect the payment of interest and related amortization of the premium or discount. b. Complete the forecasted financial statements for December 31, 2014 by including the effects of the bond payable. c. Using the financial statements from part b., calculate the times interest earned and debt to total assets ratios. d. Given your calculations in part c., is Superior forecasted to be in violation of the debt covenants? If yes, what action(s) would you recommend? Discuss the advantages/disadvantages of each recommendation. Solution 14-72 a. The interest to be paid on December 31, 2014 is $600,000 ($10,000,000 x12% x 6 ÷ 12). Half of this is to be recorded as interest expense for this quarter. Amortization of the premium is $100,000 per year, $25,000 for the fourth quarter. On September 30, 2014, at the end of the third quarter, the following entry would have been posted: Interest expense............................................................................ Bond interest payable ............................................................... Bond payable ...........................................................................

325,000 300,000 25,000

On December 31, 2014, Superior should post the following entry: Interest expense............................................................................ Bond interest payable ................................................................... Cash....................................................................................... Bond payable ......................................................................... b. Income Statement Sales COGS Gross profit Operating expenses Operating income before interest expense Bond interest expense Income before income tax Income tax (35%) Net Income 1 2

325,000 300,000 600,000 25,000

28,000,000 20,000,000 8,000,000 5,465,000 2,535,000 1,300,0001 1,235,000 432,2502 802,750

Interest expense = (10,000,000 x 12%) + 100,000 = 1,300,000 Income tax = 1,235,000 x 35% = 432,250

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Statement of financial position Current assets Non-current assets Total assets

14,100,0003 22,000,000 36,100,000

Current Liabilities Bonds payable Shareholders’ equity Total liabilities and equity

8,700,000 9,400,0004 18,000,000 36,100,000

(plug number)

Interest expense = (10,000,000 x 12%) + 100,000 = 1,300,000 Income tax = 1,235,000 x 35% = 432,250 3 Current assets = 14,700,000 – 600,000 = 14,100,000 4 Bonds payable = carrying value Jan 1/11 + 2014 amortization = 9,300,000 +100,000 = 9,400,000 2

Times Interest Earned = Income before income taxes and interest = 2,535,000 = 1.95 Interest Expense 1,300,000 Debt to Total Assets = Total debt = (8,700,000 + 9,400,000) = 18,100,000 = 0.5014 Total assets 36,100,000 36,100,000

Superior is forecasted to be in violation of the debt covenant. However, the ratios are very close to the minimum requirements. As CEO, you could recommend one of the following: 1. Do nothing and run the risk of a default on the bond, or possibly run the risk of a negative stock-market reaction for being in violation of the covenants. 2. Meet the creditors, present your case of expected economic recovery and ask them to wait one more quarter before acting or to waive the covenants for a short period. 3. Renegotiate with the creditors. The above options might be challenging given the need to convince many creditors and the possible market reaction. 4. If these are callable bonds or they can be purchased on the open market, buy some of them back to extinguish some of the debt, which will also reduce the related interest expense. 5. Sell some operating assets that will yield a gain and use the proceeds to lower debt. For example, using the proceeds to pay your suppliers earlier may improve relations if a potential debt restructuring is to be negotiated. 6. Apply earnings management techniques to increase earnings and total assets. For example, cut back on discretionary expenses such as advertising, repairs & maintenance, promotion, etc. Option 4. might help to avoid the debt to total assets ratio violation, but might be too late to avoid interest expense and the violation of the times Interest earned ratio violation.

Pr. 14-73 Bond interest and discount amortization On June 1, 2014, Santa Ana Corp. sold 10 year, $500,000 (face value) bonds for $438,800. The bonds have a stated interest rate of 8% and a yield of 10%, and pay interest annually on May 31 of each year. The bonds are to be accounted for using the effective interest method.

Long-Term Financial Liabilities

14- 35

Instructions a. Construct a bond amortization table for this bond to indicate the amount of interest expense and discount amortization at each May 31. Include only the first four years. Make sure all columns and rows are properly labelled, and round to the nearest dollar. b. The sales price of $438,800 was determined from present value tables. Explain how one would determine the price using present value tables, or by using a calculator. c. Assuming that interest and discount amortization are recorded each May 31, prepare the adjusting entry at December 31, 2016 (fiscal year end). Round values to the nearest dollar. Solution 14-73 a. Date Cash Paid Jun 1/14 May 31/15 $40,000 May 31/16 40,000 May 31/17 40,000 May 31/18 40,000 b.

Interest Expense

Discount Amortization

$43,880 44,268 44,695 45,164

$3,880 4,268 4,695 5,164

Carrying Amount of Bonds $438,800 442,680 446,948 451,643 456,807

(1) Find the present value of $500,000 due in 10 years at 10%. (2) Find the present value of 10 annual payments of $40,000 at 10%. (3) Add (1) and (2) to obtain the present value of the principal and the interest payments. Calculator: N 10 %I 5 PMT 40000 FV 500000 CPT PV

Interest Expense ........................................................................... Interest Payable ..................................................................... Bonds Payable .......................................................................

*26,072 **23,333 2,739

*7 ÷ 12 × $44,695 (from Table) = $26,072 ** 7 ÷ 12 × 8% × $500,000 = $23,333

Pr. 14-74 Bond interest and discount amortization On October 1, 2014, Irvine Corp. issued $400,000 8% bonds, due on October 1, 2019. Interest is to be paid semi-annually on April 1 and October 1. The bonds were sold to yield 10% effective annual interest. Irvine has a calendar year end. Instructions a. Complete the following amortization schedule for the dates indicated. Round all answers to the nearest dollar. Use the effective interest method.

Cash Paid

Discount Interest Expense

Carrying Amortization

Amount of Bonds $369,112

Oct 1/14 Apr 1/15 Oct 1/15 b. Prepare the adjusting entry required for these bonds at December 31, 2016. c. Calculate the interest expense to be reported in the income statement for the year ended

14- 36

Test Bank for Intermediate Accounting, Tenth Canadian Edition

December 31, 2016. Solution 14-74 a.

Oct 1/14 Apr 1/15 Oct 1/15 b.

Cash Paid

Interest Expense

Discount Amortization

$16,000 16,000

$18,456 18,578

$2,456 2,578

Interest Expense ($374,146 × 10% × 3 ÷ 12) ................................ Interest Payable (1/2 × $16,000) ............................................ Bonds Payable ($9,354 – $8,000) ..........................................

c. $ 9,228 18,578 9,354 $37,160

Carrying Amount of Bonds $369,112 371,568 374,146 9,354 8,000 1,354

(1/2 of $18,456)

Pr. 14-75 Fair value option Explain the fair value option for accounting for long-term debt, including both the ASPE approach and the IFRS requirements. Solution 14-75 Long-term debt is usually accounted for at amortized cost. However, both ASPE and IFRS allow the use of the fair value option, whereby financial instruments are carried at fair (market) value, an option encouraged by standard setters, although the requirements differ. ASPE allows the use of the fair value option for all financial instruments, with all changes in fair value recognized in net income. IFRS explicitly requires that the option be used only where fair value results in more relevant information. As well, IFRS 13 requires that non-performance risk (including credit risk) be included in the fair value measurement. This gives rise to a peculiar situation, since, if the credit risk is deemed to be high, the carrying value of the debt should be reduced (e.g. Dr Bond Payable) and a gain recognized. Any such gain is booked to Other Comprehensive Income.

Pr. 14-76 Entries for bonds payable Prepare the necessary journal entries to record the following transactions relating to the longterm issuance of bonds by Glendale Corp. Show calculations and round to the nearest dollar. March 1 Issued $200,000 (face value) 8% bonds for $218,040, including accrued interest. Interest is payable semi-annually on December 1 and June 1 with the bonds maturing 10 years from the previous December 1. The bonds are callable at 102. June 1 Paid semi-annual interest on the bonds. Use straight-line amortization for any premium or discount. December 1 Paid semi-annual interest on the bonds, and then purchased $100,000 face value bonds at the

Long-Term Financial Liabilities

14- 37

call price in accordance with the provisions of the bond indenture. Solution 14-76 March 1 Cash ............................................................................................. Bonds Payable ....................................................................... Interest Expense ($200,000 × 8% × 3 ÷ 12) ...........................

218,040

June 1 Interest Expense ........................................................................... Bonds Payable ($14,040 × 3 ÷ 117) .............................................. Cash.......................................................................................

7,640 360

December 1 Interest Expense ........................................................................... Bonds Payable ($14,040 × 6/117) ................................................. Cash.......................................................................................

7,280 720

214,040 4,000

8,000

Bonds Payable .............................................................................. *106,480 Gain on Redemption of Bonds................................................ 4,480 Cash....................................................................................... 102,000 *$100,000 plus unamortized Premium ($14,040 x 108/117 x 50% = $6,480) = 106,480

Pr. 14-77 Entries for bonds payable Prepare journal entries to record the following transactions relating to long-term bonds of Lancaster Inc. Show calculations and round to the nearest dollar. a. On June 1, 2014, Lancaster Inc. issued $400,000, 6% bonds for $391,760, including accrued interest. The bonds were dated February 1, 2014, and interest is payable semiannually on February 1 and August 1 with the bonds maturing on February 1, 2024. The bonds are callable at 102. b. On August 1, 2014, Lancaster paid the semi-annual interest and recorded the amortization of the discount or premium, using straight-line amortization. c. On February 1, 2016, Lancaster paid the semi-annual interest and recorded amortization of the discount or premium. d. The company then purchased $240,000 of the bonds at the call price. Assume that a reversing entry was made on January 1, 2016. Solution 14-77 a. Cash ............................................................................................. Bonds Payable ....................................................................... Interest Expense ($400,000 × 6% × 4 ÷ 12) ........................... b.

391,760 383,760 8,000

Interest Expense ($400,000 × 6% × 6 ÷ 12) + $280 ...................... Cash....................................................................................... Bonds Payable ($16,240 × 2 ÷ 116) .......................................

12,280

Interest Expense ($12,000 + $840) ............................................... Cash....................................................................................... Bonds Payable ($16,240 × 6 ÷ 116) .......................................

12,840

12,000 280

12,000 840

14- 38

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Bonds Payable .............................................................................. Loss on Bond Redemption ............................................................ Cash.......................................................................................

*231,936 12,864 244,800

*$240,000 less unamortized Discount ($16,240 x 96 ÷ 116 x 60% = $8,064) = $231,936

Pr. 14-78 Accounting for bond issuance and retirement Twilight Corp. desired to raise cash to fund its expansion by issuing long-term bonds. The corporation hired an investment banker to manage the issue (best efforts underwriting) and also hired the services of a lawyer, an audit firm, etc. On June 1, 2014, Twilight sold $500,000 in long-term bonds. The bonds will mature in 10 years and have a stated interest rate of 8%. Other bonds that Twilight has issued with identical terms are traded based on a market rate of 10%. The bonds pay interest semi-annually on May 31 and November 30. The bonds are to be accounted for using the effective interest method. On June 1, 2016 Twilight decided to retire 20% of the bonds. At that time the bonds were selling at 98. Instructions (Round all values to the nearest dollar) a. Prepare the journal entry for the issuance of the bonds on June 1, 2014. b. What was the interest expense related to these bonds that would be reported on Twilight’s calendar 2014 income statement? c. Prepare all entries from after the issue of the bond till December 31, 2014. d. Calculate the gain or loss on the partial retirement of the bonds on June 1, 2016. e. Prepare the journal entries to record the partial retirement on June 1, 2016. Solution 14-78 PV of bonds (i.e. selling price) CPT PV => $437,689

N 20 %i 5 PMT 20000 (500,000x 4%) FV 500000

a. Cash ............................................................................................. Bonds payable .......................................................................

437,689 437,689

Date Jun 1/14 Nov 30/14 May 31/15 Nov 30/15 May 31/16

Cash

Interest Expense

Discount Amortization

20,000 20,000 20,000 20,000

21,884 21,979 22,078 22,181

1,884 1,979 2,078 2,181

Carrying Value of Bonds 437,689 439,573 441,552 443,630 445,811

Interest expense for 2014 = 21,884 + (1 ÷ 6 x 21,979) = 25,548 c.

14- 39

Long-Term Financial Liabilities

Nov 30/14 Interest expense............................................................................ Cash....................................................................................... Bonds payable ....................................................................... Dec 31/14 Interest expense (1 ÷ 6 x $21,979) ................................................ Interest payable (1 ÷ 6 x $20,000) .......................................... Bonds payable .......................................................................

21,884 20,000 1,884

3,663 3,333 330

d. Per the amortization table in part b., the carrying value of the bond as of May 31, 2016 is $445,811. Cost to repurchase ($500,000 x 20% x.98) .......................................... Bond carrying value ($445,811 x 20%) ................................................ Loss on bond redemption .....................................................................

$98,000 89,162 $ (8,838)

e. Bonds payable .............................................................................. Loss on bond redemption .............................................................. Cash.......................................................................................

89,162 8,838 98,000

Pr. 14-79 Accounting for a troubled debt settlement Santa Ltd., who owes Claus Corp. $600,000 in notes payable, is in financial difficulty. To eliminate the debt, Claus agrees to accept from Santa land having a fair value of $455,000 and a recorded cost of $340,000. Instructions a. Calculate the amount of gain or loss to Santa on the transfer (disposition) of the land. b. Calculate the amount of gain or loss to Santa on the settlement of the debt. c. Prepare the journal entry on Santa's books to record the settlement of the debt. d. Calculate the gain or loss to Claus from settlement of the receivable from Santa. e. Prepare the journal entry on Claus's books to record the settlement of the receivable. Solution 14-79 a. Fair value of land Cost of land to Santa Gain on disposition of land

455,000 340,000 $ 115,000

Carrying amount of debt Fair value of land given Gain on settlement of debt

Note Payable ................................................................................ Land ....................................................................................... Gain on Disposition of Land ................................................... Gain on Settlement of Debt ....................................................

Carrying amount of receivable

$600,000 455,000 $ 145,000 600,000 340,000 115,000 145,000

$600,000

14- 40

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Land received in settlement Loss on settlement of debt e.

455,000 $145,000

Land .............................................................................................. Loss on Settlement of Debt ........................................................... Note Receivable .....................................................................

455,000 145,000 600,000

Long-Term Financial Liabilities

14- 41

CHAPTER 15 SHAREHOLDERS’ EQUITY SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

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

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

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

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

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

106. 107. 108. 109. 110.

2 2 2 2 2

E M M M M

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 16. 2 M 31. 2 17. 2 H 32. 2 18. 2 M 33. 2 19. 2 M 34. 2 20. 2 M 35. 2 21. 2 H 36. 2 22. 2 H 37. 2 23. 2 M 38. 2 24. 2 M 39. 2 25. 2 M 40. 2 26. 2 E 41. 2 27. 2 M 42. 2 28. 2 M 43. 2 29. 2 M 44. 3 30. 2 M 45. 4 Multiple Choice–Computational 71. 2 M 83. 2,3 72. 2 M 84. 5 73. 2 M 85. 5 74. 2 H 86. 5 75. 2 M 87. 5 76. 2 M 88. 5 77. 2 M 89. 5 78. 2 H *90. 7 79. 2 H *91. 7 80. 2 M *92. 7 81. 2 M *93. 7 82. 2 M *94. 7 Multiple Choice–CPA Adapted 111. 2 E 116. 2 112. 2 M 117. 2 113. 2 E 118. 2 114. 2 M 119. 2 115. 2 M *120. 7

M = Medium

LOD

Item

LOD

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

46. 47. 48. 49. 50. *51. *52. *53. *54. *55. *56. *57. *58.

4 5 5 5 5 7 7 7 7 8 8 8 8

M M M M H M M H H M H H H

M M M H H H H M M H H H

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

7 7 7 7 7 7 7 7 8 8 8

M M M H M M M H M M M

M M E M M

*121. *122. *123. *124.

7 7 7 8

M M M M

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item

LOD

Item

125. 126. 127. 128. 129. 130.

2 2 2 2 2 2

M M M M M M

131. 132. 133. 134. 135. 136.

2 2 2 2 2 2

146. 147.

2 2

M M

148. 149.

2 2

Note:

E = Easy

M = Medium

LOD Item LO LOD Exercises M 137. 2 M M 138. 2 M M 139. 2 M M 140. 2,3 M M *141. 3,5,7 H H *142. 7 M Problems M 150. 2 H H 151. 2,3 H

Item

LOD

*143. *144. *145.

7 8 8

H M H

152. *153.

3 7

M M

H = Hard

Shareholders’ Equity

15- 3

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

1. 2.

MC MC

3. 4.

MC MC

11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26.

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

27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42.

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

44.

83.

45.

46.

47. 48.

MC MC

49. 50.

*51. *52. *53. *54. *90.

MC MC MC MC MC

*91. *92. *93. *94. *95.

*55. *56.

MC MC

*57. *58.

Item Type Item Type Learning Objective 1 5. MC 7. MC 6. MC 8. MC Learning Objective 2 43. MC 74. MC 59. MC 75. MC 60. MC 76. MC 61. MC 77. MC 62. MC 78. MC 63. MC 79. MC 64. MC 80. MC 65. MC 81. MC 66. MC 82. MC 67. MC 83. MC 68. MC 106. MC 69. MC 107. MC 70. MC 108. MC 71. MC 109. MC 72. MC 110. MC 73. MC 111. MC Learning Objective 3 140. Ex 141. Ex Learning Objective 4

Learning Objective 5 MC 84. MC 86. MC MC 85. MC 87. MC Learning Objective 7 MC *96. MC *101. MC MC *97. MC *102. MC MC *98. MC *120. MC MC *99. MC *121. MC MC *100. MC *122. MC Learning Objective 8 MC *103. MC *105. MC MC *104. MC *124. MC

MC = Multiple Choice

Ex = Exercise

Item

Type

Item

Type

9. 10.

MC MC

112. 113. 114. 115. 116. 117. 118. 119. 125. 126. 127. 128. 129. 130. 131. 132.

MC MC MC MC MC MC MC MC Ex Ex Ex Ex Ex Ex Ex Ex

133. 134. 135. 136. 137. 138. 139. 140. 146. 147. 148. 149. 150. 151.

Ex Ex Ex Ex Ex Ex Ex Ex Pr Pr Pr Pr Pr Pr

88. 89.

MC MC

141.

*123. *141. *142. *143. *153.

MC Ex Ex Ex Pr

*144. *145.

Ex Ex

Pr = Problem

15- 4

Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER STUDY OBJECTIVES 1. Discuss the characteristics of the corporate form of organization, rights of shareholders, and different types of shares. The three main forms of organization are the proprietorship, partnership, and corporation. Incorporation gives shareholders protection against claims on their personal assets and allows greater access to capital markets. If there are no restrictive provisions, each share carries the following rights: (1) to share proportionately in profits and losses, (2) to share proportionately in management (the right to vote for directors), upon liquidation. An additional right to share proportionately in any new issues of shares of the same class (called the preemptive right) may also be attached to the share. Preferred shares are a special class of share that possess certain preferences or features that common shares do not have. Most often, these features are a preference over dividends and a preference over assets in the event of liquidation. Many other preferences may be attached to specific shares. Preferred shareholders give up some or all of the rights normally attached to common shares.

2. Explain how to account for the issuance, reacquisition, and retirement of shares, stock splits, and dividend distribution. Shares are recognized and measured at net cost when issued. Shares may be issued on a subscription basis, in which case they are not considered legally issued until they are paid up. Shares may also be issued as a bundle with other securities, in which case the cost must be allocated between the securities. The residual or relative fair value methods (sometimes referred to as the incremental or proportional methods) may be used to allocate the cost. If the reacquisition cost of the shares is greater than the original cost, the acquisition cost is allocated to share capital, then contributed surplus, and then retained earnings. If the cost is less, the cost is allocated to share capital (to stated or assigned cost) and to contributed surplus. Dividends paid to shareholders are affected by the dividend preferences of the preferred shares. Preferred shares can be cumulative or non-cumulative, and fully participating, partially participating, or non-participating. A stock dividend is a capitalization of retained earnings that generally results in a reduction in retained earnings and a corresponding increase in certain contributed capital accounts. The total shareholders’ equity remains unchanged with a stock dividend. A stock split results in an increase or decrease in the number of shares outstanding. However, no accounting entry is required. 3. Understand the components of shareholders’ equity and how they are presented. Contributed surplus is additional surplus coming from shareholder transactions. Accumulated other comprehensive income is accumulated non-shareholder income that has not been booked through net income. ASPE does not discuss this concept. The shareholders’ equity section of a balance sheet includes Share Capital, Contributed Surplus, Retained Earnings, and Accumulated Other Comprehensive Income. A statement of changes in shareholders’ equity is required under IFRS.

Shareholders’ Equity

15- 5

4. Understand capital disclosure requirements. Basic disclosure requirements include authorized and issued share capital and changes during the period. Rights attached to shares should be presented, and where dividends are in arrears, this should also be disclosed. Where there are restrictions on retained earnings or dividends, this should be disclosed. Under IFRS, companies must also disclose information about their objectives, policies, and processes for managing capital and show summary quantitative information regarding what the company considers its capital.

5. Calculate and interpret key ratios relating to equity. Common ratios used in this area are the rate of return on common shareholders’ equity, payout ratio, price earnings ratio, and book value per share.

6. Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future. In several cases, ASPE provides more guidance, as noted in the comparison chart. IFRS requires a statement of changes in shareholders’ equity, whereas ASPE requires a statement of changes in retained earnings (with additional note disclosure regarding the changes in equity). The IASB and FASB are continuing to work on a financial statements project as well as a liability and equity project.

7. Explain how to account for par value and treasury shares. These shares may only be valued at par value in the common or preferred share accounts. The excess goes to contributed surplus. On a repurchase or cancellation, the par value is removed from the common or preferred share accounts and any excess or deficit is booked to contributed surplus or retained earnings, as was discussed for no par shares. Treasury shares are created when a company repurchases its own shares and does not cancel or retire them at the same time; that is, they remain outstanding. The single-transaction method is used when treasury shares are purchased. This method treats the purchase and subsequent resale or cancellation as part of the same transaction.

8. Explain how to account for a financial reorganization. A corporation that has accumulated a large debit balance (deficit) in retained earnings may enter into a process known as a financial reorganization. During a reorganization, creditors and shareholders negotiate a deal to put the company on a new footing. This generally involves a change in control and a comprehensive revaluation of assets and liabilities. The procedure consists of the following steps: (1) The deficit is reclassified so that the ending balance in Retained Earnings is zero. (2) The change in control is recorded. (3) All assets and liabilities are comprehensively revalued at current values so that the company will not be burdened with having to complete inventory or fixed asset valuations in following years.

15- 6

Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c b a d b c b c b c d d b a c d c b c b c b d b c a c d a b b d a b c b a b b a c c b d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44.

Description Residual interest REITs Preemptive right Shareholders’ liability Features of cumulative preferred shares Cumulative preferred shares dividend provisions Callable preferred shares Total shareholders' equity Reasons for issuing preferred shares Significance of par value Common shares subscribed Classification of subscriptions receivable Allocation methods for a lump sum issuance Direct costs of issuing shares Reacquisition of shares Reacquisition of shares at less than average share value Reacquisition of shares at greater than original issue price Retirement of shares Retirement of shares Retirement of preferred shares Transactions causing a decrease in retained earnings Transactions causing an increase in retained earnings Legality of dividend distributions Timing of entry to record dividends Shares entitled to receive a cash dividend Definition of a property dividend Determine false statement regarding property dividends Fair value of a property dividend Effect of a stock dividend Knowledge of dividend declarations Knowledge of dividend declarations Effect of large stock dividend Accounting for stock split Accounting for stock dividend Large stock dividend Reporting of Common Stock Dividend Distributable Liquidating dividend Entry to record a liquidating dividend Effects of stock dividends and stock splits Effects of a stock split Valid reasons for stock splits Knowledge of what shares receive dividends Noncumulative preferred dividends in arrears Classification of shareholders' equity

Shareholders’ Equity

Answer d c b c b d a a c c d a b b

No. 45. 46. 47. 48. 49. 50. *51. *52. *53. *54. *55. *56. *57. *58.

15- 7

Description Cumulative preferred dividends in arrears Statement of Changes in Shareholders’ Equity (IFRS) Calculation of payout ratio Rate of return on common shareholders’ equity Calculation of price earnings ratio Book value per common shares Sale of treasury shares Reissuance of treasury shares at less than acquisition cost Reporting treasury shares in the balance sheet Common shares issued vs. outstanding Determining occurrence of financial reorganization Balance of retained earnings after a financial reorganization Financial reorganization requirements IFRS vs. ASPE guidance

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Computational Answer b c b a b a b a c c a c b a b d d b d b c b b b a a a

No. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

Description Calculation of contributed surplus Calculation of contributed capital Calculation of share account balance Calculation of contributed surplus Entry to record share subscriptions Entry to record share subscriptions Share subscriptions Property dividend Entry to record stock dividend Calculation of share account after stock dividend Calculation of retained earnings after stock dividend Effect on equity accounts after dividend declarations Effect of stock dividend on retained earnings Effect of stock dividend on retained earnings Effect of share cancellation on equity accounts Effect of share cancellation on equity accounts Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of cash dividend allocation Calculation of total equity Calculation of cash dividends paid (given payout ratio) Calculation of price earnings ratio

15- 8

Answer b c b d a c d c a c d c d b a b c a b d

Test Bank for Intermediate Accounting, Tenth Canadian Edition

No. 86. 87. 88. 89. *90. *91. *92. *93. *94. *95. *96. *97. *98. *99. *100. *101. *102. *103. *104. *105.

Description Calculation of rate of return on common shareholders’ equity Calculation of rate of return on common shareholders’ equity Calculation of price earnings ratio Calculation of book value Effect on income statement of sale of treasury shares Recording par value shares Retirement of par value shares Sale of treasury shares Cancellation of treasury shares Effect of treasury shares on equity Total equity with treasury shares exchange Calculation of contributed surplus with treasury shares transactions Recording retirement of shares Retained earnings balance with treasury shares transactions Retained earnings balance with cancelled shares Retained earnings balance with treasury shares transactions Effect of stock dividend on retained earnings (with treasury shares) Adjustment of common shares in a financial reorganization Effect on deficit from revaluation of assets in a financial reorganization Effect of financial reorganization on retained earnings

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—CPA Adapted Answer b b c d c a c c a d b c d d a b c c c

No. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. *120. *121. *122. *123. *124.

Description Common shares issued in payment of services Determine entry to incorporate a proprietorship. Calculate amount to credit preferred shares in lump sum issue. Accounting for share subscriptions Calculate contributed surplus from retirement of shares. Cash dividend dates Allocation of cash dividend to common and preferred shares Valuation of a property dividend Accounting effects of property dividends Entry to record declaration of property dividend Effect of a liquidating dividend on equity accounts Effect of a stock dividend on equity accounts Effect of a stock dividend on total equity Effect of stock dividend and stock split Calculate balance in retained earnings Effect of reissuance of treasury shares Effect of reissuance of treasury shares Effect of treasury shares on number of shares outstanding Determine false statement regarding financial reorganizations.

*This topic is dealt with in an Appendix to the chapter.

Shareholders’ Equity

15- 9

EXERCISES Item E15-125 E15-126 E15-127 E15-128 E15-129 E15-130 E15-131 E15-132 E15-133 E15-134 E15-135 E15-136 E15-137 E15-138 E15-139 E15-140 * E15-141 *E15-142 *E15-143 *E15-144 *E15-145

Description Lump sum issuance of shares Shareholders' equity Share subscriptions Shares issued in noncash transactions Reacquisition of shares Reacquisition of shares Determination of dividend amount Items affecting retained earnings Stock dividends Stock dividends and stock splits Dividends on preferred shares Dividends on preferred shares Dividends on preferred shares Dividends on preferred shares Lump sum issuance of par value shares True or false questions Calculation of selected financial ratios Treasury shares Treasury shares Financial reorganization Financial reorganization

*This topic is dealt with in an Appendix to the chapter.

PROBLEMS Item P15-146 P15-147 P15-148 P15-149 P15-150 P15-151 P15-152 *P15-153

Description Issuance of shares for cash, non-cash consideration, and by subscription Issuance of shares for cash, non-cash consideration, and by subscription Allocation of cash dividends Share retirement and stock dividends Dividend distribution Equity transactions Statement of Shareholders’ Equity Treasury share transactions

*This topic is dealt with in an Appendix to the chapter.

15- 10

Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. The residual interest in a corporation belongs to the a. management. b. creditors. c. common shareholders. d. preferred shareholders.

2. Which statement is correct regarding real estate income or investment trusts? a. They are often set up as unlimited purpose trust funds. b. They are considered to be special purpose entities. c. The unitholders (investors) do not pay tax on the cash received from the trust. d. The unitholders have unlimited liability.

3. The preemptive right enables a shareholder to a. share proportionately in any new issues of shares in the same class. b. receive cash dividends before other classes of shares without the preemptive right. c. sell shares back to the corporation at the option of the shareholder. d. receive the same amount of dividends on a percentage basis as the preferred shareholders.

4. The liability of shareholders is a. similar to the liability of the owners of a partnership. b. similar to the liability of the owner of a proprietorship. c. equal to an amount sufficient to satisfy all creditors. d. limited to their property or service invested in the corporation.

5. The cumulative feature of preferred shares a. limits the amount of cumulative dividends to the par value of the preferred shares. b. requires that dividends not paid in any year must be made up in a later year before dividends are distributed to common shareholders. c. means that the shareholder can accumulate preferred shares until they are equal to the stated value of common shares, at which time they can be converted into common shares. d. enables a preferred shareholder to accumulate dividends until they equal the stated value of the shares and receive the shares in place of the cash dividends.

6. Dividends on cumulative preferred shares a. must be paid each year. b. accumulate over the life of the shares and are paid on retirement. c. must be paid before dividends may be paid on common shares. d. if in arrears, must be calculated like compound interest.

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7. Callable preferred shares a. may be redeemed at any time at the shareholder’s option. b. may be called or redeemed at the option of the issuing corporation. c. usually have voting rights. d. have rights to participate in any new share issuance.

8. Total shareholders' equity represents a. a claim to specific assets contributed by the owners. b. the maximum amount that can be borrowed by the corporation. c. a claim against a portion of the total assets of the corporation. d. only the amount of earnings that have been retained in the corporation.

9. Preferred shares are often issued instead of debt a. to avoid paying dividends to the common shareholders. b. because a corporation’s debt-to-equity ratio has become too high. c. to increase the market value of the shares. d. to decrease the market value of the shares.

10. In jurisdictions where par value shares are legally allowed, the only real significance of par value is a. to enable the shares to be callable or convertible. b. to require the corporation to pay dividends. c. to establish the maximum responsibility of a shareholder in the event of insolvency. d. to establish the maximum price at which the shares can be sold.

11. Aye Corp. sells common shares on a subscription basis. The Common Shares account should be credited when the a. shares are subscribed for. b. first payment is made. c. last payment is made. d. last payment is made and the shares are issued.

12. Subscriptions Receivable are reported as a. a noncurrent asset. b. a current asset. c. a deduction from shareholders' equity. d. either a current asset or a deduction from shareholders' equity.

13. The accounting problem in a lump sum sale of shares is the allocation of the proceeds between the classes of securities. One acceptable method of allocation is the a. pro forma method. b. relative fair value method. c. direct method. d. indirect method.

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14. Direct incremental costs incurred to sell shares such as underwriting costs should be accounted for as a. a reduction of share capital. b. an expense of the period in which the shares are issued. c. an intangible asset. d. a reduction of retained earnings.

15. According to the CBCA, when a company purchases its own shares on the market a. they are recorded with a debit to Repurchased Shares. b. the amount paid is deducted from the share class to which they belong. c. they must be cancelled. d. the excess of purchase price over cost is a loss.

16. When shares are reacquired at a cost less than the average per share value, the difference is credited to a. the appropriate share capital account. b. Gain on Reacquisition of Shares. c. Retained Earnings. d. Contributed Surplus.

17. Assuming a corporation has no contributed surplus booked, when shares are reacquired at a cost greater than their original issue price and cancelled, what account(s) should be debited? a. the share account for the total cost b. the share account for the original issue price and contributed surplus for the additional amount c. the share account for the average per share amount and retained earnings for the additional amount d. the share account for the average per share amount and a loss account for the additional amount

18. When shares are purchased or redeemed and cancelled, guidelines have been established for the sequence of accounts to adjust when allocating the cost. Which of the following is the first account to be adjusted? a. a Contributed Surplus account created from a previous reacquisition of the same class of shares b. the Share Capital account c. Retained Earnings d. Accumulated Other Comprehensive Income

19. A possible result of the reacquisition and cancellation of shares by a corporation is that this may a. directly increase but not decrease retained earnings. b. increase net income if a gain is recognized. c. directly decrease but not increase retained earnings. d. decrease but not increase net income.

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20. When all outstanding preferred shares are purchased and retired by the issuing corporation for less than the original issue price, accounting for the retirement increases a. the amount of dividends available to common shareholders. b. the contributed capital of the common shareholders. c. reported income for the period. d. Accumulated Other Comprehensive Income.

21. Which of the following transactions would NOT result in a decrease to retained earnings? a. declaration and issuance of a stock dividend b. incurrence of a net loss for the period c. reacquisition of shares for less than the original issue price d. correction of an error in which depreciation expense was understated in a prior period

22. Which of the following transactions would NOT result in an increase to retained earnings? a. correction of an error in which expenses were overstated in a previous year b. issuance of a 3-for-1 stock split c. reacquisition of shares for less than the original issue price d. earning of net income for the period

23. Which of the following statements is NOT generally true about the legality of dividend distributions? a. No amounts may be distributed unless the corporate capital is left intact. b. The corporation must still be able to pay its liabilities when they become due. c. A corporation may not pay dividends that are higher than their legally available retained earnings. d. Dividends do not need to be formally approved by the Board of Directors.

24. An entry for dividends is NOT made on the a. date of declaration. b. date of record. c. date of payment (cash dividends). d. date of distribution (stock dividends).

25. Cash dividends are paid on the basis of the number of shares a. authorized. b. issued. c. outstanding. d. outstanding less the number of treasury shares.

26. Jesse Corp. owns 4,000,000 shares of James Corp. On December 31, 2014, Jesse distributed these shares as a dividend to its shareholders. This is an example of a a. property dividend. b. stock dividend.

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c. liquidating dividend. d. cash dividend.

27. Which of the following statements about property dividends is FALSE? a. A property dividend is a nonreciprocal transfer of nonmonetary assets. b. A property dividend is also called a dividend in kind. c. The accounting for a property dividend should be based on the carrying value (book value) of the nonmonetary assets transferred. d. The accounting for a property dividend should be based on the fair value of the nonmonetary assets transferred.

28. The fair value of a property dividend should NOT be determined by a. estimated realizable values in cash transactions involving similar assets. b. quoted market prices. c. independent appraisals. d. arbitrary values assigned by the Board of Directors.

29. Declaration and issuance of a stock dividend a. has no effect on total assets, liabilities, or shareholders' equity. b. decreases the amount of working capital. c. decreases total shareholders' equity. d. increases the current ratio.

30. If a corporation wishes to "capitalize" part of their earnings, it may issue a a. cash dividend. b. stock dividend. c. property dividend. d. liquidating dividend.

31. Which type of dividends do NOT reduce total shareholders' equity? a. cash dividends b. stock dividends c. property dividends d. liquidating dividends

32. The declaration and issuance of a stock dividend larger than 25% generally a. increases common shares outstanding and increases total shareholders' equity. b. increases retained earnings and increases total shareholders' equity. c. may increase or decrease common shares but does not change total shareholders' equity. d. decreases retained earnings but does not change total shareholders' equity.

33. Pryor Corporation issued a 2-for-1 common stock split. The shares had been originally issued at $10 per share. At what amount should retained earnings be capitalized for the

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additional shares issued? a. there should be no capitalization of retained earnings b. $10 per share c. market value on the declaration date d. market value on the payment date

34. The issuer of a 5% common stock dividend to common shareholders should transfer from retained earnings to contributed capital an amount equal to the a. book value of the shares issued. b. market value of the shares issued. c. minimum legal requirements. d. par or stated value of the shares issued.

35. As a minimum, how large in relation to total outstanding shares may a stock distribution be before it should be accounted for as a large stock dividend instead of as a small stock dividend? a. no less than 2% to 5% b. no less than 10% to 15% c. no less than 20% to 25% d. no less than 45% to 50%

36. The balance in the Common Stock Dividend Distributable account should be reported as a(n) a. deduction from the Common Shares account. b. addition to contributed capital. c. current liability. d. contra-asset.

37. A dividend which is a return to shareholders of a portion of their original capital investments is known as a a. liquidating dividend. b. property dividend. c. cash dividend. d. participating dividend.

38. A mining company declared a liquidating dividend. The journal entry to record the declaration must include a debit to a. Retained Earnings. b. Contributed Capital. c. Accumulated Other Comprehensive Income. d. Dividend Payable.

39. A feature common to both stock splits and stock dividends is a. a transfer to earned capital of a corporation. b. that there is no effect on total shareholders' equity. c. an increase in total liabilities of a corporation.

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d. a reduction in the contributed capital of a corporation.

40. What effect does the issuance of a 2-for-1 stock split have on each of the following? Common Shares Retained Earnings a. No effect No effect b. Increase No effect c. Decrease No effect d. Decrease Decrease

41. Which of the following is NOT a valid reason for a stock split? a. to increase the shareholder base by increasing the number of shares outstanding and making them more marketable b. to reduce the market price of the shares so that more individuals can afford to invest in the shares c. to increase the market price of the shares to make the stock more attractive d. to reduce the market price of the shares to make the stock more attractive

42. Dividends are NOT paid on a. non-cumulative preferred shares. b. non-participating preferred shares. c. treasury shares. d. non-voting common shares.

43. Noncumulative preferred dividends in arrears a. must be paid before any other cash dividends can be distributed. b. are not paid or disclosed. c. are disclosed as a liability until paid. d. are paid to preferred shareholders if sufficient funds remain after payment of the current preferred dividend.

44. Shareholders' equity is generally classified into two major categories: a. contributed capital and donated capital. b. contributed surplus and retained earnings. c. retained earnings and accumulated other comprehensive income. d. earned capital and contributed capital

45. How should cumulative preferred dividends in arrears be shown on the balance sheet? a. as an increase in shareholders' equity b. as an increase in current liabilities c. as an increase in current liabilities for the amount expected to be declared within the next year, and as an increase in long-term liabilities for the balance d. by note disclosure only 46. Under IFRS, the Statement of Changes in Shareholders’ Equity must include

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a. share capital and retained earnings only. b. share capital and contributed surplus only. c. share capital, accumulated other comprehensive income, contributed surplus, and retained earnings. d. retained earnings, share capital, and accumulated other comprehensive income.

47. The payout ratio can be calculated by a. dividing cash dividends per share by earnings per share. b. dividing cash dividends by net income less preferred dividends. c. dividing cash dividends by market price per share. d. dividing net income by cash dividends per share. 48. The rate of return on common shareholders’ equity shows a. the amount of leverage the corporation employs. b. the amount that each common shareholder would receive if the company were liquidated. c. how many dollars of net income were earned for each dollar invested by the owners. d. how the market value of the shares relates to the current earnings per share.

49. The price earnings (P/E) ratio is calculated by a. dividing dividends per share by earnings per share. b. dividing the market price of the share by earnings per share. c. dividing net income by cash dividends per share. d. dividing cash dividends paid by the market price per share.

50. Hamilton Ltd. has both common shares and non-participating, non-cumulative preferred shares outstanding. The book value per common share is NOT affected by a. the declaration of a preferred stock dividend. b. the declaration of a common stock dividend when the market price of the common is equal to its issue price. c. a 2-for-1 split of the common shares. d. the payment of a previously declared cash dividend on the common shares. *51. A “gain" on the sale of treasury shares should be credited to a. contributed surplus. b. the share capital account. c. retained earnings. d. other income.

*52. Gupta Corp. purchased its own shares on January 1, 2014 for $20,000 and debited Treasury Shares for the purchase price. The shares were subsequently sold for $12,000. The $8,000 difference between the cost and sales price should be recorded as a debit to a. Contributed Surplus to the extent that previous net "gains" from sales or retirements of the same class of shares are included therein; otherwise, to retained earnings. b. Contributed Surplus regardless of whether there have been previous net "gains" from

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sales or retirements of the same class of shares included therein. c. Retained Earnings. d. Loss from Sale of Treasury Shares.

*53. An acceptable method of reporting Treasury Shares in the balance sheet is a. as a contra to contributed surplus. b. as a contra to the share capital account. c. as an account with a debit balance after retained earnings. d. as a current asset.

*54. Common shares issued would exceed common shares outstanding as a result of the a. declaration of a cash dividend. b. declaration of a stock dividend. c. purchase of treasury shares. d. payment in full of subscribed shares.

*55. For a two-year period following a properly implemented financial reorganization, Grant Corporation operated profitably and paid dividends equal to 10% of its net income in each year. How could one determine that the financial reorganization had occurred? a. could not unless comparative statements of financial position were presented b. from the shareholders’ equity section c. by the conservative dividend policy d. from the disclosure of the reorganization in the notes to the financial statements

*56. Immediately after a financial reorganization, the retained earnings account a. has a zero balance. b. remains the same as it was before the financial reorganization. c. is frozen and dated, and subsequent transactions will be shown separately. d. has a debit balance equal to the writedown of the assets which were overstated.

*57. Which of the following statements is FALSE concerning the requirements that must be fulfilled under a financial reorganization? a. The corporation’s shareholders must approve the financial reorganization. b. Immediately after the financial reorganization, the corporation must have a credit balance in retained earnings. c. New asset valuations should not deliberately over- or understate assets or liabilities. d. The corporation may have additional contributed surplus arising from the financial reorganization.

*58. Which of the following statements is correct? a. IFRS gives specific guidance for reacquisition of shares. b. IFRS does not give explicit guidance for accounting for financial reorganizations. c. IFRS requires that changes in retained earnings are presented in a retained earnings statement, and that changes in capital accounts are given in the notes. d. ASPE does not give guidelines for accounting for financial reorganizations.

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MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

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

c b a d b c b c b c

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

d d b a c d c b c b

21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

c b d b c a c d a b

31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

b d a b c b a b b a

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

c c b d d c b c b d

*51. *52. *53. *54. *55. *56. *57. *58.

a a c c d a b b

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MULTIPLE CHOICE—Computational 59. Berlin Corporation was organized on January 1, 2014, with 400,000 no par value common shares authorized. During 2014, the corporation had the following share transactions: Jan 5 Issued 150,000 shares at $10 per share Apr 6 Issued 50,000 shares at $12 per share Jun 8 Issued 50,000 shares at $14 per share Jul 28 Purchased 20,000 shares at $11 per share and cancelled them Dec 31 Issued 20,000 shares at $18 per share What is the total amount of contributed surplus at December 31, 2014? a. $ 0 b. $ 4,000 c. $ 20,000 d. $220,000

60. Rome Corp. was organized on January 1, 2014, with the following authorized share capital: 20,000 common shares, no par value 6,000, $.05, cumulative preferred shares, no par value During 2014, the corporation issued 10,000 common shares for $350,000 and 5,000 preferred shares at $24 per share. On December 20, 2014, subscriptions for 1,000 preferred shares were taken at a purchase price of $30. These subscribed shares were paid for on January 2, 2015. What should Rome report as total contributed capital on its December 31, 2014, balance sheet? a. $440,000 b. $450,000 c. $470,000 d. $500,000

Use the following information to answer questions 61–62. Berne Ltd. was organized on January 1, 2014, with 300,000 no par value common shares authorized. During 2014, the corporation had the following share transactions: Jan 4 Issued 120,000 shares at $10 per share Mar 8 Issued 40,000 shares at $11 per share May 17 Purchased 15,000 shares at $12 per share and cancelled them Jul 6 Issued 30,000 shares at $13 per share Aug 27 Issued 10,000 shares at $14 per share

61. The total amount in the Common Shares account at December 31, 2014 is a. $2,170,000. b. $2,016,250. c. $2,007,250. d. $1,990,000.

62. The total amount of contributed surplus at December 31, 2014 is a. $ 0.

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b. $ 26,250. c. $153,750. d. $180,000.

Use the following information to answer questions 63–64. Prague Corp. is authorized to issue 400,000 no par value common shares. Subscribers agree to purchase shares at $15 per share with a 30% down payment.

63. Assume that subscribers agree to purchase 50,000 shares and make the required down payment. The journal entry to record receipt of the subscriptions includes a a. debit to Common Shares Subscribed for $750,000. b. credit to Common Shares Subscribed for $750,000. c. credit to Common Shares for $225,000. d. credit to Subscriptions Receivable for $525,000.

64. The journal entry to record the issuance of the shares upon receipt of the final instalment includes a a. debit to Common Shares Subscribed for $750,000. b. credit to Common Shares for $525,000. c. credit to Common Shares for $225,000. d. debit to Subscriptions Receivable for $525,000.

65. Presented below is information related to Madrid Corporation: Subscriptions Receivable, Common Shares............... $ 120,000 Common Shares, no par value ................................... 3,810,000 Common Shares Subscribed...................................... 240,000 $4 Preferred Shares, no par value ............................. 1,440,000 Retained Earnings...................................................... 900,000 The total amount that will be added to the Common Shares account when the final subscriptions are received will be a. $120,000. b. $240,000. c. $360,000. d. cannot be determined from the information given.

66. Scrooge Ltd. owns 100,000 shares of Marley Ltd. common shares, which are being accounting for by the equity method. On December 15, 2014, when Scrooge's "Investment in Common Shares of Marley Ltd." account has a carrying value of $5 per share, Scrooge declares all these shares to its shareholders as a property dividend, to be distributed on December 31, 2014. Scrooge had originally paid $8 for each share. Marley has 1,000,000 shares issued and outstanding, for which the quoted market price was $7 per share on the declaration date and $9 per share on the distribution date. Ignoring income taxes, what would be the reduction in Scrooge's shareholders' equity as a result of the above transactions? a. $500,000 b. $700,000

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c. $800,000 d. $900,000

67. Lisbon Corp. has 1,000,000 no par common shares authorized, of which 800,000 shares are outstanding. The average carrying value of the shares is $5 per share. When the market value was $10 per share, Lisbon declared a 10% stock dividend. What entry, if any, should Lisbon make to record this dividend declaration? a. No entry b. Retained Earnings .................................................................. 400,000 Common Stock Dividend Distributable .......................... 400,000 c. Retained Earnings .................................................................. 800,000 Common Stock Dividend Distributable .......................... 800,000 d. Stock Dividend Payable.......................................................... 800,000 Common Stock Dividend Distributable .......................... 800,000

68. On June 30, 2014, when Vienna Inc.'s shares were selling at $65 per share, its capital accounts were as follows: Common Shares, no par, 60,000 shares issued and outstanding ................................................................. $2,400,000 Retained Earnings.................................................................... 3,600,000 If a 5% stock dividend were declared and distributed, the Common Shares account balance would be a. $2,205,000. b. $2,400,000. c. $2,595,000. d. $3,600,000.

69. The shareholders' equity section of Zagreb Corp. at December 31, 2013 was: Common shares, no par value; authorized 20,000 shares; issued and outstanding 10,000 shares ................................... $ 50,000 Retained earnings ......................................................................... 200,000 $250,000 On February 28, 2014, when the market value of Zagreb’s shares was $12 per share, the board of directors declared a 15% stock dividend, and accordingly 1,500 additional shares were issued. For the two months ended February 28, 2014, Zagreb reported a net loss of $20,000. What amount should Zagreb report as retained earnings at February 28, 2014? a. $162,000 b. $180,000 c. $182,000 d. $198,000

70. Cash dividends declared on the no par value common shares of Athens Corp. were as follows: 1st quarter of 2014 .......................... $330,000 2nd quarter of 2014 ......................... 350,000 3rd quarter of 2014.......................... 420,000 4th quarter of 2014 .......................... 450,000

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The 4th quarter cash dividend was declared on December 20, 2014, to shareholders of record on December 31, 2014, to be paid on January 9, 2015. In addition, Athens declared a 10% common stock dividend on December 1, 2014, when there were 400,000 shares issued and outstanding, and the market value of the common shares was $16 per share. The shares were issued on December 21, 2014. What was the effect on Athens' shareholders' equity accounts during 2014 as a result of the above transactions? Common Shares Retained Earnings a. $ -0$1,550,000 debit b. $540,000 credit $1,740,000 debit c. $640,000 credit $2,190,000 debit d. $300,000 credit $1,950,000 debit

71. The shareholders' equity of Tirana Ltd. at July 31, 2014 is presented below: Common shares, no par value, authorized 400,000 shares, issued and outstanding 200,000 shares ................................. $4,160,000 Retained earnings ......................................................................... 2,650,000 Total shareholders’ equity ............................................................. $6,810,000 On August 1, 2014, the board of directors declared a 10% stock dividend, to be distributed on September 15. The market price of Tirana's common shares was $35 on August 1 and $38 on September 15. What is the debit to retained earnings as a result of the declaration and distribution of this stock dividend? a. $ 400,000 b. $ 700,000 c. $ 760,000 d. $1,400,000

72. On January 1, 2014, when the market value of their common shares was $20 per share, Belgrade Inc. declared a 10% common stock dividend. Shareholders' equity before the stock dividend was declared was: Common shares, no par value, authorized 200,000 shares, issued and outstanding 120,000 shares ................................. $1,350,000 Retained earnings ......................................................................... 1,700,000 Total shareholders' equity ............................................................. $3,050,000 What was the effect on Belgrade’s retained earnings as a result of the stock dividend? a. $240,000 decrease b. $400,000 decrease c. $480,000 decrease d. $800,000 decrease

73. Warsaw Ltd. has 100,000 no par value common shares authorized, issued, and outstanding. All 100,000 shares were issued at $8 per share. Retained earnings are $120,000. If 10,000 common shares were reacquired at $6 and cancelled, a. shareholders' equity would decrease $80,000. b. contributed surplus would increase $20,000. c. contributed surplus would decrease $20,000. d. retained earnings would decrease $10,000.

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74. Vilnius Corporation has 100,000 no par value common shares authorized, issued and outstanding. All 100,000 shares were issued at $90 per share. Retained earnings are $250,000. If 2,000 shares were reacquired at $98 and cancelled, shareholders' equity would decrease by a. $ 0. b. $ 16,000. c. $180,000. d. $196,000.

75. On December 31, 2014, Monaco Ltd. had outstanding 2,000 no par value, $6, cumulative preferred shares and 30,000 no par value common shares. At this time, dividends in arrears on the preferred shares were $6,000. Cash dividends declared in 2015 totalled $30,000. The amounts paid to each class of shares were Preferred Shares Common Shares a. $6,000 $24,000 b. $12,000 $18,000 c. $24,000 $6,000 d. $18,000 $12,000

Use the following information for questions 76–78. Riga Ltd. has outstanding 100,000 no par common shares and 20,000 no par, $0.40, preferred shares issued at $5 each. The preferred shares are cumulative and non-participating. Dividends have been paid every year except the past two years and the current year.

76. Assuming that $50,000 will be distributed as a dividend in the current year, how much will the common shareholders receive? a. $24,000 b. $26,000 c. $34,000 d. $42,000

77. Assuming that $21,000 will be distributed as a dividend in the current year, how much will the preferred shareholders receive? a. $ 0 b. $ 8,000 c. $16,000 d. $21,000

78. The Common Shares account currently shows a balance of $200,000. Assuming that $61,000 will be distributed as a dividend in the current year, and the preferred shares are also fully participating, how much will the common shareholders receive? a. $37,000 b. $30,000 c. $31,000 d. $16,000

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79. Sarajevo Ltd. currently has outstanding 20,000 no par value common shares with a carrying value of $200,000, and 10,000 no par value, $0.60, cumulative, fully participating preferred shares with a carrying value of $100,000. Dividends on the preferred shares are one year in arrears. Assuming that Sarajevo wishes to distribute $54,000 in dividends, the common shareholders will receive a. $12,000. b. $22,000. c. $32,000. d. $42,000.

Use the following information for questions 80–82. Instanbul Corp. has outstanding 20,000 no par value, $0.80, preferred shares and 100,000 no par value common shares. Dividends have been paid every year except last year and the current year. The carrying value of the preferred shares is $200,000 and of the common shares is $300,000.

80. If the preferred shares are cumulative and non-participating and $100,000 is distributed as a dividend, the common shareholders will receive a. $0. b. $68,000. c. $84,000. d. $100,000.

81. If the preferred shares are non-cumulative and fully participating and $70,000 is distributed as a dividend, the common shareholders will receive a. $0. b. $42,000. c. $46,000. d. $54,000.

82. If the preferred shares are cumulative and fully participating and $101,000 is distributed as a dividend, the common shareholders will receive a. $0. b. $51,000. c. $61,000. d. $69,000.

83. Presented below is information related to Madrid Corporation: Subscriptions Receivable, Common Shares.................................. $ 120,000 Common Shares, no par value ...................................................... 3,810,000 Common Shares Subscribed......................................................... 240,000 $4 Preferred Shares, no par value ................................................ 1,440,000 Retained Earnings......................................................................... 900,000

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The total shareholders' equity of Madrid Corporation is a. $6,270,000. b. $6,300,000. c. $6,390,000. d. $6,510,000.

84. Sofia Ltd. reported net income of $5,300,000 for 2014, and earnings per share of $5.00. Included in the net income was $750,000 of bond interest expense related to its long-term debt. The income tax rate for 2014 was 30%. Dividends paid on preferred shares were $1,000,000. The payout ratio on common shares was 25%. What were the dividends paid on common shares in 2014? a. $1,075,000 b. $1,325,000 c. $1,206,250 d. $1,612,500

85. For calendar 2014, Budapest Corp. reported net income of $29,280 and earnings per share of $2.46. There were 12,000 common shares outstanding during 2014. On Dec 31, 2014, the market price for Budapest's common shares was $32. To the nearest whole number, what is Budapest's price earnings ratio at Dec 31, 2014? a. 13 b. 32 c. 375 d. 915

86. Presented below is information reported by Kiev Ltd. for their last two fiscal years: Dec 31, 2015 Dec 31, 2014 Common shares ................................................................... $ 75,000 $ 60,000 6% preferred shares, no par value, cumulative .................... 350,000 350,000 Retained earnings (post closing) .......................................... 90,000 75,000 Net income for year .............................................................. 60,000 32,000 What is Kiev’s rate of return on common shareholders’ equity for 2015? a. 48.8% b. 26% c. 25% d. 22.4%

Use the following information for questions 87–89. The following data are provided for Croatia Corp.’s last two fiscal years: Dec 31, 2015 Cumulative preferred shares, $5, no par value, 4,000 shares outstanding .............................................. $200,000 Common shares, no par, 24,000 shares outstanding ........... 400,000 Retained earnings (post closing) .......................................... 480,000 Net income ........................................................................... 180,000

Dec 31, 2014 $200,000 310,000 430,000

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Additional information: On May 1, 2015, 6,000 common shares were issued. Although dividends had been declared regularly up to December 31, 2014, preferred dividends were NOT declared during 2015. The market price of the common shares was $100 at December 31, 2015. 87. To the nearest percent, the rate of return on common shareholders’ equity for 2015 is a. 23%. b. 22%. c. 20%. d. 18%.

88. The price earnings ratio for 2015 is a. 12.22. b. 13.76. c. 14.99. d. 15.55.

89. The book value per common share at December 31, 2015 is a. $16.67. b. $18.18. c. $27.50. d. $35.83.

*90. Minsk Corporation's shareholders' equity section at December 31, 2013 was: Common shares, $5 par value, authorized 1,200,000 shares; issued 900,000 shares; outstanding 800,000 shares; ........ $4,500,000 Contributed surplus .................................................................. 3,250,000 Retained earnings .................................................................... 5,240,000 12,990,000 Less treasury shares, at cost, 100,000 shares ......................... 800,000 Total shareholders' equity ........................................................ $12,190,000 During 2014, Minsk sold 30,000 treasury shares at $10 per share. No other similar transactions occurred during 2014. What amount should be reported for this transaction on the 2014 income statement? a. $0 b. $60,000 gain from sale c. $60,000 comprehensive income d. $20,000 gain from sale and $40,000 contributed surplus

*91. Stockholm Corp. was organized on January 1, 2014, with 100,000 common shares authorized, par value $10. On January 2, 2014, the corporation issued 15,000 of these shares for $190,000 cash. The entry to record this sale would be a. Cash....................................................................................... 190,000 Common Shares.............................................................. 190,000 b. Cash....................................................................................... 190,000 Common Shares.............................................................. 150,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Retained Earnings ........................................................... Cash....................................................................................... Common Shares.............................................................. Contributed Surplus ......................................................... Cash....................................................................................... Contributed Surplus................................................................ Common Shares..............................................................

40,000 190,000 150,000 40,000 100,000 90,000 190,000

*92. Nicosia Corp. was organized on January 1, 2014, with 50,000 common shares authorized, par value $15, and immediately sold 10,000 shares for $20 each. Later, Nicosia bought back 1,000 of these shares at $23 each and cancelled them. The entry to record the purchase would be a. Common Shares .................................................................... 23,000 Cash ................................................................................ 23,000 b. Common Shares .................................................................... 15,000 Retained Earnings .................................................................. 8,000 Cash ................................................................................ 23,000 c. Common Shares .................................................................... 20,000 Contributed Surplus................................................................ 3,000 Cash ................................................................................ 23,000 d. Common Shares .................................................................... 15,000 Contributed Surplus................................................................ 8,000 Cash ................................................................................ 23,000

Use the following information for questions *93–*94. When Oslo Ltd. was organized last year, they issued 100,000 no par value common shares for $1,200,000. Earlier this year, the corporation purchased 4,000 of these shares at $15 per share, to be held in the treasury, and three months later, sold 2,000 treasury shares at $19 per share. There were no other treasury share transactions.

*93. To record the sale of the 2,000 treasury shares, Oslo should credit a. Treasury Shares for $38,000. b. Treasury Shares for $20,000 and Contributed Surplus for $18,000. c. Treasury Shares for $30,000 and Contributed Surplus for $8,000. d. Treasury Shares for $30,000 and Retained Earnings for $8,000.

*94. If, instead of holding the 4,000 shares as treasury shares, Oslo had decided to cancel them, Oslo should debit a. Common Shares for $48,000 and Retained Earnings for $12,000. b. Contributed Surplus for $48,000 and Retained Earnings for $12,000. c. Contributed Surplus for $60,000. d. Common Shares for $60,000.

*95. London Corporation has 50,000 no par value common shares authorized, issued and outstanding. All 50,000 shares were issued at $40 per share. Retained earnings are $40,000. If

Shareholders’ Equity

15- 29

3,000 of these shares were reacquired at $50 and were held as treasury shares, a. shareholders' equity would increase by $150,000. b. contributed surplus would decrease by at least $30,000. c. shareholders’ equity would decrease by $150,000. d. common shares would increase by $150,000.

*96. On December 1, 2014, Dublin Ltd. exchanged 10,000 of its no par value common shares (being held in the treasury) for a used machine. The treasury shares were acquired by Dublin for $35 per share. On the date of the exchange, the common shares, which had originally been issued at $30 per share, had a market value of $55 per share. As a result of this exchange, Dublin's total shareholders' equity will increase by a. $300,000. b. $350,000. c. $400,000. d. $550,000.

Use the following information for questions *97–*98. Galba Corp.'s shareholders' equity at January 1, 2014 was: Common shares, no par value; authorized 200,000 shares; outstanding 75,000 shares ................................................ Retained earnings .................................................................... Total ................................................................................ During 2014, Galba had the following share transactions: Acquired 2,000 treasury shares for $90,000 Sold 1,200 treasury shares at $50 a share Retired the remaining treasury shares No other share transactions occurred during 2014.

$ 1,050,000 730,000 $1,780,000

*97. The total contributed surplus at December 31, 2014 is a. $24,800. b. $11,200. c. $ 6,000. d. $ 0.

*98. Instead, assume Galba cancelled the 2,000 shares when it acquired them for $90,000. The journal entry to record the retirement would be a. Dr. Common Shares, $90,000; Cr. Cash, $90,000. b. Dr. Treasury Shares, $90,000; Cr. Cash, $90,000. c. Dr. Common Shares, $28,000; Dr. Contributed Surplus, $62,000; Cr. Cash, $90,000. d. Dr. Common Shares, $28,000; Dr. Retained Earnings, $62,000; Cr. Cash, $90,000.

Use the following information for questions *99–*100. At December 31, 2013, the balance in Helsinki Ltd.’s retained earnings account was $420,000. During 2014, Helsinki had the following transactions:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Acquired 5,000 treasury shares at $27 a share. The shares are no par and had originally been issued for $24 per share. There had been no previous treasury shares transactions. Sold the 5,000 treasury shares at $32 a share. Reported net income of $150,000.

*99. The balance in retained earnings at December 31, 2014 would be a. $555,000. b. $570,000. c. $585,000. d. $610,000.

*100. Instead, assume Helsinki cancelled the 5,000 shares when it acquired them. The balance in retained earnings at December 31, 2014 would then be a. $555,000. b. $570,000. c. $585,000. d. $610,000.

*101. At December 31, 2013, the balance of Glasgow Ltd.’s retained earnings account was $450,000. During 2014, the company had the following transactions: Acquired 5,000 treasury shares at $75 per share. The shares are no par value and had originally been issued for $65 per share. There had been no previous treasury share transactions. Net income for 2014 was $400,000. Sold the 5,000 treasury shares at $80 per share. What is the balance in retained earnings at December 31, 2014? a. $900,000 b. $850,000 c. $775,000 d. $762,500

*102. On January 1, 2014, Bratislava Corporation had 110,000 no par value common shares outstanding, which had been issued at $5 each. On June 1, the corporation acquired 10,000 shares to be held in the treasury. On December 1, when the market price of the shares was $4, the corporation declared a 10% stock dividend to be issued to shareholders of record on December 16. What was the impact of the 10% stock dividend on the retained earnings account? a. $50,000 decrease b. $44,000 decrease c. $40,000 decrease d. no effect

Use the following information for questions *103–*105. The balances in Belfast Inc.’s shareholders’ equity accounts at December 31, 2014 are: Common shares, no par, 50,000 authorized, 40,000 outstanding .... $1,300,000

Shareholders’ Equity

15- 31

Retained earnings (deficit) .............................................................. (364,000) At this, time, a financial reorganization was approved. Equipment was written down $101,800, and inventory increased $5,800.

*103. As the first step of the reorganization, how much should the Common Shares account be adjusted by? a. $364,000 b. $400,000 c. $460,000 d. $1,000,000

*104. What is the net increase in the deficit from revaluation of assets? a. $ 0 b. $96,000 c. $101,800 d. $107,600

*105. What will the balance in retained earnings be after the reorganization? a. $936,000 b. $(460,000) c. $(268,000) d. $ 0

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

59. 60. 61. 62. 63. 64. 65.

b c b a b a b

66. 67. 68. 69. 70. 71. 72.

a c c a c b a

73. 74. 75. 76. 77. 78. 79.

b d d b d b c

80. 81. 82. 83. 84. 85. 86.

b b b a a a b

87. 88. 89. *90. *91. *92. *93.

c b d a c d c

*94. *95. *96. *97. *98. *99. *100 .

a c d c d b a

*101. *102. *103. *104. *105.

b c a b d

DERIVATIONS—Computational No. Answer 59. b

60.

61.

62.

63. 64. 65. 66.

b a b a

67. 68. 69. 70.

c c a c

71. 72. 73. 74. 75.

b a b d d

Derivation (150,000 × $10) + (50,000 × $12) + (50,000 × $14) = $2,800,000 $2,800,000 ÷ 250,000 = $11.20; $11.20 × 20,000 = $224,000 $11.00 × 20,000 = $220,000; $224,000 – $220,000 = $4,000. $350,000 + (5,000 × $24) = $470,000. (The Subscriptions Receivable and Common Shares Subscribed accounts should preferably both be in contributed capital, so they would cancel each other out.) [(120,000 × $10) + (40,000 × $11)] ÷ 160,000 = $10.25 (120,000 × $10) + (40,000 ×$11) – (15,000 × $10.25) + (30,000 × $13) +(10,000 ×$14) = $2,016,250 $-0. Paid more than carrying value of the shares, therefore difference Dr to Retained Earnings. 50,000 × $15 = $750,000 50,000 × $15 = $750,000 $240,000, the subscription price (100,000 × $7) value of dividend – [100,000 x ($7 – $5)] gain on appreciation = $500,000 800,000 × $10 = $8,000,000 $2,400,000 + (60,000 x 5% x $65) = $2,595,000 $200,000 – $20,000 – (1,500 × $12) = $162,000 400,000 x 10% x $16 = $640,000 Cr. (common shares, i.e. stock dividend) $330,000 + $350,000 + $420,000 + $450,000 + $640,000 = $2,190,000 Dr. (retained earnings) 200,000 × 10% × $35 = $700,000 120,000 × 10% × $20 = $240,000 decrease 10,000 × ($8 – $6) = $20,000 2,000 × $98 = $196,000 $6,000 + (2,000 × $6) = $18,000 (preferred shares) $30,000 – $18,000 = $12,000 (common shares)

Shareholders’ Equity

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$50,000 – (20,000 × $0.40 × 3) = $26,000 20,000 × $0.40 × 3 = $24,000 > $21,000 8% × $200,000 = $16,000 (equivalent dividend) *2 ÷ 3 × $21,000 = 14,000 (participation) $30,000 *20,000 × $0.40 × 3 = $24,000(preferred dividends) $0.40 ÷ $5 = 8% dividend $200,000 × 8% = $16,000 (equivalent common dividend) Balance left = $61,000 – $24,000 – $16,000 = $21,000 Shared $200,000: $100,000 C:P i.e. 2:1 Common Shares $200,000 × 6% = $12,000 (current year) $200,000 × 10%* = 20,000 (participating) $32,000 *$54,000 – $12,000 – (10,000 × $0.60 × 2) = $30,000 $30,000 ———— = 10% $300,000 $100,000 – (20,000 × $0.80 × 2) = $68,000 Common Shares $300,000 × 8% = $24,000 (current year) $300,000 × 6%* = 18,000 (participating) $42,000 *$70,000 – $24,000 – (20,000 × $0.80) = $30,000 $30,000 ———— = 6%. $500,000 Common Shares $300,000 × 8% = $24,000 (current year) $300,000 × 9%* = 27,000 (participating) $51,000 *$101,000 – $24,000 – (20,000 × .8 × 2) = $45,000 $45,000 ÷ $500,000 = 9% $3,810,000 + $240,000 + $1,440,000 + $900,000 – $120,000 = $6,270,000

76. 77. 78.

b d b

79.

80. 81.

b b

82.

83.

84.

X ($5,300,00 0 − $1,000,000 )

85.

$32 ÷ $2.46 = 13

86.

$60,000 − (.06  $350,000) = 26% [($60,000 + $75,000) + ($75,000 + $90,000)]  2

87.

Note: preferred shares are not included in denominator $180,000 – (4,000 x $5) = 20% ($400,000 + $480,000 + $310,000 + $430,000) ÷ 2 Note: preferred shares are not included in denominator

88.

89.

= .25, X = $1,075,000

 $180,000 − $20,000  $100    = $100  ($160  22) = 13.76 18,000 + (6,000  8  12)  ($400,000 + $480,000 – $20,000 pfd div in arrears) ÷ 24,000 = $35.83

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*90.

*91. *92. *93. *94.

c d c a

*95. *96. *97. *98. *99. *100. *101.

c d c d b a b

*102. *103. *104. *105.

c a b d

30,000 × $2 = $60,000, recorded as contributed surplus (not an income statement item) Common shares 15,000 x $10 par = $150,000, bal to contributed surplus Common shares 1,000 × $15 par = $15,000; bal to contributed surplus 2,000 × $15 = $30,000; 2,000 × $4 = $8,000 Common shares 4,000 × $12 (average issue price)= $48,000; R/E 4,000 × $3 = $12,000 3,000 × $50 = $150,000 (cost of treasury shares) 10,000 × $55 = $550,000 1,200 × $5 = $6,000 avg issue price $1,050,000 ÷ 75,000 = $14, Dr C/S 2,000 x $14 = $28,000 $420,000 + $150,000 = $570,000 $420,000 – (5,000 × $3) + $150,000 = $555,000 $450,000 + $400,000 = $850,000. Sale of treasury shares above cost has no effect on R/E. (110,000 – 10,000) x 10% x $4 = $40,000 decrease $364,000, the amount of the deficit $101,800 – $5,800 = $96,000 RE should always have a $0 balance after reorganization

Shareholders’ Equity

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MULTIPLE CHOICE—CPA Adapted 106. Aye Corp. was organized in January 2014 with authorized capital of 1,000,000 no par value common shares. On February 1, 2014, shares were issued at $10 per share. On March 1, 2014, the corporation's lawyer accepted 7,000 common shares with a fair value of $85,000 in settlement for legal services. Total shareholders’ equity would increase on February 1, 2014 March 1, 2014 a. Yes No b. Yes Yes c. No No d. No Yes

107. The December 31, 2014 condensed balance sheet of Bee Services, a proprietorship, follows: Current assets ............................................................ $140,000 Property, plant and equipment (net) ........................... 130,000 $270,000 Liabilities .................................................................... Betty Bee, Capital ...................................................... Fair values at December 31, 2014, are as follows: Current assets ............................................................ Equipment .................................................................. Liabilities ....................................................................

$ 70,000 200,000 $270,000 $160,000 210,000 70,000

On January 1, 2015, Bee Services was incorporated as Bee-Line Ltd., with 10,000 no par value common shares issued. How much should be credited to Common Shares? a. $370,000 b. $300,000 c. $270,000 d. $200,000

108. On July 1, 2014, Cee Corp. issued 1,000 of its no par common shares and 2,000 of its no par preferred shares for a lump sum of $100,000. At this date Cee's common shares were selling for $48 per share and the preferred shares for $36 per share. Using the relative fair value method, the amount of the proceeds allocated to the preferred shares account should be a. $50,000. b. $55,000. c. $60,000. d. $72,000.

109. On December 1, 2014, Dee Ltd. agreed to sell 40,000 of their no par common shares on a subscription basis. On that day, 25% of the subscription price was collected as a down payment, with the remaining 75% due in 2015. On the December 31, 2014 statement of financial position, the shareholders' equity section would report

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a. common shares issued for 25% of the subscription price. b. common shares issued for 100% of the subscription price less a subscription receivable for 75% of the subscription price. c. common shares subscribed for 75% of the subscription price. d. common shares subscribed for 100% of the subscription price less a subscription receivable for 100% of the subscription price

110. Eff Ltd. was organized on January 2, 2014, with 100,000 no par value common shares authorized. During 2014, Eff had the following capital transactions: Jan 5 Issued 75,000 shares at $14 per share Jul 27 Purchased and retired 5,000 shares at $10 per share Nov 25 Issued 4,000 shares at $13 per share What would be the balance in the Contributed Surplus account at December 31, 2014? a. $ 0 b. $10,000 c. $20,000 d. $50,000

111. The dollar amount of a cash dividend to be paid is determined on the date of a. record. b. declaration. c. declaration or date of record, whichever is earlier. d. payment.

112. At December 31, 2013 and 2014, Gee Corp. had outstanding 3,000 no par value, $8, cumulative preferred shares and 10,000 no par value common shares. At December 31, 2013, dividends in arrears on the preferred shares were $12,000. Cash dividends declared in 2014 totalled $45,000. What amounts were payable on each class of shares? Preferred Shares Common Shares a. $24,000 $21,000 b. $33,000 $12,000 c. $36,000 $9,000 d. $45,000 $0

113. An investment in marketable securities was distributed to shareholders as a property dividend. The dividend should be recorded at the a. fair value of the asset transferred or the book value of the asset transferred, whichever is higher. b. fair value of the asset transferred or the book value of the asset transferred, whichever is lower. c. fair value of the asset transferred. d. book value of the asset transferred.

114. Emily Corp. owned shares in Carr Ltd. On December 1, 2014, Emily declared and distributed a property dividend of Carr shares when their fair value exceeded the carrying amount. As a consequence of the dividend declaration and distribution, the accounting effects

Shareholders’ Equity

would be Property Dividends Recorded At a. Fair value b. Fair value c. Cost d. Cost

15- 37

Retained Earnings Decreased Increased Increased Decreased

115. Eye Corp. owned 20,000 shares of Lash Corp., which had been purchased in 2010 for $300,000. On December 15, 2014, Eye declared a property dividend of all of its Lash Corp. shares. The property dividend was distributed on January 15, 2015. On the declaration date, the fair value of Eye’s investment in Lash was $400,000. The entry to record the declaration of the dividend would include a debit to Retained Earnings of a. $ 0. b. $100,000. c. $300,000. d. $400,000.

116. A corporation declared a dividend, a portion of which was liquidating. How would this distribution affect each of the following? Contributed Surplus Retained Earnings a. Decrease No effect b. Decrease Decrease c. No effect Decrease d. No effect No effect

117. How would the declaration of a 15% stock dividend affect each of the following? Total Retained Earnings Shareholders' Equity a. No effect No effect b. No effect Decrease c. Decrease No effect d. Decrease Decrease

118. On May 1, 2014, when the market value of Jay Ltd.'s common shares was $15 per share, the corporation had 100,000 no par value common shares issued and outstanding. On this day, Jay declared and issued a 15% common stock dividend. As a result of this stock dividend, Jay's total shareholders' equity a. increased by $225,000. b. decreased by $225,000. c. decreased by $15,000. d. did not change.

119. How would total shareholders' equity be affected by the declaration of each of the following?

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a. b. c. d.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Stock dividend No effect Decrease Decrease No effect

Stock split Increase Decrease No effect No effect

*120. On December 31, 2013, the shareholders' equity section of Kay Inc. was as follows: Common shares, no par value: authorized 30,000 shares; issued and outstanding 9,000 shares ..................................... $206,000 Retained earnings ......................................................................... 261,000 Total shareholders' equity ............................................................. $467,000 On March 31, 2014, when the market value of Kay’s shares was $27 per share, the corporation declared a 20% stock dividend, and accordingly 1,800 additional shares were issued. For the three months ended March 31, 2014, Kay reported a net loss of $48,000. The balance of Kay’s retained earnings at March 31, 2014, should be a. $164,400. b. $213,000. c. $216,600. d. $261,600.

*121. In 2014, Elle Corp. acquired 9,000 of its own no par value common shares at $18 per share, to be held in the treasury. In 2015, Elle sold 6,000 of these shares at $25 per share. What accounts and what amounts should Elle credit in 2015 to record this sale? Treasury Contributed Retained Common Shares Surplus Earnings Shares a. $108,000 $42,000 b. $108,000 $ 42,000 c. $108,000 $42,000 d. $42,000 $108,000

*122. At its date of incorporation, Emm Inc. sold 100,000 of its $10 par common shares at $11 per share. During the current year, Emm acquired 20,000 of these common shares at $16 per share to hold as treasury shares. Subsequently, these shares were sold at $12 per share. Emm has had no other sales or acquisitions of its common shares. What effect does the sale of the treasury shares have on the following accounts? Retained Earnings Contributed Surplus a. Decrease Decrease b. No effect Decrease c. Decrease No effect d. No effect No effect

*123. The reacquisition of issued and outstanding shares will cause the number of shares outstanding to decrease if they are accounted for As Treasury Shares By Retirement a. Yes No b. No No c. Yes Yes

Shareholders’ Equity

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Yes

*124. Which statement is FALSE regarding financial reorganizations? a. The proposed reorganization should receive the approval of the corporation’s shareholders before it is put into effect. b. The new asset and liability valuations should be fair. c. Subsequent to the financial reorganization, no disclosures are required in subsequent periods. d. After the reorganization, the corporation must have a zero balance in the Retained Earnings account.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

106. 107. 108. 109.

b b c d

110. 111. 112. 113.

c a c c

114. 115. 116. 117.

a d b c

118. 119. *120. *121.

d d a b

*122. *123. *124.

c c c

Item

Ans.

DERIVATIONS—CPA Adapted No. Answer 106. b 107. b 108. c

109. 110. 111. 112.

d c a c

113. 114. 115. 116. 117. 118. 119. *120. *121. *122. *123. *124.

c a d b c d d a b c c c

Derivation Conceptual $160,000 + $210,000 – $70,000 = $300,000 ($48 × 1,000) + ($36 × 2,000) = $120,000 $72,000 ———— × $100,000 = $60,000 $120,000 Conceptual 5,000 × 4 = $20,000 Conceptual (3,000 × $8) + $12,000 = $36,000 $45,000 – $36,000 = $9,000 Conceptual Conceptual $400,000 (market value) Conceptual Conceptual Conceptual Conceptual $261,000 – $48,000 – 1,800 × $27) = $164,400 (6,000 × $18) = $108,000; (6,000 × $7) = $42,000 Conceptual Conceptual Conceptual

Shareholders’ Equity

15- 41

EXERCISES Ex. 15-125 Lump sum issuance of shares Bertram Corp. is authorized to issue 15,000 no par value common shares and 5,000 no par value preferred shares. On January 16, 2014, the corporation sold 50 common shares and 75 preferred shares for a lump sum of $18,000. The common were selling at $50 and the preferred at $100. Instructions Using the relative fair value method, prepare the entry to record the sale for cash. Show calculations. Solution 15-125 Cash .................................................................................................... Common Shares ........................................................................... Preferred Shares ...........................................................................

18,000 4,500 13,500

Calculations: Common ($2,500 ÷ $10,000) × $18,000 = $4,500 Preferred ($7,500 ÷ $10,000) × $18,000 = $13,500 Ex. 15-126 Shareholders’ Equity Indicate the effect of each of the following transactions on total shareholders' equity by placing an "X" in the appropriate column. Increase Decrease No Effect 1. Declaration of a cash dividend.

________

2. Operating loss for the period.

________

3. Retirement of bonds at more than carrying value.

________

4. Declaration of a stock dividend.

________

5. Exchanging common shares for machinery.

________

6. Conversion of bonds into common shares.

________

7. Not declaring a dividend on cumulative preferred shares.

________

8. Payment of a cash dividend.

________

Increase

Decrease X

No Effect

Solution 15-126 1. Declaration of a cash dividend.

15- 42

Test Bank for Intermediate Accounting, Tenth Canadian Edition

2. Operating loss for the period.

3. Retirement of bonds at more than carrying value.

4. Declaration of a stock dividend.

5. Exchanging common shares for machinery.

6. Conversion of bonds into common shares.

7. Not declaring a dividend on cumulative preferred shares.

8. Payment of a cash dividend.

Ex. 15-127 Share subscriptions On April 28, 2014, Sweden Inc. accepted subscriptions for 10,000 of its no par value common shares. At this time, the shares were selling for $45 each. A 40% down payment was received with the remainder due in six months. On October 28, 2014 the balance of the subscription price was received and the shares were issued. Instructions a. Prepare the journal entries required on April 28, 2014. b. Prepare the journal entries required on October 28, 2014. Solution 15-127 a. Subscriptions Receivable (10,000 x $45) ...................................... Common Shares Subscribed ..................................................

450,000 450,000

Cash ($450,000 x 40%) ............................................................... Subscriptions Receivable .......................................................

180,000

Cash ............................................................................................. Subscriptions Receivable .......................................................

270,000

Common Shares Subscribed......................................................... Common Shares ....................................................................

450,000

180,000

270,000

450,000

Ex. 15-128 Shares issued in noncash transactions What are the different bases for share valuation when assets other than cash are received for issued shares? Solution 15-128 The general rule to be applied when shares are issued for services or assets other than cash is that the shares be recorded at either their fair value or the fair value of the services or assets, whichever is more clearly determinable. If neither is readily determinable, the value to be assigned is generally established by the board of directors.

Shareholders’ Equity

15- 43

Ex. 15-129 Reacquisition of shares Norway Corp. originally sold 1,000,000 of its no par common shares at $13 a share. Later, Norway bought back 6,000 shares of these shares at $17 a share. Norway is incorporated under the CBCA and therefore retired these shares. Instructions Record the retirement of the shares. Solution 15-129 Common Shares (6,000 x $13) ............................................................ Retained Earnings ............................................................................... Cash (6,000 x $17)........................................................................

78,000 24,000 102,000

Ex. 15-130 Reacquisition of shares For numerous reasons, a corporation may reacquire its own shares. When a corporation does this, the CBCA requires that the purchased shares be cancelled. Instructions Explain how a corporation would account for each of the following: a. Purchase of shares at a price less than the carrying value of the shares b. Purchase of shares at a price greater than the carrying value of the shares c. The effect on net income Solution 15-130 a. If the acquisition cost is less than the carrying value of the shares, the acquisition cost should be allocated as follows: i. To share capital, in an amount equal to the par, stated, or average value of the shares; ii. The difference to contributed surplus. b.

If the acquisition cost is greater than the carrying value of the shares, the acquisition cost should be allocated as follows: i. To share capital, in an amount equal to the par, stated, or average value of the shares; ii. Any excess, to contributed surplus, to the extent that contributed surplus was created by any excess of proceeds over cost on cancellation or resale of shares of the same class; iii. Any excess, to contributed surplus in an amount equal to the pro rata share of the portion of contributed surplus that arose from transactions, other than those in b. above, in the same class of shares; iv. Any excess to retained earnings.

There is no effect on net income as a result of the reacquisition and cancellation of shares.

Ex. 15-131 Determination of dividend amount Describe some of the factors that a board of directors may consider when determining the amount of cash dividends to declare.

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Solution 15-131 Some factors are: 1. agreements (bond and loan covenants) with creditors that require the retention of retained earnings 2. desire to use profits to reinvest in and expand the business 3. desire to have a smooth dividend stream even if income stream is not smooth 4. desire to build up a safety margin for losses or errors 5. availability of cash to pay the dividend (liquidity)

Ex. 15-132 Items affecting retained earnings What are the items that increase or decrease retained earnings? Solution 15-132 Items that increase retained earnings are net incomes, prior period adjustments (error corrections), financial reorganization, and certain changes in accounting principle. Items that decrease retained earnings are net losses, cash, property and most stock dividends, some treasury shares transactions, prior period adjustments (error corrections), and certain changes in accounting principle.

Ex. 15-133 Stock dividends Describe the accounting treatment for the declaration of a common stock dividend. Solution 15-133 If the issuing corporation is incorporated under the CBCA, the declaration would result in the transfer from retained earnings to contributed capital of an amount equal to the market value of each new share issued. Retained Earnings is debited for the total amount transferred; Common Stock Dividend Distributable is credited for the same amount. If the dividend is less than 20–25%, it is considered a small stock dividend, and would be treated this way. If, however, the stock dividend is greater than 20–25%, it is called a large stock dividend, and if the issuing corporation is not incorporated under the CBCA, it can choose to account for it like a small stock dividend, but measure at either the market value or the par or stated value of the shares, OR it can treat it as a stock split (memo entry only). In the U.S., the SEC supports treating a large stock dividend as a split. In Canada, there is no specific guidance, thus professional judgement must be used, although there may be legal constraints to consider.

Ex. 15-134 Stock dividends and stock splits Indicate the principal effects of a stock dividend versus a stock split as they affect the issuing corporation. Respond in the spaces as follows: "C" for change; "NC" for no change. Stock dividend Stock split Legal capital ________ ________ Number of shares outstanding ________ ________ Total shareholders’ equity ________ ________ Retained earnings ________ ________ Composition of shareholders' equity ________ ________

Shareholders’ Equity

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Solution 15-134 Legal capital Number of shares outstanding Total shareholders’ equity Retained earnings Composition of shareholders' equity

Stock dividend C C NC C C

Stock split NC C NC NC NC

Ex. 15-135 Dividends on preferred shares On December 31, 2014, the shareholders' equity of Finland Corporation shows the following: Preferred shares—$6, no par, 8,000 shares outstanding .............. $ 400,000 Common shares—no par, 60,000 shares outstanding ................... 800,000 Retained earnings ......................................................................... 240,000 Total shareholders' equity ............................................................. $1,440,000 Assume that preferred dividends were last paid on December 31, 2012, and that all of the company's retained earnings are to be paid out in dividends on December 31, 2014. Instructions If the preferred shares are cumulative and fully participating, how much should each class of shares receive? Solution 15-135 Dividends in arrears ($6 × 8,000) Current year's dividends (1:2) Participating dividend (1:2)

Preferred $48,000 48,000 16,000 $112,000

Common $ — 96,000 32,000 $128,000

Total $ 48,000 144,000 48,000 $240,000

Ex. 15-136 Dividends on preferred shares In each of the following independent cases, it is assumed that the corporation has outstanding 20,000, $0.80, preferred shares, with a carrying value of $200,000, and 80,000 common shares, with a carrying value of $800,000. Although dividends have been paid regularly up to 2011, no dividends were declared in 2012 or 2013. 1. At December 31, 2014, the board of directors wants to distribute $125,000 in dividends. How much will the preferred shareholders receive if their shares are cumulative and nonparticipating? 2. At December 31, 2014, the board of directors wants to distribute $200,000 in dividends. How much will the preferred shareholders receive if their shares are cumulative and participating up to 15% in total? 3. On December 31, 2014, the preferred shareholders received an $80,000 dividend on their shares, which are cumulative and fully participating. How much money was distributed in total for dividends? Solution 15-136 1. $48,000 2.

$62,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

$272,000 ($192,000 to common and $80,000 to preferred)

Ex. 15-137 Dividends on preferred shares At December 31, 2014, Russia Inc. has outstanding the following shares: 5,000, $3.20, no par value preferred shares with a carrying value of $200,000, and 40,000 no par value common shares with a carrying value of $600,000. No dividends have been paid since December 31, 2011. The corporation now desires to distribute $120,000 in dividends. Instructions Calculate how much the preferred and common shareholders will receive if the preferred shares are cumulative and fully participating. Solution 15-137 Dividends in arrears (5,000 × $3.20 × 2) Current year's dividends (5,000 × $3.20) 1:3 ratio Participating dividend (1:3)

Preferred $32,000 16,000 6,000 $54,000

Common $ — 48,000 18,000 $66,000

Total $ 32,000 64,000 24,000 $120,000

Ex. 15-138 Dividends on preferred shares Lithuania Corp. has been authorized to issue 20,000 no par value, $6, cumulative and fully participating preferred shares and 100,000 no par value common shares. The account balances at December 31, 2014 are: $6 Preferred shares, 4,000 shares outstanding ............................. $ 400,000 Common shares, 60,000 shares outstanding ................................ 1,600,000 No dividends have been paid since December 31, 2010. The corporation now desires to pay $280,000 in dividends. Instructions Calculate how much the preferred and common shareholders will receive. Solution 15-138 Dividends in arrears (4,000 × $6 x 3) Current year's dividends (1:4) Participating dividend (1:4)

Preferred $72,000 24,000 17,600 $113,600

Common $ — 96,000 70,400 $106,400

Total $ 72,000 120,000 88,000 $280,000

Ex. 15-139 Lump sum issuance of par value shares Chile Corp. issued 2,000 common shares and 400 preferred shares to an investor for $72,000 cash. Instructions a. Prepare the journal entry for the issuance, assuming the par value of the common shares

Shareholders’ Equity

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was $5 and the market value was $30, and the par value of the preferred shares was $40 and the market value was $50. b. Prepare the journal entry for the issuance, assuming the same facts as a., except the preferred shares have no ready market and the common shares have a market value of $24. Solution 15-139 a. Use relative fair value method. Cash ............................................................................................. Common shares (2,000 x $5) ................................................. Contributed surplus—common ($54,000 – $10,000) .............. Preferred shares (400 x $40) .................................................. Contributed surplus—preferred ($18,000 – $16,000) .............. common $30 × 2,000 = preferred $50 × 400 =

60 ÷ 80 × $72,000 = 20 ÷ 80 × $72,000 =

$60,000 20,000 $80,000 $54,000 18,000 $72,000

72,000 10,000 44,000 16,000 2,000

market value common preferred

Use residual method. Cash ............................................................................................. Common shares (2,000 x $5) ................................................. Contributed surplus—common ($48,000 – $10,000) .............. Preferred shares (400 x $40) .................................................. Contributed surplus—preferred (balance) ...............................

72,000 10,000 38,000 16,000 8,000

Ex. 15-140 True or false questions Indicate True or False by writing T or F in the space provided. ____ a. Common Shares Subscribed is a current asset. ____ b. A stock split does not require a formal journal entry. ____ c. Bad debt expense is recognized on defaulted subscriptions. ____ d. The date of declaration for a dividend precedes the date of payment, but follows the date of record. ____ e. Retained earnings is part of contributed capital. ____ f.

Stock dividends distributable should be classified as a current liability.

____ g. Stock dividends always involve the transfer of some per-share amount of retained earnings to share capital.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

____ h. At one time a nationally known distillery annually distributed a bottle of "its finest" to its shareholders for every 10 shares outstanding; this was a property dividend.

Solution 15-140 a. F b.

*Ex. 15-141 Calculation of selected financial ratios Cuba Corp. provides the following information for 2014: Preferred shares, 8%, par value $100, cumulative, callable: Call price per share ................................................................ Shares outstanding ................................................................ Dividends in arrears ............................................................... Common shares, no par value: Shares issued ........................................................................ Dividends paid per share ........................................................ Market price per share............................................................ Carrying value ........................................................................ Retained earnings (after closing) ................................................... Treasury shares (common) ........................................................... Number of treasury shares held ............................................. Net income for 2014 ......................................................................

$105 5,000 none 60,000 $1.60 $36.00 $800,000 $175,000 $125,000 5,000 $260,000

Instructions Calculate the following (assume no changes in share account balances during 2014): a. Total amount of shareholders’ equity on the December 31, 2014 statement of financial position b. Earnings per share c. Price earnings ratio of common shares d. Payout ratio of common shares e. Book value per common share *Solution 15-141 a. (5,000 × $100) + $800,000 + $175,000 – $125,000 = $1,350,000

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[$260,000 – (5,000 × $100 × 8%)] ÷ (60,000 – 5,000) = $220,000 ÷ 55,000 = $4.00

$36 ÷ $4 = 9

[($1.60 × 55,000) ÷ ($260,000 – $40,000)] = 40% OR dividend per share divided by EPS $1.60 ÷ $4 = 40%

[($1,350,000 – (5,000 x $105) ÷ (60,000 – 5,000)] = $825,000 ÷ 55,000 = $15

*Ex. 15-142 Treasury shares At December 31, 2013, Ukraine Ltd.’s statement of financial position reported the following: Common shares, no par value, 5,000 shares outstanding ............. $115,000 Retained earnings ......................................................................... 200,000 The following transactions occurred during 2014: 1. Purchased 140 common shares at $30 per share, to be held as treasury shares 2. Sold 120 treasury shares at $32 per share 3. Retired the remaining treasury shares Instructions Prepare journal entries for these transactions. *Solution 15-142 1. Treasury shares (140 x $30) ......................................................... Cash.......................................................................................

4,200

Cash (120 x $32)........................................................................... Treasury shares (120 x $30)................................................... Contributed surplus ................................................................

3,840

Common shares 20 x ($115,000 ÷ 5,000) ..................................... Contributed surplus ....................................................................... Treasury shares (20 x $30) ....................................................

460 140

4,200

3,600 240

600

*Ex. 15-143 Treasury shares Zambia Ltd. currently has 150,000 no par value common shares outstanding, with a carrying value of $3,900,000. Instructions Record the following transactions: a. Purchased 1,500 common shares at $29 per share, to be held as treasury shares b. Sold 800 treasury shares at $30 a share c. Retired the rest of the treasury shares *Solution 15-143 a. Treasury shares (1,500 x $29) ...................................................... Cash.......................................................................................

43,500 43,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash (800 x $30)........................................................................... Treasury shares (800 x $29)................................................... Contributed surplus ................................................................

24,000

Common shares [(700 x ($3,900,000 ÷ 150,000) .......................... Contributed surplus (maximum) .................................................... Retained earnings (difference) ...................................................... Treasury shares (700 x $29)...................................................

18,200 800 1,300

23,200 800

20,300

*Ex. 15-144 Financial reorganization The following shareholders’ equity accounts were reported by India Inc. at December 31, 2014. Common shares, no par value, 10,000 shares outstanding ........... $720,000 Retained earnings (deficit) ............................................................ (247,000) A financial reorganization was approved. Equipment is to be written down by $68,000, and inventory increased by $5,200. Instructions Prepare the required journal entries for the financial reorganization. *Solution 15-144 Common shares................................................................................... Inventory .............................................................................................. Equipment ..................................................................................... Common shares................................................................................... Retained earnings (deficit) ............................................................

62,800 5,200 68,000 247,000 247,000

*Ex. 15-145 Financial reorganization Describe the accounting steps involved in a financial reorganization. *Solution 15-145 A financial reorganization consists of the following steps: 1. Any asset writedowns or impairments that existed prior to the reorganization should be recorded first. 2.

The changes in debt and equity as negotiated are recorded. Often debt is exchanged for equity, resulting in a change in control.

The assets and liabilities are comprehensively revalued. This step assigns appropriate fair values to all assets and liabilities as per the negotiations. The difference between the carrying values prior to the reorganization and the new values after is known as a revaluation adjustment. The revaluation adjustment and any costs incurred to carry out the financial reorganization are accounted for as capital transactions and are closed to Share Capital, Contributed Surplus or a separately identified account within Shareholders’ Equity. The new costs of the identifiable assets and liabilities must not exceed the fair value of the entity if known.

Shareholders’ Equity

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The deficit balance (retained earnings) is brought to zero. The deficit is reclassified to Common Shares, Contributed Surplus or a separately identified account within Shareholders’ Equity.

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PROBLEMS Pr. 15-146 Issuance of shares for cash, non-cash consideration, and by subscription Presented below is information related to Rhodesia Corp.: 1. Rhodesia is granted a charter that authorizes issuance of 100,000 no par value preferred shares and an unlimited number of no par value common shares. 2. 10,000 common shares are issued for land with a fair value of $400,000. 3. 3,000 preferred shares are sold for cash at $110 per share. 4. Rhodesia issues 100 common shares to its lawyer for costs associated with starting the company. At this time, the common shares are selling at $60 per share. 5. Rhodesia issues shares on a subscription basis, giving each subscriber the right to purchase 300 common shares at a price of $65 per share. Fifty individuals accept the company's offer and agree to pay 10% down and the remainder in three equal instalments. 6. The final instalment payment (for the subscriptions) is received and the shares are issued. Instructions Prepare the required general journal entries to record these transactions. Solution 15-146 1. No entry necessary. 2.

Land .............................................................................................. Common Shares ....................................................................

400,000

Cash (3,000 x $110)...................................................................... Preferred Shares ....................................................................

330,000

Organization Expense (100 x $60) ................................................ Common Shares ....................................................................

6,000

Subscriptions Receivable (50 x 300 x $65).................................... Common Shares Subscribed .................................................. Cash (10% x $975,000)................................................................. Subscriptions Receivable .......................................................

975,000

Cash [($975,000 – $97,500) x 1 ÷ 3] ............................................. Subscriptions Receivable .......................................................

292,500

Common Shares Subscribed......................................................... Common Shares ....................................................................

975,000

400,000

330,000

6,000

975,000 97,500 97,500

292,500

975,000

Pr. 15-147 Issuance of shares for cash, non-cash consideration, and by subscription Dahomey Corp. is authorized to issue an unlimited number of no par common shares. Prepare the journal entries for the following transactions: 1. Sold 600,000 shares for $10 cash each, which was the fair market value of the shares. 2. Issued 80,000 shares and paid $140,000 cash in total payment for a piece of land. The market value of the shares had not changed.

Shareholders’ Equity

3. 4.

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Received subscriptions for 40,000 shares at $18 per share; received 60% of the subscription price in cash. Received the balance of the subscriptions receivable.

Solution 15-147 1. Cash (600,000 x $10) .................................................................... 6,000,000 Common Shares ..................................................................... 6,000,000 2.

Land .............................................................................................. Cash ....................................................................................... Common Shares (80,000 x $10) ............................................

940,000

Subscriptions Receivable (40,000 x $18) ...................................... Common Shares Subscribed...................................................

720,000

Cash ($720,000 x 60%)................................................................. Subscriptions Receivable ........................................................

432,000

Cash ($720,000 x 40%)................................................................. Subscriptions Receivable ........................................................

268,000

Common Shares Subscribed......................................................... Common Shares .....................................................................

720,000

Pr. 15-148 Allocation of cash dividends Togo Inc. has the following shares outstanding: 40,000, $0.80, no par value preferred shares 60,000 no par value common shares

140,000 800,000

720,000

432,000

268,000

720,000

$400,000 $600,000

All shares were sold for $100 each. No dividends have been declared since December 31, 2011. It is now December 31, 2014, and the board of directors wants to distribute $204,000 in dividends. Instructions Calculate how much the preferred and common shareholders will receive under each of the following assumptions: a. The preferred is non-cumulative and non-participating. b. The preferred is cumulative and non-participating. c. The preferred is cumulative and fully participating. d. The preferred is cumulative and participating to 12% total. Solution 15-148 a. Current year's dividend $.80 × 40,000 Remainder to common

b. Dividends in arrears, $.80 × 40,000 x 2

Preferred $32,000 $32,000

Common $ — 172,000 $172,000

Total $ 32,000 172,000 $204,000

Preferred $64,000

Common $ —

Total $ 64,000

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$96,000

— 108,000 $108,000

32,000 108,000 $204,000

Dividends in arrears, $.80 × 40,000 x 2 Current year's dividend 2:3 ratio Participating dividend 6% ($60,000 ÷ $1,000,000)

Preferred $ 64,000 32,000 24,000 $120,000

Common $ — 48,000 36,000 $84,000

Total $ 64,000 80,000 60,000 $204,000

Dividends in arrears, $.80 × 40,000 x 2 Current year's dividend 2:3 ratio *Participating dividend (additional 4% – max) Remainder to common

Preferred $ 64,000 32,000 16,000 — $112,000

Common $ — 48,000 24,000 20,000 $92,000

Total $ 64,000 80,000 40,000 20,000 $204,000

Current year's dividend Remainder to common

32,000

* basic PFD dividend is $.80 ÷ $100 = 8%

Pr. 15-149 Share retirement and stock dividends Sudan Enterprises Inc. reported the following shareholder’s equity at December 31, 2013: Contributed Capital Preferred shares, $1, no par value, 100,000 shares authorized, cumulative, callable at $107 plus dividends in arrears; issued and outstanding, 20,000 shares .................................................... $2,040,000 Common shares, no par, 100,000 shares authorized, 80,000 issued and outstanding ................................................................. 640,000 Contributed surplus (retirement of common shares) ........................................ 120,000 Retained earnings ........................................................................................... 1,600,000 The following transactions took place in 2014: Jan 20 Redeemed 1,000 preferred shares at the call price. There were no dividends in arrears. Jan 28 Declared $100,000 in dividends. Use separate accounts for each class of dividends. Feb 28 Retired 8,000 common shares at $12 per share. Mar 2 Declared and distributed a 3% common stock dividend. The market value of the shares at that time was $11.50. Instructions Prepare journal entries for the 2014 transactions. Solution 15-149 Jan 20: Preferred shares ($2,040,000 ÷ 20,000) × 1,000 ........................... Retained earnings ......................................................................... Cash ($107 × 1,000)............................................................... Jan 28: Retained earnings ......................................................................... Preferred dividends payable (19,000 × $1) .............................

102,000 5,000 107,000

100,000 19,000

Shareholders’ Equity

Common dividends payable ($100,000 – $19,000).................

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81,000

Feb 28: Common shares (8,000 × ($640,000 ÷ 80,000)) ............................ Contributed surplus (retirement of common shares) ...................... Cash (8,000 × $12).................................................................

64,000 32,000

Mar 2: Retained earnings (72,000 × 3% × $11.50) ................................... Common shares .....................................................................

24,840

96,000

24,840

Pr. 15-150 Dividend distribution You have recently been appointed CEO of Dumbledore Ltd., a wholesale distributor of magic supplies. One day your CFO reminds you that next week you will have to make recommendations to the board of directors regarding this year’s annual dividend. This catches you totally by surprise. Luckily, the CFO was kind enough to provide you with some additional information. He shows you the projected income statement and balance sheet, without the effect of any dividend declaration. Income Statement: Sales ........................................................................................ 44,000,000 COGS ...................................................................................... 29,400,000 Gross profit .............................................................................. 14,600,000 Operating expenses ................................................................. 6,000,000 Operating income before interest ............................................. 8,600,000 Interest expense....................................................................... 1,000,000 Income before tax .................................................................... 7,600,000 Income tax (30%) ..................................................................... 2,300,000 Net income ............................................................................... 5,300,000 Statement of Financial Position: Current Assets Cash ........................................................................................ Accounts receivable ................................................................. Inventory .................................................................................. Other ........................................................................................ Total Current Assets ................................................................

4,000,000 5,000,000 2,000,000 3,700,000 14,700,000

Long term investments .............................................................

7,000,000

Property, plant and equipment (net) ......................................... Total Assets .............................................................................

17,000,000 38,700,000

Current Liabilities Accounts payable ..................................................................... Accrued liabilities ..................................................................... Other ........................................................................................ Total Current Liabilities.............................................................

2,000,000 3,000,000 4,000,000 9,000,000

Non-current liabilities ................................................................

16,000,000

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Shareholders’ Equity Common shares ....................................................................... Contributed surplus .................................................................. Retained earnings (includes this year’s net income) ................. Total Shareholders’ Equity .......................................................

1,000,000 4,900,000 7,800,000 13,700,000

Total Liabilities and Equity ..............................................................

38,700,000

Other information: 1) Last year, the net income was $3,500,000, and $3,300,000 cash dividends were paid. 2) Dumbledore has two debt agreements that call for the corporation to maintain at least $2,500,000 in retained earnings, as well as maintain a debt-to-total-assets ratio of no more than 70%. 3) There has been no change in the number of shares outstanding during the year. You start to think about the recommendations you are going to make. It is the end of November, and historically the corporation has declared dividends five days before the end of the year. Instructions a. What factors will limit the amount to be distributed as dividends? b. What are important considerations in your decision? What would you recommend? Provide any journal entry that is related to your decision. Solution 15-150 a. You need to ascertain how much can be distributed in dividends. Look at all your constraints. i) Retained earnings constraint. The debt covenant requires that Dumbledore must maintain $2,500,000 in retained earnings. The balance in retained earnings is currently $7,800,000, so the maximum dividend is $5,300,000. ii) Cash on hand constraint. As long as you do not decide to borrow additional cash, theoretically you could distribute all your cash on hand, so the dividend would be a maximum of $4,000,000. However, for practical purposes, the firm must maintain a certain level of cash for its day-to-day operations, so the actual dividend you can pay is lower. iii) Debt-to-total assets constraint. You can distribute dividends only to the point that this ratio does not exceed 70%. Currently, the ratio is 64.6% as total debt is $25,000,000 and total assets are $38,700,000. You are limited to distributing at most $3,000,000. This will bring the ratio to 70% = 25 ÷ 35.7. b.

There are many considerations involved in this decision, and there is no single correct answer. Some of the main considerations are: i) Since Dumbledore distributed $3,300,000 in dividends last year, a dividend of “only” $3,000,000 will imply a dividend reduction. Firms are usually reluctant to lower dividends, so distributing $3,000,000 may not be good for shareholder relations or your image in the marketplace. ii)

Even if you are not constrained, you might not want to make the dividend too large. True, this year the firm fared well, but if you distribute all the income as a dividend, and

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next year’s income is lower, you would have to lower your dividend, which again is not desirable. iii) Another reason to not distribute a high dividend is that it might suggest the firm does not have future growth opportunities. A business should limit dividends, if the retained capital can be invested in projects with high returns. If the business does not have such projects, it is better off to distribute the earnings. If the business still has good investment opportunities, then you do not want to send the wrong message. iv) Last year’s payout ratio was very high - 94.3% (3.3 ÷ 3.5). However, maintaining a high payout ratio might create the problems already mentioned. v)

You need to make sure that after you distribute cash dividends, enough resources are available to pay current liabilities. Current ratio excluding cash = 10,400,000 ÷ 9,000,000 = 1.16, so the firm does seem to be able to meet its short-term obligations even if it distributes all its cash.

vi) Another solution would be to distribute a cash dividend of $3,000,000 and then a stock dividend (e.g. for $1,000,000). This will allow Dumbledore to increase the overall dividends and not violate any of the constraints. However, since the stock dividend does not give cash to the shareholders, they might not appreciate it. vii) To be able to pay more cash dividends, you need to take some action. You could sell some non-current assets and use some of the proceeds to pay down on debt, and some to distribute as dividends. Suppose you sell a $4,000,000 asset at no gain and use $2,000,000 of the proceeds to reduce debt. The change to the balance sheet amounts is: Cash plus $2,000,000 Non-current assets minus $4,000,000 Liabilities minus $2,000,000 Debt is down to $23,000,000, total assets are down to $36,700,000, and cash is increased to $6,000,000. The-debt-to-total-assets constraint allows you to distribute dividends of up to $3,840,000 and you will have plenty of cash to do so. So if you declare a cash dividend of $3,800,000, you are able to increase the dividend but still satisfy all constraints. viii) Since Dumbledore has $7,000,000 in investments, given other constraints are satisfied, another consideration is a property dividend. ix) If time allows, the corporation could issue more shares, which will relax the debt-tototal- assets ratio and the cash constraint.

Pr. 15-151 Equity transactions Congo Corp. has the following capital structure at the beginning of this year: Preferred shares, $3, no par value, cumulative, 20,000 shares authorized, 6,000 shares issued and outstanding .................................................. Common shares, no par value, 60,000 shares authorized, 40,000 shares issued and outstanding ................................................ Total contributed capital .............................................................................

300,000 510,000 810,000

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Retained earnings ...................................................................................... Total shareholders' equity ..........................................................................

340,000 $1,150,000

Instructions a. Record the following transactions which occurred consecutively this year. Show all calculations. i. There are no dividends in arrears. A total cash dividend of $90,000 was declared. The preferred shares are participating to a maximum of 10%. Record dividends payable to common and preferred shares in separate accounts. ii. A 10% common stock dividend was declared. The current market value of the common shares is $16 a share. iii. Net income for the year was $180,000. Record the closing entry. b. Incorporating all the above information, construct the shareholders' equity. Solution 15-151 a. i. Current year's dividend, $3 × 6,000* Participating dividend 4% Remainder to common

Preferred $18,000 12,000 $30,000

Common $30,600** 20,400 9,000 $60,000

Total $48,600 32,400 9,000 $90,000

*basic div is $3 ÷ $50 = 6% **6% x $510,000 Retained Earnings......................................................................... Dividends Payable—Common ................................................ Dividends Payable—Preferred ............................................... ii.

40,000 x 10% x $16 =

90,000 60,000 30,000

$64,000

Retained Earnings .................................................................. Common Stock Dividend Distributable ..........................

64,000

iii. Income Summary ................................................................... Retained Earnings ........................................................

180,000

64,000

Shareholders' equity Preferred shares, $3, no par value, cumulative, 20,000 shares authorized, 6,000 shares issued and outstanding .................................................. Common shares, no par value, 60,000 shares authorized, 40,000 shares issued and outstanding ................................................ Common stock dividend distributable ......................................................... Total contributed capital ...................................................................... Retained earnings*** .................................................................................. Total shareholders' equity ..........................................................................

180,000

$ 300,000 510,000 64,000 874,000 366,000 $1,240,000

***$340,000 – $90,000 – $64,000 + $180,000 = $366,000 Pr. 15-152 Statement of Shareholders’ Equity

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Following is information provided by Timbuktu Inc. for their last two year ends:

Common Shares, no par value Common shares sold during year Accumulated Other Comprehensive Income Other Comprehensive Income for year (unrealized holding gain, after tax) Retained Earnings Net income for year

Balances at Dec 31, 2013 $300,000

Balances at Dec 31, 2014 ?? $50,000 ??

60,000

30,000 50,000

?? 110,000

Instructions In good format, prepare a Statement of Shareholder’s Equity for the year ended December 31, 2014. Solution 15-152 TIMBUKTU INC. Statement of Shareholders’ Equity For the year ended December 31, 2014 Common Shares Beginning balances Common shares sold Net income Other compre.income Compre. income Ending balances

Comprehensive Income

$300,000 50,000

$50,000 110,000 30,000 140,000

$350,000

Retained Earnings

Accumulated Other Comprehensive Income $60,000

30,000

$410,000 50,000 110,000 30,000

$90,000

$600,000

110,000

$160,000

Total Shareholders’ Equity

*Pr. 15-153 Treasury share transactions Algeria Corp. currently has 5,000 no par value common shares outstanding, with a book value of $150,000. Instructions Record the share transactions given below: a. Bought 300 common shares at $31 each, to be held as treasury shares b. Sold 80 treasury shares at $30 c. Sold 40 treasury shares at $34 d. Retired the rest of the treasury shares *Solution 15-153 a. Treasury Shares (300 x $31) ......................................................... Cash....................................................................................... b.

Cash (80 x $30)............................................................................. Retained Earnings.........................................................................

9,300 9,300 2,400 80

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Treasury Shares (80 x $31) .................................................... c.

2,480

Cash (40 x $34)............................................................................. Treasury Shares (40 x $31) .................................................... Contributed Surplus................................................................

1,360

Common Shares [($150,000 ÷ 5,000) x (300 – 80 – 40)] ............... Contributed Surplus (maximum) .................................................... Retained Earnings (balance) ......................................................... Treasury Shares (180 x $31) ..................................................

5,400 120 60

1,240 120

5,580

Shareholders’ Equity

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CHAPTER 16 COMPLEX FINANCIAL INSTRUMENTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

1 1 1 1 1 1 1 1 1 2

E E E M E M E E E E

41. 42. 43. 44. 45. 46. 47. 48.

2 2 2 2 2 2 2 2

M M H E E E M M

73. 74.

4 4

M M

78. 79. 80.

1 2 3

M M H

87. 88.

2 2,5

H H

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 11. 2 E 21. 4 12. 2 M 22. 4 13. 2 M 23. 4 14. 2 E 24. 4 15. 2 M 25. 4 16. 3 E 26. 4 17. 4 M 27. 5 18. 4 E 28. 6 19. 4 M 29. 6 20. 4 M 30. 6 Multiple Choice–Computational 49. 2 M 57. 4 50. 4 M 58. 4 51. 4 M 59. 4 52. 4 H 60. 4 53. 4 M 61. 4 54. 4 M 62. 4 55. 4 H 63. 4 56. 4 H 64. 4 Multiple Choice–CPA Adapted 75. 4 M *77. 10 76. 5 M Exercises 81. 4 H 84. 5 82. 4 M 85. 6 83. 4 M *86. 10 Problems 89. 3,4 M *91. 9 *90. 9 M

M = Medium

LOD

Item

LOD

E M E M M M H M M M

*31. *32. *33. *34. *35. *36. *37. *38. *39. *40.

8 9 9 9 9 10 10 10 10 10

E M M M M M M M H H

M M H H M M M H

65. 66. 67. 68. 69. *70. *71. *72.

4 4 6 6 6 10 10 10

H H M H M M M M

M M H H

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

1. 2.

MC MC

3. 4.

MC MC

10. 11. 12.

MC MC MC

13. 14. 15.

MC MC MC

16.

80.

17. 18. 19. 20. 21. 22.

MC MC MC MC MC MC

23. 24. 25. 26. 50. 51.

MC MC MC MC MC MC

27.

76.

28. 29.

MC MC

30. 67.

MC MC

*31.

*32.

*33.

*36. *37.

MC MC

*38. *39.

MC MC

MC = Multiple Choice

Item Type Item Type Learning Objective 1 5. MC 7. MC 6. MC 8. MC Learning Objective 2 41. MC 44. MC 42. MC 45. MC 43. MC 46. MC Learning Objective 3 89. Pr Learning Objective 4 52. MC 58. MC 53. MC 59. MC 54. MC 60. MC 55. MC 61. MC 56. MC 62. MC 57. MC 63. MC Learning Objective 5 84. Ex 88. Pr Learning Objective 6 68. MC 85. Ex 69. MC Learning Objective 8 Learning Objective 9 *34. MC *35. MC Learning Objective 10 *40. MC *71. MC *70. MC *72. MC Ex = Exercise

Item

Type

Item

Type

9. 78.

MC Ex

47. 48. 49.

MC MC MC

79. 87. 88.

Ex Pr Pr

64. 65. 66. 73. 74. 75.

MC MC MC MC MC MC

81. 82. 83. 89.

Ex Ex Ex Pr

*90.

*91.

*77. *86.

MC Ex

Pr = Problem

Complex Financial Instruments

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CHAPTER STUDY OBJECTIVES 1. Understand what derivatives are and how they are used to manage risk. Derivatives are financial instruments that derive (get) their value from an underlying instrument. They are attractive since they transfer risks and rewards without having to necessarily invest directly in the underlying instrument. They are used for both speculative purposes (to expose a company to increased risks in the hope of increased returns) and for hedging purposes (to reduce existing risk). Financial risks include credit, currency, interest rate, liquidity, market, and other price risks. Credit risk is the risk that the other party to a financial instrument contract will fail to deliver. Currency and interest rate risk are the risk of a change in value and cash flows due to currency or interest rate changes. Liquidity risk is the risk that the company itself will not be able to honour the contract due to cash problems. Finally, market risk is the risk of a change in value and/or cash flows related to market forces.

2. Understand how to account for derivatives. Derivatives are recognized on the SFP on the date that the contract is initiated. They are remeasured, on each SFP date, to their fair value. The related gains and losses are recorded through net income. Written options create liabilities. Futures contracts require the company to deposit a portion of the contracts’ value with the broker/exchange. The contracts are marked to market by the broker/exchange daily and the company may have to deposit additional funds to cover deficiencies in the margin account. Purchase commitments that are net settleable and are not “expected use” contracts are accounted for as derivatives under IFRS. Under ASPE, purchase commitments are never accounted for as derivatives because they are not exchange-traded futures contracts. Exchange-traded derivatives relating to commodities are generally accounted for as derivatives under ASPE. Special hedge accounting may affect how derivatives are accounted for. Under IFRS, derivatives that are settleable in the entity’s own equity instruments are accounted for as equity (or contra-equity) if they will be settled by exchanging a fixed number of equity instruments for a fixed amount of cash or other assets and they do not create an obligation to deliver cash or other assets. Otherwise, they are financial assets/liabilities. In general, if the instruments are net settleable or have settlement options, they most often do not meet the criteria for equity presentation and are therefore financial assets/liabilities. IFRS provides significantly more guidance with respect to the accounting for these instruments.

3. Analyze whether a hybrid/compound instrument issued for financing purposes represents a liability, equity, or both. Complex instruments include compound and hybrid instruments where the legal form may differ from the economic substance. The economic substance dictates the accounting. The main issue is that of presentation: should the instrument be presented as debt or equity? The definitions of debt and equity are useful in analyzing this. It is also important to understand what gives the instruments their value from a finance or economic perspective. If an instrument has both debt and equity components, use of the proportional and incremental methods will help in allocating the carrying value between the two components. There are differences in measuring compound financial instruments under IFRS versus ASPE. Related interest, dividends, gains, and losses are treated in a way that is consistent with the SFP presentation.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

4. Explain the accounting for hybrid/compound instruments. The method for recording convertible bonds at the date of issuance is different from the method that is used to record straight debt issues. As the instrument is a compound instrument and contains both debt and equity components, these must be measured separately and presented as debt and equity, respectively. Any discount or premium that results from the issuance of convertible bonds is amortized, assuming the bonds will be held to maturity. If bonds are converted into other securities, the principal accounting problem is to determine the amount at which to record the securities that have been exchanged for the bond. The book value method is often used in practice. ASPE allows an entity to value the equity portion of compound instruments at $0.

5. Describe the various types of stock compensation plans. Stock compensation includes direct awards of stock (when a company gives the shares to an employee as compensation), compensatory stock option plans whereby an employee is given stock options in lieu of salary, share appreciation rights (SARs), and performance-type plans. SARs and performance-type plans are discussed in Appendix 16B. Employee stock option plans are meant to motivate employees and raise capital for the company. They are therefore capital transactions. Compensatory stock option plans are operating transactions since they are meant to compensate the employee for service provided.

6. Describe the accounting for share-based compensation. CSOPs and direct awards of stock are measured at fair value (using an options pricing model) at the grant date. The cost is then allocated to expense over the period that the employee provides service. As noted above, SARs and performance-type plans are discussed in Appendix 16B.

7. Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future. The differences are noted in the comparison chart. The stock-based compensation standards are largely converged and stable; however, the IASB is currently working on several projects relating to financial instruments including defining equity versus liabilities and hedging.

Complex Financial Instruments

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MULTIPLE CHOICE—Conceptual Answer b d c c d a c b b d c a b c d b b c b a d a c a d a d c a c b c d b c a a d c a

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. *31. *32. *33. *34. *35. *36. *37. *38. *39. *40.

Description Characteristics of derivatives Purpose of derivatives Definition of credit risk Types of market risks Speculator’s objective Arbitrageur’s objective Valuation of derivatives Recording gains on derivatives Meaning of writing an option Definition of a call option Definition of a put option Intrinsic value of an option Time value of an option Characteristics of a forward contract Characteristics of a futures contract Advantages of issuing debt Measurement of hybrid/compound instruments Classification of hybrid/compound instruments Presentation of high/low preferred shares under ASPE Classification of term preferred shares under IFRS Characteristics of convertible bonds Reasons for issuing convertible bonds Recording of convertible debt Recording conversion of bonds Classification of options on convertible securities Recording dividends on term preferred shares Characteristics of a non-compensatory stock option plan Accounting for a non-compensatory stock option plan Measurement date for a compensatory stock option plan Recognition of compensation expense for a stock option plan Definition of hedging Fair value hedge Hedge accounting Hedge accounting Swap contract SAR and timing of valuation Performance-type plan Executive compensation plans Compensation expense in a SAR plan Basis of performance-type plan

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational Answer a d b a b a b d c a b a b b c c d a d c d a d c b d c b a c b c

No. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. *70. *71. *72.

Description Settlement of a call option Recording a forward contract Settlement of a forward contract Calculating the intrinsic value of an option Calculating the time value of an option Recording a call option Recording the adjusting entry for a call option Recording expiry of a call option Recording the adjusting entry for a forward contract Conversion of convertible bonds Conversion of convertible bonds Conversion of convertible bonds Conversion of convertible bonds Effective interest rate on convertible bonds Calculating interest expense on bonds sold between interest dates Calculating unamortized bond discount on converted bonds Conversion of preferred shares Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Bonds issued with detachable stock warrants Preferred shares with detachable stock warrants Valuation of convertible bonds (IFRS) Determine compensation expense in a stock option plan Determine compensation expense in a stock option plan Determine compensation expense in a stock option plan Compensation expense recognized in first year of a SAR plan Compensation expense recognized in second year of a SAR plan Compensation expense recognized in third year of a SAR plan

*This topic is dealt with in an Appendix to the chapter.

Complex Financial Instruments

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MULTIPLE CHOICE—CPA Adapted Answer c b d c b

No. 73. 74. 75. 76. *77.

Description Allocation of proceeds from issuance of convertible bonds Recognition of gains/losses on bond conversion Bond issue with detachable stock warrants Compensation expense in a stock option plan Compensation expense recognized in a SAR plan

*This topic is dealt with in an Appendix to the chapter.

EXERCISES Item E16-78 E16-79 E16-80 E16-81 E16-82 E16-83 E16-84 E16-85 *E16-86

Description Definition of derivative instruments Put options Convertible debt and debt with warrants Convertible bonds Convertible bonds Redeemable preferred shares and succession planning Stock options Employee share ownership plans Stock appreciation rights

*This topic is dealt with in an Appendix to the chapter.

PROBLEMS Item P16-87 P16-88 P16-89 *P16-90 *P16-91

Description Forward contract Employee stock options Convertible bonds and warrants Interest rate swap Hedging (forward contract)

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual 1. Derivative instruments a. require significant investments. b. transfer financial risks. c. transfer primary instruments. d. are settled at the date of issuance.

2. Derivatives exist to help companies a. hide financial irregularities. b. reduce interest expense. c. manage cash flows. d. manage risks.

3. Credit risk is the risk that a. an instrument’s price or value will change. b. the company itself will not be able to fulfill its obligation. c. one of the parties to the contract will fail to fulfill its obligation and cause the other party loss. d. cash flow will change over time.

4. The three types of market risk are a. currency, interest rate, and liquidity risks. b. interest rate, other price, and credit risks. c. currency, interest rate, and other price risks. d. liquidity, currency, and other price risks. 5. A speculator’s objective is to a. reduce pre-existing risks. b. take delivery of the underlying. c. take advantage of information asymmetry. d. maximize potential returns by being exposed to greater risks.

6. An arbitrageur depends on a. information asymmetry between markets. b. hedging opportunities between markets. c. differing credit risks. d. differing liquidity risks.

7. Derivatives should be valued at a. historical cost. b. fair value or historical cost. c. fair value.

Complex Financial Instruments

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d. discounted cost.

8. Gains on derivatives should a. be booked through other comprehensive income. b. be booked through net income. c. be recorded as deferred revenue. d. not be recorded.

9. If a company writes an option, it a. pays a fee and gains a right. b. charges a fee and gives the holder a right. c. charges a fee for handling option transactions. d. endorses an option over to another party.

10. A call option is a right to a. force another party to buy the underlying security. b. repurchase a previously sold underlying security. c. sell the underlying security. d. buy the underlying security.

11. A put option is a right to a. force another party to buy the underlying security. b. repurchase a previously sold underlying security. c. sell the underlying security. d. buy the underlying security

12. The intrinsic value of an option is the a. difference between the price of the underlying security and the strike price. b. value due to expectations that the price of the underlying security will rise above the strike price. c. minimum value of the option. d. option premium value.

13. The time value of an option is the a. difference between the price of the underlying security and the strike price. b. value due to expectations that the price of the underlying security will rise above the strike price. c. minimum value of the option. d. option premium value.

14. A forward contract a. is generally exchange traded, therefore has a ready market value. b. creates a right but not an obligation. c. commits the contracting parties upfront to do something in the future.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. has no locked in time period.

15. A futures contract a. is not exchange traded, therefore does not have a ready market value. b. exposes the contracting party to credit risk. c. does not require a margin account to be established. d. is standardized as to amounts and dates.

16. An advantage of issuing debt instead of equity is that a. interest must be paid, regardless of earnings. b. the interest is tax deductible. c. it increases solvency or liquidity risks. d. no leverage is possible.

17. With regard to the measurement of hybrid/compound instruments, a. IFRS requires the use of the relative fair value method. b. IFRS requires the use of the residual method. c. ASPE does not allow the equity component to be valued at zero. d. After the initial measurement, the debt portion is always measured at fair value.

18. Which of the following would be classified as a hybrid/compound financial instrument? a. perpetual debt b. mandatorily redeemable preferred shares c. debt with detachable warrants d. puttable shares

19. ASPE requires that high/low (redeemable) preferred shares be presented as a. long-term debt. b. equity. c. either equity or long-term debt. d. a contra-asset.

20. Under IFRS, mandatorily redeemable preferred shares (term preferred shares) are treated as a. a liability. b. equity. c. a contra-asset. d. either a liability or a contra-asset.

21. Convertible bonds a. have priority over all other types of bonds. b. are usually secured by a first or second mortgage. c. pay interest only in the event earnings are sufficient to cover the interest. d. may usually be exchanged for common shares.

Complex Financial Instruments

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22. A common reason for issuing convertible bonds is a. to obtain debt financing at cheaper rates. b. to avoid paying dividends on common shares. c. to give the purchaser the option of buying preferred shares. d. to reduce the debt-to-total assets ratio.

23. Under IFRS, a convertible debt security is recorded as a debt instrument a. with the equity feature ignored. b. with the equity feature described in a note. c. and an equity component. d. with the conversion component credited to the Common Shares account.

24. When convertible debt is converted to common shares, IFRS requires that this is recorded by the a. book value method. b. relative fair value method. c. market value method. d. residual method.

25. For convertible securities, the portion relating to the option should be classified as a(n) a. liability. b. asset. c. reduction of contributed surplus. d. addition to contributed surplus.

26. Dividends on term preferred shares, where the shares have been recorded as a liability, should be debited to a. interest expense. b. retained earnings. c. contributed surplus. d. other comprehensive income.

27. Which of the following is NOT a characteristic of a non-compensatory employee stock option plan (ESOP)? a. The plan is generally available to all employees. b. There is only a small discount from the market price. c. The plan requires the employee to pay an up-front premium. d. The plan is accounted for as compensation expense.

28. Under a (non-compensatory) employee stock option plan (ESOP), when an option is sold to an employee, the employer debits Cash and credits a. Common Shares. b. Stock Option Payable.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. Contributed Surplus – Stock Options. d. Stock Option Revenue.

29. The date on which to measure the compensation element in a compensatory stock option plan (CSOP) is normally the date on which the employee a. is granted the option. b. has fulfilled all the conditions required to exercise the option. c. may first exercise the option. d. actually exercises the option.

30. Compensation expense resulting from a compensatory stock option plan (CSOP) is generally recognized a. in the period of exercise. b. at the grant date. c. in the periods in which the employee performs the service. d. over the periods of the employee's service life to retirement.

*31. Hedging is the use of a. derivatives or other instruments to increase returns. b. derivatives or other instruments to offset risks. c. debt to offset risks. d. forward contracts.

*32. A fair value hedge protects the company against a. errors in valuation of derivative instruments. b. a future transaction that has not yet been recognized. c. an existing exposure related to an existing asset or liability. d. fluctuations in exchange rates.

*33. Hedge accounting is a. mandatory. b. mandatory if specified criteria are met. c. optional until December 2015 and mandatory thereafter. d. optional.

*34. Using IFRS, hedge accounting allows the gain or loss on the hedge transaction to a. be booked through net income. b. be booked through other comprehensive income. c. not be booked. d. not be booked until the hedge closes.

*35. If a company enters into a hedging contract to swap a floating interest rate for a fixed rate, by the end of the contract the interest rate incurred by the company will equal a. the difference between the fixed and the floating rate.

Complex Financial Instruments

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b. the floating rate. c. the fixed rate. d. whichever rate is highest.

*36. If an SAR is determined to be an equity instrument, it would be valued at a. grant date and not revised at subsequent interim dates. b. each interim date. c. exercise date. d. grant date and revalued at exercise date.

*37. Compensation expense resulting from a performance-type plan is generally a. determined at the measurement date. b. recognized in the period of the grant. c. allocated to the periods subsequent to the measurement date. d. recognized in the period of exercise.

*38. An executive compensation plan in which the executive may receive compensation in cash, shares, or a combination of both, is known as a. a nonqualified shares option plan. b. a performance-type plan. c. a stock appreciation rights plan. d. both a performance-type and a stock appreciation rights plan.

*39. The date on which to measure the compensation in a stock appreciation rights plan is the a. date of grant. b. date of exercise. c. end of each interim period up to the date of exercise. d. date that the market price exceeds the option price.

*40. The payment to executives from a performance-type plan is NEVER based on the a. market price of the common shares. b. return on assets (investment). c. return on common shareholders' equity. d. sales.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

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

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

b d c c d a

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

c b b d c a

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

b c d b b c

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

b a d a c a

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

d a d c a c

*31. *32. *33. *34. *35. *36.

b c d b c a

*37. *38. *39. *40.

a d c a

Complex Financial Instruments

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MULTIPLE CHOICE—Computational 41. On July 5, 2014, Alpha Corp. purchased a call option for $2,400, giving it the right to buy 1,000 shares of Omega Corp. for $40 per share. On August 18, 2014, when the option value is $12,000, Omega settles the option for cash. The entry on Alpha’s books to record the settlement is a. Cash....................................................................................... 12,000 Derivatives—Financial Assets/Liabilities .......................... 2,400 Gain................................................................................. 9,600 b. Cash....................................................................................... 12,000 Gain................................................................................. 12,000 c. Cash....................................................................................... 12,000 Derivatives—Financial Assets/Liabilities .......................... 12,000 d. Derivatives—Financial Assets/Liabilities ................................. 2,400 Cash....................................................................................... 9,600 Gain................................................................................. 12,000

Use the following information for questions 42–43. On August 25, 2014, Beta Inc. entered into a forward contract to buy 50,000 Krubles (KRB) for $8,300 Canadian (CAD) on September 5, 2014. On August 31, 2014, 50,000 KRB can be purchased for $8,000 CAD. On September 5, Beta settles the contract but does NOT take delivery of the KRB.

42. The entry to record the change in value of the contract on August 31, 2014 is a. no entry. b. Other Comprehensive Loss .................................................... 300 Derivatives—Financial Assets/Liabilities .......................... c. Derivatives—Financial Assets/Liabilities ................................. 300 Gain................................................................................. d. Loss ....................................................................................... 300 Derivatives—Financial Assets/Liabilities ..........................

300 300 300

43. On September 5, 2014, the KRB is trading at $0.17 CAD. The entry to record the settlement of the contract is a. Derivatives—Financial Assets/Liabilities ................................. 300 Cash....................................................................................... 500 Gain................................................................................. 800 b. Derivatives—Financial Assets/Liabilities ................................. 300 Cash....................................................................................... 200 Gain................................................................................. 500 c. Derivatives—Financial Assets/Liabilities ................................. 300 Cash ................................................................................ 200 Gain................................................................................. 100 d. Cash....................................................................................... 500 Derivatives—Financial Assets/Liabilities .......................... 300

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Gain.................................................................................

200

Use the following information for questions 44–48. On April 1, 2014, Gamma Corp. purchases a call option for $500, which gives Gamma the right to buy 1,000 shares of Delta Inc. for $30 each until December 1, 2014. Delta Inc. shares are currently trading for $30. At June 30, 2014, the options are trading at $4,800 and the shares at $32 each. At December 1, 2014, the options expire with no value.

44. The intrinsic value of the option at April 1, 2014 is a. $ 0. b. $ 500. c. $1,000. d. $4,800.

45. The time value of the option at April 1, 2014 is a. $ 0. b. $ 500. c. $ 4,800. d. $30,000.

46. The entry to record the purchase of the call option is a. Derivatives—Financial Assets ................................................ Cash ................................................................................ b. Cash....................................................................................... Derivatives—Financial Assets ......................................... c. Investments—Held-To-Maturity .............................................. Cash ................................................................................ d. No entry required. 47. At June 30, 2014, Gamma’s quarter end, the adjusting entry would be a. No entry required. b. Derivatives—Financial Assets ................................................ Gain................................................................................. c. Derivatives—Financial Assets ................................................ Other Comprehensive Income ......................................... d. Derivatives—Financial Assets ................................................ Gain................................................................................. 48. At December 1, 2014, Gamma’s entry would be a. No entry required. b. Loss ....................................................................................... Derivatives—Financial Assets ......................................... c. Loss ....................................................................................... Derivatives—Financial Assets .........................................

500 500 500 500 500 500

4,300 4,300 4,300 4,300 4,800 4,800

2,000 2,000 4,300 4,300

Complex Financial Instruments

Loss ....................................................................................... Derivatives—Financial Assets .........................................

16- 17

4,800 4,800

49. On October 5, 2014, Kappa Cloth Ltd. enters into a forward contract to purchase 10,000 metres of cotton fabric at $1 per metre, good until February 1, 2015. At December 31, 2014, the forward price for February 2015 delivery of cotton fabric has increased to $1.04 per metre. The adjusting entry at December 31, 2014 would be a. No entry required. b. Derivatives—Financial Assets/Liabilities ................................. 400 Unrealized Gain (OCI) ..................................................... 400 c. Derivatives—Financial Assets/Liabilities ................................. 400 Gain................................................................................. 400 d. Loss ....................................................................................... 400 Derivatives—Financial Assets/Liabilities .......................... 400

Use the following information for questions 50–51. Dakar Inc. has $3,000,000 (par value), 8% convertible bonds outstanding. Each $1,000 bond is convertible into thirty no par value common shares. The bonds pay interest on January 31 and July 31. On July 31, 2014, the holders of $900,000 worth of bonds exercised the conversion privilege. On that date the market price of the bonds was 105, the market price of the common shares was $36, the carrying value of the common shares was $18 and the Contributed Surplus—Conversion Rights account balance was $450,000. The total unamortized bond premium at the date of conversion was $210,000.

50. Using the book value method, Dakar should record as a result of this conversion a. no gain or loss. b. a loss of $9,000. c. other comprehensive income of $9,000. d. a gain of $18,000.

51. Using the book value method, Dakar should record as a result of this conversion a. a credit of $135,000 to Contributed Surplus—Conversion Rights. b. a debit of $135,000 to Contributed Surplus—Conversion Rights. c. a credit of $63,000 to Bonds Payable. d. a debit of $210,000 to Bonds Payable.

52. On July 1, 2014, an interest payment date, $180,000 (par value) of Lusaka Corp. bonds were converted into 3,600 of their no par common shares. At this time, the unamortized discount on the bonds was $7,200. When the bonds were originally issued, the equity portion of the bond was valued at $1,700. Using the book value method, Lusaka would record a. an $174,500 increase in Common Shares. b. an $172,800 increase in Common Shares. c. an $171,100 increase in Common Shares. d. no change to Contributed Surplus.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

53. Johannesburg Corp. has two issues of securities outstanding: no par value common shares and 8% convertible bonds with a par value of $8,000,000. Bond interest payment dates are June 30 and December 31. The conversion clause in the bond indenture entitles the bondholders to receive 40 common shares in exchange for each $1,000 bond. The value of the equity portion of the bond issue is $60,000. On June 30, 2014, the holders of $1,200,000 par value bonds exercise the conversion privilege. The market price of the bonds on that date is $1,100 per bond and the market price of the common shares is $35. The total unamortized bond discount at the date of conversion is $500,000. In applying the book value method, what amount should Johannesburg credit to Common Shares as a result of this conversion? a. $1,284,000 b. $1,134,000 c. $1,125,000 d. $1,116,000

Use the following information for questions 54–56. On July 1, 2014, Casablanca Ltd. issued $6,000,000 (par value), 9%, ten-year convertible bonds at 98 plus accrued interest. The bonds were dated April 1, 2014 with interest payable on April 1 and October 1. If the bonds had NOT been convertible, they would have sold for 96.1 plus accrued interest. The bond discount is amortized on a straight-line basis. On April 1, 2015, $1,200,000 of these bonds were converted into 500 no par common shares. Accrued interest was paid in cash at the time of conversion.

54. What was the effective interest rate on the bonds when they were issued? a. 9% b. above 9% c. below 9% d. cannot determine from the information given

55. If Interest Payable were credited when the bonds were issued, what is the debit to Interest Expense on October 1, 2014? a. $129,000 b. $135,000 c. $141,000 d. $143,923

56. What is the amount of the unamortized bond discount on April 1, 2015 relating to the bonds that were converted? a. $64,246 b. $46,800 c. $43,200 d. $44,400

57. In 2013, Algiers Inc. issued 10,000 no par value convertible preferred shares for $103 each. One preferred share can be converted into three shares of Algiers' no par value common shares

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at the option of the shareholder. In August 2014, all of the preferred shares were converted into common shares. The market value of the common shares at the date of the conversion was $30 per share. What amount should be credited to Common Shares as a result of this conversion? a. $ 300,000 b. $ 500,000 c. $ 900,000 d. $1,030,000

58. On December 1, 2014, Cairo Ltd. issued 500 of its 9%, $1,000 bonds at 103. Attached to each bond was one detachable warrant entitling the holder to purchase ten of Cairo's common shares. At this time, the market value of the bonds, without the warrants, was 95, and the market value of each warrant was $50. Using the residual method, the amount of the proceeds from the issuance that should be credited to Bonds Payable would be a. $475,000. b. $489,250. c. $500,000. d. $515,000.

59. On March 1, 2014, Rabat Corp. sold $300,000 (par value), 20 year, 8% bonds at 104. Each $1,000 bond was issued with 25 detachable warrants, each of which entitled the bondholder to purchase for $50 one of Rabat’s no par value common shares. The bonds without the warrants would normally sell at 95. At this time, the market value of Rabat’s common shares was $40 per share and the market value of each warrant was $2.00. Using the relative fair value method, what amount should Rabat record on March 1, 2014 as Contributed Surplus—Stock Warrants? a. $10,800 b. $12,600 c. $15,000 d. $15,600

60. During 2014, Khartoum Corp. issued four hundred $1,000 bonds at 104. One detachable warrant, entitling the holder to purchase 15 of Khartoum’ common shares, was attached to each bond. At the date of issuance, the market value of the bonds, without the warrants, was 96. The market value of each warrant was $40. Using the relative fair value method, what amount should Khartoum credit to Bonds Payable from the proceeds? a. $416,000 b. $400,000 c. $399,360 d. $384,000

61. On April 7, 2014, Soweto Corp. sold a $1,000,000 (par value), 20 year, 8% bond issue for $1,060,000. Each $1,000 bond has two detachable warrants. Each warrant permits the purchase one of Soweto's no par value common shares for $30. At the time of the sale, Soweto's securities had the following market values: Each $1,000 bond without warrants $1,006 Warrants $21 Common shares $27 Assuming that Soweto adheres to IFRS, what entry should the corporation make to record the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

sale of the bonds? a. Cash....................................................................................... Bonds Payable ................................................................ Contributed Surplus—Stock Warrants ............................. b. Cash....................................................................................... Bonds Payable ................................................................ Contributed Surplus—Stock Warrants ............................. c. Cash....................................................................................... Bonds Payable ................................................................ d. Cash....................................................................................... Bonds Payable ................................................................ Contributed Surplus—Stock Warrants .............................

1,060,000 1,000,000 60,000 1,060,000 1,018,000 42,000 1,060,000 1,060,000 1,060,000 1,006,000 54,000

Use the following information for questions 62–63. On May 1, 2014, Durban Ltd. issued $500,000, 10 year, 7% bonds at 103. Twenty detachable warrants were attached to each $1,000 bond, which entitled the holder to purchase one of Durban’s no par value common shares for $40. At this time, similar bonds without warrants were selling at 96. It was determined that the fair value of Durban’s common shares was $35, but the value of the warrants was NOT determinable. Durban is a private corporation that follows ASPE, but does NOT use the residual method.

62. On May 1, 2014, Durban should credit Bonds Payable for a. $515,000. b. $500,000. c. $480,000. d. cannot be determined from the information given.

63. On May 1, 2014, Durban should credit Contributed Surplus—Stock Warrants for a. $35,000. b. $20,000. c. $15,000. d. $ 0.

64. Lagos Inc. issued bonds with detachable warrants for $5,000,000 (par value). The bonds have a present value of $4,934,400. The fair value of the warrants is determined to be $220,000. Using the relative fair value method, how much of the issue price should be allocated to the warrants? a. $ 65,600 b. $211,200 c. $213,500 d. $220,000

65. On July 1, 2014, Juba Inc. issued 10,000, $7 non-cumulative, no par value preferred shares for $1,050,000. Attached to each share was one detachable warrant, giving the holder the right to purchase one of Juba’s no par value common shares for $30. At this time, the shares without

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the warrants would normally sell for $1,025,000, while the market price of the warrants was $2.50 each. On October 31, 2014, when the market price of the common shares was $19 and the market value of the warrants was $3.00, 4,000 warrants were exercised. Juba adheres to IFRS. As a result of the exercise of the warrants and the issuance of the related common shares, what journal entry would Juba make? a. Cash....................................................................................... 120,000 Common Shares.............................................................. 120,000 b. Cash....................................................................................... 120,000 Contributed Surplus—Stock Warrants .................................... 10,000 Common Shares.............................................................. 130,000 c. Cash....................................................................................... 120,000 Contributed Surplus—Stock Warrants .................................... 25,000 Common Shares.............................................................. 145,000 d. Cash....................................................................................... 120,000 Contributed Surplus—Stock Warrants .................................... 15,000 Common Shares.............................................................. 135,000

66. Bissau Ltd. issued $4,000,000, 5-year, 8% convertible bonds at par. Each $1,000 bond is convertible to 200 of Bissau’s no par value common shares, which are currently trading at $25 each. The current market rate for similar non-convertible bonds is 10%. Assuming Bissau adheres to IFRS, the value to be recorded for the conversion option is a. $ 0. b. $ 5,000. c. $100,000. d. $303,267.

67. On January 1, 2012, Tunis Inc. granted stock options for 50,000 of its no par value common shares to key employees, at an option price of $25. On that date, the market price of the common shares was $23. The Black-Scholes option pricing model determined total compensation expense to be $375,000. The options are exercisable beginning January 1, 2015, providing the key employees are still employed by Tunis at the time the options are exercised. The options expire on January 1, 2016. On January 2, 2015, when the market price of the shares was $29 per share, all 50,000 options were exercised. The amount of compensation expense Tunis should have recorded for calendar 2013 is a. $ 0. b. $ 50,000. c. $125,000. d. $187,500.

68. On June 30, 2012, Kinshasa Corp. granted stock options for 30,000 of its no par value common shares to key employees, at an option price of $36. On that date, the market price of the common shares was $32. The Black-Scholes option pricing model determined total compensation expense to be $720,000. The options are exercisable beginning January 1, 2015, providing the key employees are still employed by Kinshasa at the time the options are exercised. The options expire on June 30, 2016. On January 2, 2015, when the market price of the shares was $42, all 30,000 options were exercised. The amount of compensation expense Kinshasa should have recorded for calendar 2014 is a. $120,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b. $288,000. c. $360,000. d. $720,000.

69. On December 31, 2012, in order to retain certain key executives, Entebbe Corporation granted them stock options. 25,000 options were granted at an option price of $40 per share. Market prices of the shares were as follows: December 31, 2013 $35 per share December 31, 2014 $39 per share The options were granted as compensation for services to be rendered over a two-year period beginning January 1, 2013. The Black-Scholes option pricing model determined total compensation expense to be $500,000. The amount of compensation expense Entebbe should have recorded for calendar 2014 is a. $250,000. b. $500,000. c. $875,000. d. $1,000,000.

Use the following information for questions *70–*72. On January 1, 2013, Luanda Ltd. established a stock appreciation rights plan for its executives. This plan entitles them to receive cash at any time during the next four years for the difference between the market price of its common shares and a pre-established price of $20, on 50,000 SARs. Market prices of the shares are as follows: January 1, 2013 $35 per share December 31, 2013 $38 per share December 31, 2014 $30 per share December 31, 2015 $33 per share Compensation expense relating to the plan is to be recorded over a four-year period beginning January 1, 2013.

*70. What amount of compensation expense should Luanda recognize for calendar 2013? a. $150,000 b. $187,500 c. $225,000 d. $900,000

*71. What amount of compensation expense should Luanda recognize for calendar 2014? a. $ 0 b. $ 25,000 c. $125,000 d. $250,000

*72. On December 31, 2015, 8,000 SARs are exercised by executives. What amount of compensation expense should Luanda recognize for calendar 2015? a. $ 65,000

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b. $162,500 c. $237,500 d. $487,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

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

a d b a b a

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

b d c a b a

53. 54. 55. 56. 57. 58.

b b c c d a

59. 60. 61. 62. 63. 64.

d c d a d c

65. 66. 67. 68. 69. *70.

b d c b a c

*71. *72.

b c

DERIVATIONS—Computational No. Answer 41. a 42. d 43. b

44. 45. 46. 47. 48. 49. 50. 51. 52. 53.

a b a b d c a b a b

54. 55.

b c

56. 57. 58. 59.

c d a d

Derivation $12,000 – $2,400 = $9,600 gain Agreed payment $8,300 – $8,000 current cost = $300 loss 50,000 KRB @.$17 = $8,500 $8,500 – $8,300 settlement amount = $200 gain overall $200 gain + $300 loss previously recorded = $500 gain $30 – $30 = $0 $500 – $0 = $500 Conceptual $4,800 fair value less $500 recorded cost = $4,300 gain $0 – $4,800 = $4,800 loss ($1.04 – $1.00) × 10,000 = $400 gain Conceptual $450,000 x 900 ÷ 3,000 = $135,000 $180,000 – $7,200 + $1,700 = $174,500 ($1,200,000 ÷ 8,000,000) × $500,000 = $75,000 (unamortized discount) ($1,200,000 ÷ 8,000,000) × $60,000 = $9,000 (cont. surplus) $1,200,000 – $75,000 + $9,000 = $1,134,000 Bonds issued at a discount, therefore effective (market) rate > stated rate $6,000,000 × 96.1% = $5,766,000 $6,000,000 × 98% = $5,880,000 $5,880,000 – $5,766,000 = $114,000 (cont. surplus) $5,880,000 + ($6,000,000 × .09 × 3 ÷ 12) = $6,015,000 (cash rec’d) $6,000,000– $5,766,000 = $234,000 (bond discount) ($6,000,000 × .09 × 3 ÷ 12) + ($234,000 × 3 ÷ 117) = $141,000 $234,000 × ($1,200,000 ÷ $6,000,000) × (108 ÷ 117) = $43,200 $103 × 10,000 = $1,030,000 500 x $1,000 x .95 = $475,000, balance to contrib surplus ($300,000 × .95) + (300 × 25 × $2) = $300,000; $300,000 × 1.04 = $312,000

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$15,000 × $312,000 = $15,600 $300,000

60.

61.

62.

63. 64.

d c

65.

66.

67. 68. 69. *70. *71. *72.

c b a c b c

($400,000 × .96) + (400 × $40) = $400,000; $400,000 × 1.04 = $416,000 $384,000 x $416,000 = $399,360 $400,000 IFRS requires residual method $1,000,000 ÷ $1,000 = 1,000 bonds sold; 1,000 x $1,006 = $1,006,000; balance to cont. surplus Under ASPE, if not using residual method, can assign zero to equity component, therefore entire proceeds of $500,000 x 1.03 = $515,000 credited to Bonds Payable see Q 62 Bonds $4,934,400 95.73% Warrants 220,000 4.27% Total $5,154,400 100% $5,000,000 issue price × 4.27% = $213,500 Dr. Cash: 4,000 × $30 = $120,000 Dr. Contributed Surplus—Stock Warrants: $25,000 × 4 ÷ 10 = $10,000 Cr. Common Shares: $120,000 + $10,000 = $130,000 PV $4,000,000, 5 years,10% = $2,483,680 PV $320,000/year, 5 years, 10% = 1,213,053 Total $3,696,733 Issue price of $4,000,000 – $3,696,733 = $303,267 value of option $375,000 ÷ 3 = $125,000/year $720,000 x 12 ÷ 30 = $288,000 $500,000 ÷ 2 = $250,000 ($38 – $20) × 50,000 × .25 = $225,000 ($30 – $20) × 50,000 × .5 = $250,000; $250,000 – $225,000 = $25,000 ($33 – $20) × 50,000 × .75 = $487,500; $487,500 – $250,000 = $237,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Use the following information for questions 73–74. On January 2, 2014, Perseus Corp. issued 10-year convertible bonds at 105. During 2015, all the bonds were converted into common shares having a total value equal to the total face amount of the bonds. At conversion, the market price of Perseus's common shares was 50% above its average carrying value. Perseus adheres to IFRS.

73. At issuance, the cash proceeds from the issuance of these bonds should be reported as a. contributed surplus for the entire proceeds. b. contributed surplus for the portion of the proceeds attributable to the conversion feature and as a liability for the balance. c. a liability for the present value of the bonds and contributed surplus for the balance. d. a liability for the entire proceeds.

74. On conversion, Perseus would credit the Common Shares account with a. the par value of the bonds plus the balance in the contributed surplus account. b. the carrying value of the bonds plus the balance in the contributed surplus account. c. the carrying value of the bonds minus the balance in the contributed surplus account. d. the market value of the bonds plus the balance in the contributed surplus account.

75. Antigone Corp. issued bonds with detachable common stock warrants. Only the bonds had a known market value. Using the residual method, the value attributable to the warrants is reported as a. Stock Warrants Distributable. b. Other Comprehensive Income. c. Common Shares Subscribed. d. Contributed Surplus—Stock Warrants.

76. On January 1, 2014, Orion Corp. granted an employee an option to purchase 5,000 of Orion's no par value common shares at $50 per share. The Black-Scholes option pricing model determined total compensation expense to be $220,000. The option became exercisable on December 31, 2015, after the employee completed two years of service. The market prices of Orion's shares were as follows: January 1, 2014 $40 December 31, 2015 $52 For calendar 2015, Orion should recognize compensation expense of a. $ 0. b. $ 50,000. c. $110,000. d. $250,000.

*77. On January 2, 2014, for past services rendered, Zeus Corp. granted Joanna Wood, its

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president, 18,000 stock appreciation rights that are exercisable immediately and expire on January 2, 2015. On exercise, Wood is entitled to receive cash for the excess of the market price of the shares on the exercise date over the market price on the grant date. Wood did NOT exercise any of the rights during 2014. The market price of Zeus's shares was $35 on January 2, 2014, and $45 on December 31, 2014. As a result of the stock appreciation rights, Zeus should recognize compensation expense for 2014 of a. $ 0. b. $180,000. c. $630,000. d. $810,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

73.

74.

75.

76.

*77.

DERIVATIONS—CPA Adapted No. Answer 73. c 74. b 75. d 76. c *77. b

Derivation Conceptual Conceptual Conceptual $220,000 ÷ 2 = $110,000 ($45 – $35) × 18,000 = $180,000

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Complex Financial Instruments

EXERCISES Ex. 16-78 Definition of derivative instruments Define and explain derivative instruments. Solution 16-78 Derivatives are financial instruments, which create rights and obligations that have the effect of transferring between parties to the instrument one or more of the financial risks inherent in an underlying primary instrument without having to transfer the underlying instrument. Derivative instruments require little or no initial investment, their values change in response to the underlying instrument, and they are settled at a future date.

Ex. 16-79 Put options On November 15, 2014, Raleigh Inc. purchases a held-for-trading investment for $250,000. Rowena also enters into a put option to sell the shares for $250,000. At December 31, 2014, the investment is valued at $255,000. Instructions Record any adjusting entries required at December 31, 2014 in connection with the above transactions. Solution 16-79 Investment—HFT ($255,000 – $250,000) ............................................ Gain .............................................................................................. Loss ..................................................................................................... Derivatives—Financial Assets/Liabilities .......................................

5,000 5,000 5,000 5,000

Ex. 16-80 Convertible debt and debt with warrants What accounting treatment is required for convertible debt? Why? What accounting treatment is required for debt issued with stock warrants? Why? Solution 16-80 Convertible debt is a hybrid/compound financial instrument and is generally treated as having both a debt component and an equity component. The conversion feature makes the bond more valuable to an investor and therefore the convertible feature has value. Under IFRS, compound instruments must be split into their components and presented separately in the financial statements. IFRS also requires the use of the residual method: the value of the debt component is determined, and the balance is assigned to the equity component (as contributed surplus). ASPE allows a zero value to be assigned to the equity component, or the use of the residual method. When debt is issued with stock warrants, the warrants are also given separate recognition. After issue, the debt and the detachable warrants trade separately. The proceeds may be allocated to the two elements based on the relative fair values of the debt security without the warrants and the warrants at the time of issue, or by the residual method. The proceeds allocated to the warrants should also be accounted for as contributed surplus.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Ex. 16-81 Convertible bonds On December 1, 2014, Boston Corp. issued $5,000,000 (par value), 12%, 5-year convertible bonds for $5,026,000 plus accrued interest. The bonds were dated April 1, 2014 with interest payable April 1 and October 1. If the bonds had NOT been convertible, they would have sold for $5,006,000. Bond premium/discount is amortized each interest period on a straight-line basis. Boston does NOT value the equity component at zero. Boston’s fiscal year end is September 30. On October 1, 2015, half of these bonds were converted into 35,000 no par common shares. Accrued interest was paid in cash at the time of conversion. Instructions a. Prepare the entry to record the interest expense at April 1, 2015. Assume that interest payable was credited when the bonds were issued (round to nearest dollar). b. Prepare the entry to record the conversion on October 1, 2015. Use the book value method. Assume that the entry to record amortization of the bond premium/discount and interest payment has been made. Solution 16-81 a. April 1, 2015 Interest Payable ............................................................................ Interest Expense ........................................................................... Bonds Payable .............................................................................. Cash.......................................................................................

100,000 199,540 460 300,000

Calculations: Issuance price ........................................................................ $5,026,000 Price without conversion......................................................... 5,006,000 Contributed surplus-conversion .............................................. $ 20,000 Premium ($5,006,000 – $5,000,000) ...................................... Months remaining ................................................................... Premium per month ................................................................ Premium amortized (4 × $115) ............................................... b.

$6,000 52 $115 $460

October 1, 2015 Bonds Payable ($2,500,000 + $2,423*) ......................................... 2,502,423 Contributed Surplus—Conversion Rights ($20,000 x 50%) ........... 10,000 Common Shares .................................................................... 2,512,423 Calculations: Premium related to 1/2 of the bonds ($6,000 ÷ 2) ................... Less premium already amortized [($6,000 x 10 ÷ 52) ÷ 2] ...... Premium remaining* ...............................................................

$3,000 577 $2,423

Ex. 16-82 Convertible bonds Atlanta Ltd. sold convertible bonds at a premium. Interest is paid on May 31 and November 30.

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On May 31, after the required interest was paid, all the bonds were converted into 3,000 no par value common shares, which were currently trading at $50 per share. Instructions How should Atlanta account for the conversion of the bonds under the book value method? Discuss the rationale for this method. Solution 16-82 To account for the conversion of bonds under the book value method, Bonds Payable should be debited for the current carrying value, the entire amount of Contributed Surplus—Conversion Rights should be removed (debited) and Common Shares should be credited for the total of these two amounts. The current market value of the shares is irrelevant. No gain or loss on conversion is recorded. The amount to be recorded for the shares is equal to the carrying value of the bonds plus the balance of the Contributed Surplus—Conversion Rights that was recorded when the convertible bonds were first issued. The rationale for the book value method is that the conversion is the completion of the transaction initiated when the bonds were issued. Since this is viewed as a transaction with shareholders, no gain or loss should be recognized. Note that both ASPE and IFRS require the use of the book value method.

Ex. 16-83 Redeemable preferred shares and succession planning Explain how redeemable preferred shares are used in succession planning for small business corporations. Solution 16-83 In succession planning for a small business, it is advantageous to use high/low redeemable preferred shares. The common shares of the existing company are transferred to a new company on a tax deferred basis. The retiring family member receives new redeemable preferred shares that will freeze his/her interest at the current value of the business. These shares may be redeemed over time. The next generation of the family receives the new common shares which will result in any future increase in value of the business accruing to them.

Ex. 16-84 Stock options Prepare the necessary entries from January 1, 2014 to February 1, 2016 for the following events. If no entry is needed, write "No entry necessary." 1. On January 1, 2014, the shareholders of Musetta Inc. adopted a stock option plan for its top executives, where each could receive rights to purchase up to 3,000 common shares at $40 per share. At this date, the shares were trading for $32 per share. 2. On February 1, 2014, options were granted to five executives to purchase 3,000 shares each. The options were non-transferable and the executive had to remain an employee of the company to exercise the option. The options expire on February 1, 2016. It is assumed that the options were for services performed equally in 2014 and 2015. The Black-Scholes option pricing model determined total compensation expense to be $390,000. 3. On February 1, 2016, four executives exercised their options. The fifth executive chose not to exercise her options, which therefore were forfeited. Solution 16-84 1. January 1, 2014

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

No entry necessary. 2.

February 1, 2014 No entry necessary. December 31, 2014 Compensation Expense ($390,000 ÷ 2) ........................................ Contributed Surplus—Stock Options ......................................

195,000

December 31, 2015 Compensation Expense ................................................................ Contributed Surplus—Stock Options ......................................

195,000

February 1, 2016 Cash (4 × 3,000 × $40) ................................................................. Contributed Surplus—Stock Options ($390,000 × 4 ÷ 5) ............... Common Shares ....................................................................

480,000 312,000

Contributed Surplus—Stock Options ($380,000 – $312,000) ........ Contributed Surplus—Expired Stock Options .........................

78,000

195,000

792,000

78,000

Ex. 16-85 Employee share ownership plans Lilly Inc. set up an ESOP under which employees may purchase shares of the company for $20 per share. The option premium is $.50 per share and Lilly set aside 20,000 shares. On January 1, 2014, 12,000 options are purchased by employees. On December 1, 2014, all 12,000 options are exercised. Instructions Prepare the journal entries to record the above events. Solution 16-85 January 1, 2014 Cash (12,000 × $.50) ........................................................................... Contributed Surplus—Stock Options ............................................. December 1, 2014 Cash (12,000 × $20) ............................................................................ Contributed Surplus—Stock Options .................................................... Common Shares ...........................................................................

6,000 6,000

240,000 6,000 246,000

*Ex. 16-86 Stock appreciation rights On January 1, 2014, Hay Ltd. established a stock appreciation rights (SAR) plan for its executives. They could receive cash at any time during the next four years equal to the difference between the market price of the common shares and a pre-established price of $16 for 180,000 SARs. The market prices are: Dec 31, 2014—$21 Dec 31, 2015—$18 Dec 31, 2016—$19 Dec 31, 2017—$20

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On December 31, 2016, 40,000 SARs are exercised, and the remaining SARs are exercised on December 31, 2017. Instructions a. Prepare a schedule that shows the amount of compensation expense for each of the four years, starting with 2014. b. Prepare the journal entry at December 31, 2015 to record compensation expense. c. Prepare the journal entry at December 31, 2017 to record the exercise of the remaining SARs. *Solution 16-86 a.

Schedule of Compensation Expense 180,000 SARs

Date Dec. 31, 2015

Market Price $21

Set Price $16

Value of SARs $900,000

Percent Accrued 25%

Dec. 31, 2015

360,000

50%

Dec. 31, 2016

540,000

75%

Dec. 31, 2017

560,000 ($4 × 140,000)

100%

Accrued to Date $225,000 (45,000) 180,000 225,000 405,000 155,000 560,000

Liability Under Share Appreciation Rights Plan ............................. Compensation Expense .........................................................

45,000

Liability Under Share Appreciation Rights Plan ............................. Cash.......................................................................................

560,000

Expense $225,000 (45,000) 225,000 155,000

45,000

560,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 16-87 Forward contract Hudson Bay Builders Ltd. uses fir 2x6 lumber as its framing material. On November 15, 2014, Hudson Bay enters into a forward contract for 1,500,000 board feet of lumber at $0.25 per board foot for March 2015 delivery. At December 31, 2014, the market price for March delivery is $0.26. On March 5, 2015, Hudson Bay took delivery of 1,500,000 board feet for $0.25 and settled the forward contract. The market rate on this date was $0.28 per board foot. Instructions Record any required entries related to this contract. Solution 16-87 a. November 15, 2014 No entry. b.

December 31, 2014 Record gain to date Derivatives—Financial Assets/Liabilities ....................................... Gain ($0.26 – $0.25) × 1,500,000 ........................................... March 5, 2015 Settlement of futures contract Inventory ($0.28 × 1,500,000) ....................................................... Derivatives—Financial Assets/Liabilities ................................. Gain ....................................................................................... Cash ($0.25 x 1,500,000) .......................................................

15,000 15,000

420,000 15,000 30,000 375,000

Pr. 16-88 Employee stock options On November 1, 2012, London Corp. adopted a stock option plan allowing certain of their executives to purchase a total of 30,000 common shares. The options were granted on January 2, 2013, and were exercisable four years after the grant date (Jan 2, 2017), as long as the executives were still employees. The options expire eight years from the grant date. The exercise price was set at $46 and, using an option pricing model to value the options, the total compensation expense was estimated to be $510,000. At January 2, 2013, the market price of the shares was $50. On January 1, 2014, 3,000 options were terminated (forfeited) when an employee left the company. The market value of the shares at that date was $32. All the remaining options were exercised during 2017: 17,000 on January 3 when the market price was $62, and 10,000 on May 1 when the market price was $77. Instructions a. Calculate the intrinsic value and the time value of the stock option. b. Prepare journal entries relating to the stock option plan for the years 2013 through 2017. Assume that the employees perform services equally from 2013 through 2016. Year end is December 31. c. Discuss the advantages and disadvantages of offering stock options to employees as a means of compensation.

Complex Financial Instruments

16- 35

Solution 16-88 a. The intrinsic value of the option is the difference between the market price and the strike (exercise) price. In this case the market price is $50 and the strike price is $46. Intrinsic value component: ($50 – $46) x 30,000 = $120,000 The time value of the option is the remaining value of the options. Since the total value of the options is $510,000, then the difference between the total value and the intrinsic value should be the time value component. Time value component: $510,000 – $120,000 = $390,000 b. Jan 2/13

No entry required

Dec 31/13

Jan 1/14

Dec 31/14

Dec 31/15

Dec 31/16

Jan 3/17

May 1/17

Compensation Expense................................................... Contributed Surplus—Stock Options.........................

127,500

Contributed Surplus—Stock Options ............................... Compensation Expense ............................................

12,750

Compensation Expense................................................... Contributed Surplus—Stock Options.........................

114,750

Compensation Expense................................................... Contributed Surplus—Stock Options.........................

114,750

Compensation Expense................................................... Contributed Surplus—Stock Options.........................

114,750

Cash ................................................................................ Contributed Surplus—Stock Options ............................... Common Shares .......................................................

782,000 289,000

460,000 170,000

127,500

12,750

14,750

114,750

1,071,000

630,000

Calculation of compensation expense

2013:

$510,000 ÷ 4 = $127,500

2014:

Jan 1 – remove compensation expense related to employee who left $127,500 x 3,000 ÷ 30,000 = $12,750

For 2014, 2015 & 2016: New annual compensation expense: ($510,000 ÷ 4) – $12,750 or $127,500 x 90% = $114,750 Jan 3/17 Dr to Cash: 17,000 x $46 = $782,000 Dr to Contributed Surplus: $459,000 x 17 ÷ 27 = $289,000 May 1/17

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Dr to Cash: 10,000 x $46 = $460,000 Dr to Contributed Surplus: $459,000 x 10 ÷ 27 = $170,000 c.

There are several advantages and disadvantages to the use of stock options as compensation. Advantages • This type of compensation is tied to performance which should motivate employees to work hard. • The mandatory service period helps to retain employees. If employees become more productive over time, as they become more experienced, then the firm benefits. • Employees become shareholders if they exercise the options. This ensures that they will act in the best interests of the company. • Employees will benefit from any appreciation of the stock price. Disadvantages • Employees might be low risk tolerant and therefore not like the risk inherent in stock options. • If employees do not understand the value of the options, they will not consider it a benefit and might ask for additional pay instead, so the firm will end up paying them more. • Employees have limited ability to affect the stock price, so the stock options might not motivate them to work hard.

Pr. 16-89 Convertible bonds and warrants For each of the unrelated situations described below, prepare the entries required to record the transactions. 1. On August 1, 2014, Alpha Corporation called its 10% convertible bonds for conversion. The $4,000,000 par value bonds were converted into 160,000 no par common shares. On August 1, there was $350,000 of unamortized premium applicable to the bonds. At the time of issuance, Contributed Surplus—Conversion Rights was credited for $150,000, which represented the equity portion of the convertible bonds, and the market value of the common shares was $20 per share. The company records the conversion using the book value method. Ignore all interest payments. 2. Beta Inc. issues 10% convertible bonds, par $1,000,000, at 97. The investment banker indicates that if the bonds had not been convertible they would have sold at 94. Use the residual method. 3. Gamma Ltd. issues $2,000,000 par value, 8% bonds. To help the sale, detachable stock warrants are issued at the rate of ten warrants for each $1,000 bond sold. It is estimated that the value of the bonds without the warrants is $1,974,000 and the value of the warrants is $126,000. The bonds with the warrants sold at 101. Use the residual method. Solution 16-89 1. Bonds Payable ($4,000,000 + $350,000) ...................................... 4,350,000 Contributed Surplus—Conversion Rights ...................................... 150,000 Common Shares .................................................................... 4,500,000 2.

Cash ............................................................................................. Bonds Payable ($1,000,000 x 94%) ....................................... Contributed Surplus—Conversion Rights ...............................

970,000 940,000 30,000

Cash ($2,000,000 x 101%) ............................................................ 2,020,000

Complex Financial Instruments

Bonds Payable ....................................................................... Contributed Surplus—Stock Warrants ....................................

16- 37

1,974,000 46,000

*Pr. 16-90 Interest rate swap On January 1, 2014, Montreal Ltd. issues a floating rate bond for $500,000. At the same time, the corporation enters into an interest rate swap whereby it agrees to pay interest on $500,000 at 10% (the current interest rate) and to receive payments based on the floating rate. At December 31, 2014, the floating interest rate is 8%, and the value of the swap contract is $40,000 to the counterparty’s benefit. Instructions Prepare any journal entries required related to the swap agreement and the interest payment on the bond. *Solution 16-90 a. January 1, 2014 No entry (memorandum entry only) b.

December 31, 2014 Payment of bond interest Interest Expense ($500,000 × 8%) ................................................ Cash.......................................................................................

40,000 40,000

Payment of swap interest (net) Interest Expense ($500,000 x 10%) – $40,000 .............................. Cash.......................................................................................

10,000

Record swap contract liability Unrealized Gain or Loss—OCI ...................................................... Derivatives—Financial Assets/Liabilities .................................

40,000

10,000

40,000

*Pr. 16-91 Hedging (forward contract) On May 1, 2014, Startrek Corp., a coffee wholesaler, placed an order with its supplier for six tons of coffee, to be delivered and paid for on September 30, 2014. At this time, the spot (current) price for one ton of coffee is $3,000, and the future (forward) price for September 30, 2014 delivery is $2,900. Thus, Startrek decided to enter into a forward contract for six tons of coffee at $2,900 per ton for September 30, 2014 delivery. It designated the contract as a cash flow hedge. The contract further calls for a net cash settlement. Startrek’s year end is June 30, 2014. At that date the spot price was $2,980, the future price for three month delivery was $2,880, and the future price for five month delivery was $2,850. On September 30, 2014, when the spot price was $2,940 and the future price for five month delivery was $2,980, the company took delivery of the coffee, paid its supplier and settled the forward contract. On October 31, 2014, Startrek sold three tons of coffee from this delivery to Java Unlimited for $3,400 per ton cash. Assume all prices are in Canadian dollars (CAD). Instructions

16- 38

a. b.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Given the information above, should Startrek have hedged this transaction? Why? Would your answer be different if the future price were $3,100? Prepare journal entries for the following dates in 2014: May 1, June 30, September 30 and October 31. Startrek is a publicly traded corporation and follows IFRS requirements.

*Solution 16-91 a. The decision as to whether or not to hedge this transaction should depend on whether the company desires to eliminate the market risk associated with the fluctuations in the price of coffee. There is an optimal level of risk a firm desires to take on, and accordingly a decision should be made. The future price should not affect the decision as it represents the market expectations of the price at the time the company will take delivery and pay for the coffee. The future price will affect the decision only in case the company has different expectations than the market about the future price. Because Startrek is not a currency speculator, but makes its profits from selling coffee, it would make sense for this company to lower its market risk and hedge the transaction. b. May 1: No entry. The contract value is zero. Memo entry only. Jun 30 (year end) Unrealized Gain or Loss—OCI ...................................................... Derivatives—Financial Assets/Liabilities ................................. 6 x ($2,880 – $2,900) = 120 Sep 30 (settlement of contract) Cash ............................................................................................. Derivatives—Financial Assets/Liabilities ....................................... Unrealized Gain or Loss—OCI ............................................... 6 x ($2,940 – $2, 880) = 360

120 120

240 120 360

Inventory ($2,940 x 6 – spot price) ................................................ Cash.......................................................................................

17,640

Oct 31 (sale of coffee) Cash ($3,400 x 3).......................................................................... Sales Revenue .......................................................................

10,200

17,640

10,200

Cost of Goods Sold ($2,940 x 3) ................................................... Inventory ................................................................................

8,820

Unrealized Gain or Loss—OCI ...................................................... Cost of Goods Sold ................................................................ Gain/Loss (360 – 120) x 1 ÷ 2

120

8,820

120

Complex Financial Instruments

16- 39

CHAPTER 17 EARNINGS PER SHARE SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

1. 2. 3. 4. 5.

3 3 3 3 3

E M M M E

18. 19. 20. 21. 22.

3 3 3 3 3

E E M E E

37. 38.

3 3

E E

43. 44.

3 3,4

M M

49. 50.

3 3

H M

Note:

E = Easy

Item LO LOD Item LO Multiple Choice–Conceptual 6. 3 M 11. 4 7. 4 M 12. 4 8. 4 E 13. 4 9. 4 E 14. 4 10. 4 M 15. 4 Multiple Choice–Computational 23. 3 M 28. 4 24. 3,4 M 29. 4 25. 3,4 M 30. 4 26. 3,4 H 31. 4 27. 4 M 32. 4 Multiple Choice–CPA Adapted 39. 3 E 41. 4 40. 4 M 42. 4 Exercises 45. 3,4 M 47. 4 46. 3,4 H 48. 4 Problems 51. 3,4 H 53. 3,4 52. 3,4 H 54. 3,4

M = Medium

LOD

Item

LOD

M M M E H

16. 17.

4 4

M M

M M M M M

33. 34. 35. 36.

4 4 4 4

H H M M

55. 56.

3,4 3,4

H H

M M M M H M

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

1. 2. 3. 4. 5.

MC MC MC MC MC

6. 18. 19. 20. 21.

MC MC MC MC MC

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

MC MC MC MC MC MC MC

14. 15. 16. 17. 24. 25. 26.

MC MC MC MC MC MC MC

MC = Multiple Choice

Item Type Item Type Learning Objective 3 22. MC 37. MC 23. MC 38. MC 24. MC 39. MC 25. MC 43. Ex 26. MC 44. Ex Learning Objective 4 27. MC 34. MC 28. MC 35. MC 29. MC 36. MC 30. MC 40. MC 31. MC 41. MC 32. MC 42. MC 33. MC 44. Ex Ex = Exercise

Item

Type

Item

Type

45. 46. 49. 50. 51.

Ex Ex Pr Pr Pr

52. 53. 54. 55. 56.

Pr Pr Pr Pr Pr

45. 46. 47. 48. 51. 52. 53.

Ex Ex Ex Ex Pr Pr Pr

54. 55. 56.

Pr Pr Pr

Pr = Problem

Earnings Per Share

17 - 3

CHAPTER STUDY OBJECTIVES 1. Understand why earnings per share (EPS) is an important number. Earnings per share numbers give common shareholders an idea of the amount of earnings that can be attributed to each common share. This information is often used to predict future cash flows from the shares and to value companies.

2. Understand when and how earnings per share must be presented, including related disclosures. Under IFRS, EPS must be presented for all public companies or companies that are intending to go public. The calculations must be presented on the face of the income statement for net income from continuing operations and net income (for both basic EPS and diluted EPS in the case of complex capital structures). When there are discontinued operations, the per share impact of these items must also be shown, but it can be shown either on the face of the income statement or in the notes. Comparative calculations must also be shown.

3. Calculate earnings per share for companies with a simple capital structure. Basic earnings per share is an actual calculation that takes income available to common shareholders and divides it by the weighted average number of common shares outstanding during the period.

4. Calculate earnings per share for companies with a complex capital structure. Diluted earnings per share is a “what if” calculation that considers the impact of potential common shares. Potential common shares include convertible debt and preferred shares, options and warrants, contingently issuable shares, and other instruments that may result in additional common shares being issued by the company. They are relevant because they may cause the present interests of the common shareholders to become diluted. The if-converted method considers the impact of convertible securities such as convertible debt and preferred shares. It assumes that the instruments are converted at the beginning of the year (or issue date, if later) and that any related interest or dividend is thus avoided. The treasury stock method looks at the impact of written call options on EPS numbers. It assumes that the options are exercised at the beginning of the year and that the money from the exercise is used to buy back shares in the open market at the average common share price. The reverse treasury stock method looks at the impact of written put options. It assumes that the options are exercised at the beginning of the year and that the company first issues shares in the market (at the average share price) to obtain sufficient funds to buy the shares under the option. Antidilutive potential common shares are irrelevant since they would result in diluted EPS calculations that are higher than the basic EPS. Diluted EPS must show the worst possible EPS number. Note that purchased options and written options that are not in the money are ignored for purposes of calculating diluted EPS because they are either antidilutive or will not be exercised.

5. Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future. ASPE does not prescribe accounting standards for

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EPS. The IASB and FASB were working on a revised plan of action to study the issues. At the time of writing, work on the project was paused.

Earnings Per Share

17 - 5

MULTIPLE CHOICE—Conceptual Answer c a d c a d c d b a d a b d d b b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

Description Simple capital structure Calculating basic EPS Weighted average of common shares outstanding Contingently issuable shares IFRS nomenclature Choose incorrect statement. Effect of treasury shares on EPS Diluted EPS Dilutive convertible securities Cumulative convertible preferred shares effect on EPS Treasury stock method Treasury stock method Treasury stock method Antidilutive securities EPS calculation with two dilutive convertible securities Reverse treasury stock method. Choose correct statement.

MULTIPLE CHOICE—Computational Answer c c b b c c b b a b c b c c

No. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31.

b b b

32. 33. 34.

d b

35. 36.

Description Calculate basic EPS. Calculate basic EPS. Calculate weighted average of common shares outstanding. Calculate basic EPS. Calculate basic EPS with non-convertible preferred shares. Calculate basic EPS. Calculate denominator for basic and diluted EPS with convertible bonds. Calculate denominator for basic and diluted EPS with convertible bonds. Calculate denominator for basic and diluted EPS with convertible bonds. Calculate diluted EPS with convertible bonds. Calculate diluted EPS with convertible bonds. Calculate diluted EPS with convertible bonds. Calculate diluted EPS with convertible preferred shares. Calculate diluted EPS with convertible bonds and convertible preferred shares. Calculate diluted EPS with convertible preferred shares. Calculate diluted EPS with convertible bonds. Calculate diluted EPS with convertible preferred shares and convertible bonds. Use of treasury stock method with outstanding warrants Calculate denominator for diluted EPS with outstanding stock options.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Answer b b b b d a

No. 37. 38. 39. 40. 41. 42.

Description Calculate basic EPS. Calculate basic EPS. Effect of dividends on non-convertible preferred shares Calculate denominator for diluted EPS with call options. Calculate diluted EPS. "If-converted" method

EXERCISES Item E17-43 E17-44 E17-45 E17-46 E17-47 E17-48

Description Weighted average of common shares outstanding Earnings per share (definitions) Basic and diluted earnings per share Basic and diluted earnings per share Effect of dilutive securities on earnings per share calculations Diluted earnings per share

PROBLEMS Item P17-49 P17-50 P17-51 P17-52 P17-53 P17-54 P17-55 P17-56

Description Weighted average calculations Basic earnings per share Diluted earnings per share Basic and diluted earnings per share Basic and diluted earnings per share Basic and diluted earnings per share Basic and diluted earnings per share Basic and diluted earnings per share

Earnings Per Share

17 - 7

MULTIPLE CHOICE—Conceptual 1. With respect to the calculation of earnings per share, which of the following would suggest a simple capital structure? a. common shares and convertible bonds b. earnings derived from one primary line of business c. common shares and non-convertible preferred shares d. common shares and convertible preferred shares

2. In calculating basic earnings per share, if the preferred shares are cumulative, the amount that should be deducted as an adjustment to the numerator is the a. annual preferred dividend. b. preferred dividends in arrears. c. annual preferred dividend times (one minus the income tax rate). d. preferred dividends in arrears times (one minus the income tax rate).

3. In calculating the weighted average of common shares outstanding, when a stock dividend or stock split occurs, the additional shares are a. ignored. b. weighted by the number of months outstanding. c. considered outstanding at the beginning of the year. d. considered outstanding at the beginning of the earliest year reported.

4. When a corporation agrees to issue common shares if some specific future event occurs, such shares are known as a. potential treasury shares. b. potential common shares. c. contingently issuable shares. d. convertible common shares.

5. Under IFRS, common shares are also called a. ordinary shares. b. potential shares. c. treasury shares. d. non-dilutive shares.

6. Which of the following statements is INCORRECT? a. Options that are out of the money are ignored in earnings per share calculations. b. The treasury stock method is used for written call options. c. Corporations that have only antidilutive securities are not permitted to increase their earnings per share and are required to report only basic earnings per share. d. Contingently issuable shares are never included in diluted earnings per share calculations.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

7. What effect will the acquisition of treasury shares have on shareholders' equity and basic earnings per share, respectively? Shareholders equity Basic EPS a. Decrease No effect b. Increase No effect c. Decrease Increase d. Increase Decrease

8. When calculating diluted earnings per share, convertible bonds are a. ignored. b. assumed converted whether they are dilutive or antidilutive. c. assumed converted only if they are antidilutive. d. assumed converted only if they are dilutive.

9. Dilutive convertible securities must be used in the calculation of a. basic earnings per share only. b. diluted earnings per share only. c. diluted and basic earnings per share. d. silly question: such securities are never included.

10. In calculating diluted earnings per share, the equivalent number of convertible preferred shares is added as an adjustment to the denominator. If the preferred shares are cumulative, which amount should then be added as an adjustment to the numerator? a. annual preferred dividend b. annual preferred dividend times (one minus the income tax rate) c. annual preferred dividend times the income tax rate d. annual preferred dividend divided by the income tax rate

11. In calculating diluted earnings per share, the treasury stock method is used for written call options and equivalents to reflect assumed reacquisition of common shares at the average market price during the period. If the exercise price of the options or warrants exceeds the average market price, the calculation would a. fairly present diluted earnings per share on a prospective basis. b. fairly present the maximum potential dilution of diluted earnings per share on a prospective basis. c. reflect the excess of the number of shares assumed issued over the number of shares assumed reacquired as the potential dilution of earnings per share. d. be antidilutive.

12. In applying the treasury stock method to determine the dilutive effect of options and warrants, the proceeds assumed to be received upon exercise of the options and warrants a. are used to calculate the number of common shares repurchased at the average market price, when calculating diluted earnings per share. b. are added, net of tax, to the numerator of the calculation for diluted earnings per share.

Earnings Per Share

17 - 9

c. are disregarded in the calculation of earnings per share if the exercise price of the options and warrants is less than the ending market price of common shares. d. are not included in the calculation.

13. When applying the treasury stock method, the price of the common shares used for the assumed repurchase is the a. market price at the end of the year. b. average market price during the year. c. market price at the beginning of the year. d. market price at the time the options or warrants were granted.

14. Antidilutive securities a. should be included in the calculation of diluted earnings per share but not basic earnings per share. b. are those whose inclusion in earnings per share calculations would cause basic earnings per share to exceed diluted earnings per share. c. include call options and warrants whose exercise price is less than the average market price of common shares. d. should be ignored in all earnings per share calculations.

15. Assume a corporation has two potentially dilutive convertible securities outstanding. The one that should be used first to calculate diluted earnings per share is the security with the a. greater earnings adjustment. b. greater earnings per share adjustment. c. smaller earnings adjustment. d. smaller earnings per share adjustment.

16. The reverse treasury stock method is used for a. written call options. b. written put options. c. convertible preferred shares. d. convertible bonds.

17. Which of the following statements is correct? a. Options that are in the money are ignored in earnings per share calculations. b. Options that are out of the money are ignored in earnings per share calculations. c. Contingently issuable shares are never included in diluted earnings per share calculations. d. The treasury stock method is used for written put options.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3.

c a d

4. 5. 6.

c a d

7. 8. 9.

c d b

10. 11. 12.

a d a

13. 14. 15.

b d d

16. 17.

b b

Earnings Per Share

17 - 11

MULTIPLE CHOICE—Computational 18. At January 1, 2014, Afghan Corp. had 300,000 common shares outstanding (no preferred shares issued). On July 1, 2014, the corporation issued 450,000 shares, and reported net income of $630,000 for calendar 2014. Basic earnings per share for 2014 would be a. $2.10. b. $1.40. c. $1.20. d. $0.84.

19. At December 31, 2014, Basset Corp. had 500,000 common shares outstanding, 400,000 of which were issued and outstanding throughout the year and 100,000 of which were issued on October 1, 2014. Net income for calendar 2014, was $255,000. There are no preferred shares issued. Basic earnings per share for 2014 would be a. $0.51. b. $0.57. c. $0.60. d. $0.64.

20. At January 1, 2014, Corgi Ltd had 600,000 common shares outstanding (no preferred shares issued). During 2014, Corgi issued 84,000 shares on May 1, purchased 42,000 treasury shares on September 1, and issued 36,000 more shares on November 1. The weighted average of common shares outstanding for 2014 is a. 634,000. b. 648,000. c. 662,000. d. 676,000.

21. During 2014, Malamute Ltd. had 200,000 common shares, 30,000 non-cumulative convertible preferred shares, and $1,500,000 10% convertible bonds outstanding. The preferred shares are convertible into 40,000 common shares. During 2014, Malamute paid dividends of $1.20 per share to the common shares and $2.00 per share to the preferred shares. Each $1,000 bond is convertible into 45 common shares. The net income for 2014 was $900,000 and the income tax rate was 30%. Basic earnings per share for 2014 is a. $3.75. b. $4.20. c. $4.35. d. $4.50.

22. At December 31, 2013, Rottweiler Corp. had 300,000 common shares outstanding. No additional common shares were issued during 2014. On January 1, 2014, Rottweiler issued 400,000 non-cumulative, non-convertible preferred shares. During 2014, Rottweiler paid cash dividends of $180,000 to the common shares and $150,000 to the preferred shares. Net income for calendar 2014, was $480,000. Their income tax rate is 40%. Basic earnings per share for 2014 is

17 - 12

Test Bank for Intermediate Accounting, Tenth Canadian Edition

a. $0.46. b. $1.00. c. $1.10. d. $1.60.

23. Information concerning the capital structure of Shepherd Corporation follows: December 31, 2014 2013 Common shares outstanding 100,000 shares 100,000 shares Convertible preferred shares outstanding 10,000 shares 10,000 shares 9% convertible bonds $2,000,000 $2,000,000 During 2014, Shepherd paid dividends of $1.00 per common share and $2.50 per preferred share. The preferred shares are non-cumulative, and convertible into 20,000 common shares. The 9% convertible bonds are convertible into 50,000 common shares. Net income for calendar 2014 was $500,000. Assume the income tax rate is 30%. Basic earnings per share for 2014 is a. $3.33. b. $3.65. c. $4.75. d. $5.00.

24. At December 31, 2013, Mastiff Inc. had 6,000,000 common shares outstanding. An additional 1,000,000 common shares were issued on April 1, 2014, and 500,000 more on July 1, 2014. On October 1, 2014, Mastiff issued 25,000, $1,000 par value, 8% convertible bonds. Each bond is convertible into 20 common shares. No bonds were converted in 2014. What is the number of shares to be used in calculating 2014 basic earnings per share and diluted earnings per share, respectively? a. 7,000,000 and 7,000,000 b. 7,000,000 and 7,125,000 c. 7,000,000 and 7,500,000 d. 7,500,000 and 8,500,000

25. At December 31, 2013, Poodle Corp. had 1,000,000 common shares outstanding (no preferred shares issued). An additional 100,000 shares were issued on April 1, 2014, and 240,000 more on September 1. On October 1, Poodle issued $3,000,000 (par value) 9% convertible bonds. Each $1,000 bond is convertible into 40 common shares. No bonds have been converted yet. The number of shares to be used in calculating basic earnings per share and diluted earnings per share for 2014 is a. 1,155,000 and 1,155,000. b. 1,155,000 and 1,185,000. c. 1,155,000 and 1,275,000. d. 1,540,000 and 1,660,000.

26. At December 31, 2013, Samoyed Limited had 4,000,000 common shares outstanding (no preferred shares issued). An additional 250,000 common shares were issued on July 1, 2014, and 500,000 more on October 1, 2014. As well, on April 1, 2014, Samoyed issued 10,000,

Earnings Per Share

17 - 13

$1,000 face value, 8% convertible bonds. Each bond is convertible into 40 common shares. No bonds were converted in 2014. What is the number of shares to be used in calculating basic earnings per share and diluted earnings per share, respectively, for 2014? a. 4,250,000 and 4,550,000 b. 4,250,000 and 4,250,000 c. 4,250,000 and 4,650,000 d. 4,750,000 and 5,050,000

27. On January 2, 2014, Dalmatian Inc. issued at par $10,000 6% bonds convertible into 1,000 of their common shares. No bonds were converted during 2014. Throughout 2014, Dalmatian had 1,000 common shares outstanding (no preferred shares issued). Dalmatian's 2014 net income was $6,000, and their income tax rate is 30%. No potentially dilutive securities other than the convertible bonds were outstanding during 2014. Dalmatian's diluted earnings per share for 2014 would be a. $3.00. b. $3.21. c. $3.30. d. $6.42.

28. At December 31, 2013, Foxhound Ltd. had 500,000 common shares outstanding (no preferred shares issued). On October 1, 2014, an additional 100,000 common shares were issued. In addition, Foxhound had $5,000,000, 6% convertible bonds outstanding at December 31, 2013, which are convertible into 225,000 common shares; however, no bonds were converted during 2014. Net income for calendar 2014 was $1,500,000. Assuming the income tax rate was 30%, the diluted earnings per share for 2014 would be a. $3.26. b. $2.40. c. $2.28. d. $2.00.

29. On January 2, 2014, Husky Ltd. issued at par $300,000, 9% convertible bonds. Each $1,000 bond is convertible into 30 shares. No bonds were converted during 2014. There were 50,000 common shares outstanding during 2014 (no preferred shares issued). Husky's 2014 net income was $160,000 and their income tax rate was 30%. Husky's diluted earnings per share for 2014 would be a. $2.71. b. $3.03. c. $3.20. d. $3.58.

30. At December 31, 2013, Labrador Ltd. had 800,000 common shares outstanding. In addition, the corporation had 300,000 non-cumulative preferred shares outstanding, which were convertible into 500,000 common shares. During 2014, Labrador paid cash dividends of $300,000 to the common shares and $200,000 to the preferred shares. Net income for 2014 was $1,200,000 and the income tax rate was 40%. Diluted earnings per share for 2014 is a. $2.40. b. $1.50.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. $0.92. d. $0.55.

31. During 2014, Malamute Ltd. had 200,000 common shares, 30,000 non-cumulative convertible preferred shares, and $1,500,000 10% convertible bonds outstanding. The preferred shares are convertible into 40,000 common shares. During 2014, Malamute paid dividends of $1.20 per share to the common shares and $2.00 per share to the preferred shares. Each $1,000 bond is convertible into 45 common shares. The net income for 2014 was $900,000 and the income tax rate was 30%. Diluted earnings per share for 2014 is a. $2.98. b. $3.38. c. $3.27. d. $3.41.

32. At December 31, 2013, Retriever Ltd. had 2,000,000 common shares outstanding. On January 1, 2014, Retriever issued 500,000 non-cumulative preferred shares, which were convertible into 1,000,000 common shares. During 2014, Retriever paid cash dividends of $900,000 to the common shares and $300,000 to the preferred shares. Net income for calendar 2014, was $6,000,000. Assuming an income tax rate of 30%, the diluted earnings per share for 2014 is a. $1.80. b. $2.00. c. $2.80. d. $3.00.

33. At December 31, 2013, Jack Russell Ltd. had 900,000 common shares outstanding (no preferred shares issued). On September 1, 2014, an additional 300,000 common shares were issued. In addition, Jack Russell had $10,000,000 (par value) 6% convertible bonds outstanding at December 31, 2013, which are convertible into 600,000 common shares. No bonds were converted in 2014. Net income for calendar 2014 was $3,750,000. Assuming the income tax rate is 30%, the diluted earnings per share for 2014 is a. $2.35. b. $2.61. c. $2.72. d. $3.75.

34. Information concerning the capital structure of Shepherd Corporation follows: December 31, 2014 2013 Common shares outstanding 100,000 shares 100,000 shares Convertible preferred shares outstanding 10,000 shares 10,000 shares 9% convertible bonds $2,000,000 $2,000,000 During 2014, Shepherd paid dividends of $1.00 per common share and $2.50 per preferred share. The preferred shares are non-cumulative, and convertible into 20,000 common shares. The 9% convertible bonds are convertible into 50,000 common shares. Net income for calendar 2014 was $500,000. Assume the income tax rate is 30%.

Earnings Per Share

17 - 15

What is the diluted earnings per share for 2014? a. $4.00. b. $3.68. c. $3.54. d. $2.94.

35. Warrants exercisable at $20 each to obtain 50,000 common shares were outstanding during a period when the average market price of the common shares was $25. Application of the treasury stock method in calculating diluted earnings per share will increase the weighted average number of outstanding shares by a. 50,000. b. 40,000. c. 12,500. d. 10,000.

36. At December 31, 2014, Spaniel Inc. had 300,000 common shares outstanding (no preferred shares issued). In addition, the corporation had granted 90,000 stock options to certain executives, and which gave them the right to purchase Spaniel's shares at the option price of $37 per share. None of these options have yet been exercised. The average market price of Spaniel's common shares during 2014 was $50. What is the number of shares that should be used in calculating diluted earnings per share for 2014? a. 300,000 b. 323,40. c. 331,622 d. 366,600

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 18. 19. 20.

c c b

21. 22. 23.

b c c

24. 25. 26.

b b a

27. 28. 29.

b c b

30. 31. 32.

c c b

33. 34. 35.

b b d

36.

DERIVATIONS—Computational No. Answer 18. c 19. c 20. b 21. b 22. c

Derivation $630,000 ÷ 300,000 + (450,000 x 6 ÷ 12) = $1.20 $255,000 ÷ 400,000 + (100,000 x 3 ÷ 12) = $0.60 600,000 + (84,000 × 8 ÷ 12) – (42,000 × 4 ÷ 12) + (36,000 × 2 ÷ 12) = 648,000 $900,000 – (30,000 x $2)÷ 200,000 = $4.20 $480,000 – $150,000 ÷ 300,000 = $1.10. $500,000 − (10,000  $2.50) = $4.75 100,000

23.

24.

25.

26.

27.

28.

29.

30.

31.

32.

$6,000,000 ÷ (2,000,000 + 1,000,000) = $2.00

33.

$3,750,000 + ($10,000,0 00  .06  .7) = $2.61 900,000 + (300,000   ÷ ) + 

34.

$500,000 + ($2,000,00 0  .09  .7) = $3.68 100,000 + 50,000 + 20,000

35.

6,000,000 + (1,000,000 × 9/12) + (500,000 × 6 ÷ 12) = 7,000,000 7,000,000 + (25,000 × 20 × 3 ÷ 12) = 7,125,000 1,000,000 + (100,000 × 9 ÷ 12) + (240,000 × 4 ÷ 12) = 1,155,000 1,155,000 + ($3,000,000  $1,000 )  40  3 ÷ 12  = 1,185,000 4,000,000 + (250,000 × 6 ÷ 12) + (500,000 × 3 ÷ 12) = 4,250,000 4,250,000 + (10,000 × 40 × 9 ÷ 12) = 4,550,000 $6,000 + ($10,000  .06  .70) = $3.21 1,000 + 1,000 $1,500,000 + ($5,000,00 0  .06  .7) = $2.28 3   500,000 + 100,000   + 225,000 12   $160,000 + ($300,000  .09  .7) = $3.03 50,000 + ($300,000  $1,000 )  30

$1,200,000 ÷ (800,000 + 500,000) = $0.92 $900,000 + ($1,500,00 0  .10  .7) = $3.27 200,000 + 67,500 + 40,000

50,000 × $20 ÷ $25 = 40,000 50,000 – 40,000 = 10,000

Earnings Per Share

36.

17 - 17

90,000 – (90,000 × $37 ÷ $50) = 23,400 300,000 + 23,400 = 323,400

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 37. At December 31, 2013, Terrier Corp. had 300,000 common shares outstanding. No common shares were issued during 2014; however, on January 1, 2014, Terrier issued 200,000 noncumulative, non-convertible preferred shares. During 2014, Terrier paid cash dividends of $100,000 to the common shareholders and $80,000 to the preferred shareholders. Net income for calendar 2014 was $300,000. Basic earnings per share for 2014 would be a. $0.67. b. $0.73. c. $1.00. d. $1.67.

38. At December 31, 2013 and 2014, Great Dane Corp. had 100,000 common shares and 10,000, $5, no par value cumulative preferred shares outstanding. No dividends were declared in 2013 or 2014. Net income for 2014 was $400,000. For 2014, basic earnings per share would be a. $4.00. b. $3.50. c. $3.00. d. $2.00.

39. In calculating diluted earnings per share, dividends on non-convertible cumulative preferred shares should be a. ignored. b. deducted from net income whether declared or not. c. deducted from net income only if declared. d. added back to net income whether declared or not.

40. At December 31, 2013, Skye Inc. had 500,000 common shares outstanding (no preferred shares issued). On July 1, 2014, an additional 50,000 common shares were issued. Skye also had unexercised call options to purchase 40,000 common shares at $15 per share outstanding throughout 2014. The average market price of Skye's common shares was $20 during 2014. The number of shares that should be used in calculating diluted earnings per share for 2014 is a. 525,000. b. 535,000. c. 560,000. d. 565,000.

41. Throughout 2014, Boxer Ltd. had 1,200,000 common shares outstanding. As well, the corporation paid $300,000 in preferred dividends and reported net income of $5,100,000 for 2014. In connection with the acquisition of a subsidiary company in June 2013, Boxer is required to issue 50,000 additional common shares on July 1, 2015, to the former owners of the subsidiary. Boxer's diluted earnings per share for 2014 should be a. $4.25. b. $4.08.

Earnings Per Share

17 - 19

c. $4.00. d. $3.84.

42. The if-converted method of calculating earnings per share data assumes conversion of convertible securities as of the a. beginning of the earliest period reported (or at time of issuance, if later). b. beginning of the earliest period reported (regardless of time of issuance). c. middle of the earliest period reported (regardless of time of issuance). d. ending of the earliest period reported (regardless of time of issuance).

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item 37.

Ans. b

Item 38.

Ans. b

Item 39.

Ans. b

Item 40.

Ans. b

Item 41.

Ans. d

Item 42.

Ans. a

DERIVATIONS—CPA Adapted No. Answer 37. b

Derivation $300,000 – $80,000/ 300,000 = $0.73

38.

$400,000 − (10,000  $5.00) = $3.50 100,000

39. 40.

b b

41.

42.

Conceptual 500,000 + (50,000 × 6 ÷ 12) + 40,000 – (40,000 × $15 ÷ $20) = 535,000 $5,100,000 − $300,000 = $3.84 1,200,000 + 50,000 Conceptual

Earnings Per Share

17 - 21

EXERCISES Ex. 17-43 Weighted average of common shares outstanding At January 1, 2014, Akita Corporation had 300,000 common shares outstanding (no preferred issued). On March 1, the corporation issued 45,000 new shares to raise additional capital. On July 1, the corporation declared and issued a 2 for 1 stock split. On October 1, the corporation purchased on the open market 180,000 of its own shares at $35 each and retired them. Instructions Calculate the weighted average number of common shares outstanding to be used in calculating earnings per share for 2014. Solution 17-43 Increase (Decrease) Jan 1 Mar 1 45,000 Jul 1 345,000 Oct 1 (180,000)

Shares Portion of yr Stock Outstanding Outstanding Split 300,000 2/12 x2 345,000 4/12 x2 690,000 3/12 510,000 3/12 Weighted average of common shares

100,000 230,000 172,500 127,500 630,000

Ex. 17-44 Earnings per share Define the following: a. The calculation of earnings per share b. Complex capital structure c. Basic earnings per share d. Diluted earnings per share Solution 17-44 a. Earnings per share is calculated by dividing net income less preferred dividends by the weighted average number of common shares outstanding. b.

A complex capital structure exists when a corporation has convertible securities, options, warrants, or other rights that upon conversion or exercise could dilute earnings per share.

Basic earnings per share is calculated based on the weighted average number of shares outstanding during the period.

Diluted earnings per share is calculated based on the weighted average number of shares outstanding during the period, plus all potentially dilutive common shares that were outstanding during the period.

Ex. 17-45 Basic and diluted earnings per share Throughout the calendar year 2014, Collie Corporation has 400,000 common shares outstanding (no preferred shares issued). In addition, Collie has 5,000, 20-year, 7% bonds outstanding, issued at par in 2012. Each $1,000 bond is convertible into 20 common shares

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

after June 30, 2015. Collie reported net income of $600,000 for calendar 2014. Their income tax rate is 30%. Instructions Calculate basic and diluted earnings per share for 2014. Solution 17-45 Basic earnings per share:

Net income $600,000 = $1.50 = Outstandin g shares 400,000

Incremental effect of conversion of bonds: Bond interest after taxes $245,000 = $2.45 = Assumed incrementa l shares 100,000 Net income + Interest after taxes Diluted earnings per share: Assumed outstanding shares $600,000 + $245,000 ($350,000 × .7 = $245,000); = $1.69 400,000 + 100,000 Therefore the bonds are antidilutive, and basic and diluted earnings per share of $1.50 should be reported.

Ex. 17-46 Basic and diluted earnings per share Bulldog Inc. reported net income (30% tax rate) of $1,600,000 for calendar 2014, and an average of 500,000 common shares outstanding during the year. Bulldog issued $2,000,000 par value, 10-year, 9% convertible bonds on January 1, 2012 at a $18,000 discount. The bonds are convertible into 60,000 common shares. Bulldog uses the straight-line method for amortizing the bond discount. Instructions Calculate basic and diluted earnings per share for 2014. Solution 17-46 Basic earnings per share ($1,600,000 ÷ 500,000 shares) = $3.20 Diluted earnings per share $1,600,000 + .7($180,000 + $1,800) ————————————————— = $3.08 500,000 + 60,000

Ex. 17-47 Effect of dilutive securities on earnings per share calculations A publicly accountable enterprise is planning on issuing the following two securities in the coming year: 1. Convertible debt where mandatory conversion will take place five years after issue. 2. Debt with detachable warrants. The warrants can be exercised if profits exceed $1,000,000 in the next five years.

Earnings Per Share

17 - 23

Instructions Discuss how these two securities will affect the earnings per share calculation. Solution 17-47 1. The convertible debt is an example of an instrument that is mandatorily convertible. As a result, it is assumed the conversion has already taken place for calculating earnings per share. The common shares should be treated as if they were outstanding and included in the weighted average of common shares calculation. 2.

The second instrument is an example of contingently issuable shares, contingent on profits exceeding $1,000,000 for the shares to be issued. If this condition is already met, then the shares must be treated as if they are issued. However, if the condition has not been met, then these shares should not be included in the EPS calculation until the condition has been met.

Ex. 17-48 Diluted earnings per share During 2014, Basenji Corp. had 300,000 common shares outstanding. In addition, at December 31, 2014, 50,000 shares were issuable upon exercise of executive stock options, which require a $40 cash payment upon exercise (options were granted in 2012). The average market price of the common shares during 2014 was $50. Instructions Calculate the number of shares to be used in determining diluted earnings per share for 2014. Solution 17-48 Shares outstanding (given) ......................................................... Add: Assumed issuance of stock options .................................... Deduct: Proceeds/Average market price ($2,000,000 ÷ $50) ...... Number of shares to use for diluted EPS ....................................

300,000 50,000 350,000 (40,000) 310,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Use the following information to answer Pr. 17-49–17-50. Golden Corp. has been operating successfully for the past fifteen years. However, during recent years, its common shares outstanding changed as shown below. The corporation uses the calendar year as its fiscal year.

Shares outstanding, Jan 1 Shares sold, Apr 2012 25% stock dividend, Jul 1, 2013 2-for-1 stock split, Jul 1, 2014 Shares sold, Oct 1, 2014 Shares outstanding, Dec 31 Net Income

2014 300,000

2013 240,000

2012 200,000 40,000

60,000 300,000 100,000 700,000 $ 750,000

300,000 660,000

240,000 598,000

Pr. 17-49 Weighted average calculations Calculate the weighted average number of shares outstanding for each year. Solution 17-49 2012: (200,000 x 3 ÷ 12) + (240,000 x 9 ÷ 12) = 230,000 2013:

(300,000 x 12 ÷ 12) = 300,000 Stock dividend is weighted back to the beginning of the period. Alternate calculation: (240,000 x 1.25 x 6 ÷ 12) + (300,000 x 6 ÷ 12)

2014:

(300,000 x 2 x 6 ÷ 12) + (600,000 x 3 ÷ 12) + (700,000 x 3 ÷ 12) = 625,000

Pr. 17-50 Basic earnings per share Assuming there were no preferred shares outstanding, calculate EPS for each year based on your calculations in Pr 17-49. Solution 17-50 Net income Average shares outstanding (including stock dividend and stock split) Earnings per share

2014 $750,000

2013 $660,000

2012 $598,000

625,000 $1.20

300,000 $2.20

230,000 $2.60

Pr. 17-51 Diluted earnings per share On January 1, 2014, Bernard Corp. had 200,000 common shares outstanding. On April 1, 2014, 20,000 common shares were issued and on September 1, 2014, Bernard bought back 30,000 treasury shares. The market price of the common shares averaged $50 during 2014. The corporation’s income tax rate is 40%.

17 - 25

Earnings Per Share

During 2014, there were 30,000 call options to buy common shares at $40 a share outstanding; and there were 20,000, $7, no par value, cumulative and convertible preferred shares outstanding. Each preferred share is convertible into three common shares. During 2013, the corporation had issued $2,000,000 of 8% convertible bonds at face value. Each $1,000 bond is convertible into 20 common shares. The corporation reported $750,000 net income for calendar 2014. Instructions Calculate diluted earnings per share for 2014. Complete the schedule below and show all calculations. Adjust -ment

Adjusted Net Income

Adjust -ment

Adjusted Shares

EPS

Net Adjust Security Income -ment Com. Shares $750,000 $(140,000) Options Preferred 610,000 140,000 Bonds 750,000 96,000c

Adjusted Net Income $610,000 610,000 750,000 846,000

Shares 200,000 205,000 211,000 271,000

Adjust -ment 5,000a 6,000b 60,000 40,000

Adjusted Shares 205,000 211,000 271,000 311,000

EPS $2.98 2.89 2.77 2.72

Security

Net Income

Solution 17-51

20,000 × 3 ÷ 4 = 30,000 × 1 ÷ 3 =

$1,200,000 ÷ $50 =

15,000 (10,000) 5,000 SA 30,000 (24,000) (or) [(50 – 40) ÷ 50] × 30,000 = 6,000 SA 6,000 SA

$2,000,000 × .08 × .6 = $96,000

$96,000 = $2.40 40,000

$140,000 = $2.33 60,000

Pr. 17-52 Basic and diluted earnings per share Bloodhound Corp. provides the following data for calendar 2014: Net Income ....................................................................... $2,400,000 Transactions in Common Shares Jan 1 beginning Mar 1 purchase of treasury shares Jun 1 shares split 2 for 1 Nov 1 issuance of new shares

Change (60,000) 940,000 120,000

Cumulative 1,000,000 940,000 1,880,000 2,000,000

8% Cumulative Convertible Preferred Shares (no par) Convertible into 200,000 common shares adjusted for split on June 1. ....................................... $1,000,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Stock Options Exercisable at the option price of $25 per share. Average market price in 2014 was $30 (market price and option price adjusted for split)................................. 60,000 shares Instructions a. Calculate basic earnings per share for 2014. b. Calculate diluted earnings per share for 2014. Solution 17-52 Calculation of weighted average shares outstanding during the year: Jan 1- Feb 29 Mar 1- May 31 Jun 1- Oct 31 Nov 1- Dec 31

1,000,000 x 2/12 x 2= 940,000 x 3/12 x 2= 1,880,000 x 5/12= 2,000,000 x 2/12=

333 333 470,000 783,333 333,333 1,920,000

Additional shares for purposes of diluted earnings per share: Potentially dilutive securities 8% convertible preferred shares.................................................... Stock options Proceeds from exercise of 60,000 options (60,000 × $25) ...... $1,500,000 Shares issued upon exercise of options ................................. 60,000 Less: treasury shares purchasable with proceeds ($1,500,000 ÷ $30) ................................................................. 50,000 Dilutive securities—additional shares ............................................

200,000

10,000 210,000

$2,400,000 − $80,000 = $1.21 1,920,000

Basic earnings per share:

Diluted earnings per share:

$2,400,000 = $1.13 1,920,000 + 210,000

Pr. 17-53 Basic and diluted earnings per share Lhasa Ltd. provides the following information for calendar 2014: 1. Net income $420,000 2. Capital Structure: a. $8 preferred shares, no par value, cumulative, 6,000 shares outstanding $600,000 No dividends were declared during 2014. b. Common shares, 76,000 shares outstanding on January 1. On April 1, 40,000 shares were issued for cash. On October 1, 16,000 shares were purchased and retired. $1,000,000 c. On January 2, 2013, Lhasa purchased Apso Corporation. One of the terms of the purchase was that if Lhasa's net income for 2013 or subsequent years is $400,000 or more, 50,000 additional common shares would be issued to Apso shareholders.

Earnings Per Share

17 - 27

Instructions Calculate basic and diluted earnings per share for 2014. Solution 17-53 Net income........................................................................................... *Less preferred dividends ($6,000 x $8) ............................................... Income available to common (numerator) ............................................ * Since they are cumulative, PFD dividends are deducted from NI. The fact dividends were not declared is irrelevant. Share Changes: Jan 1 ............................................................................................. Apr 1, issuance 40,000.................................................................. Oct 1, retirement 16,000................................................................ Ending Balance ....................................................................................

$420,000 (48,000) $372,000

76,000 40,000 116,000 (16,000) 100,000

Weighted average shares outstanding: Jan 1- Mar 31 Apr 1- Sep 30 Oct 1- Dec31

76,000 x 3/12= 116,000 x 6/12= 100,000 x 3/12=

19,000 58,000 25,000 102,000

Basic earnings per share: $372,000 ÷ 102,000 = $3.65 Diluted earnings per share: $372,000 ÷ (102,000 + 50,000) = $2.45

Pr. 17-54 Basic and diluted earnings per share Satsuma Ltd. provides the following information for 2014: 1. Net income $560,000 2. Capital structure: a. Convertible 6% bonds. Each of the 300, $1,000 bonds is convertible into 50 common shares for the next 10 years 300,000 b. Common shares, 200,000 shares issued and outstanding during the entire year 2,000,000 c. Stock options outstanding to buy 16,000 common shares at $20 per share. 3. Other information: a. Bonds converted during 2014 None b. Income tax rate 30% c. Convertible debt was outstanding the entire year d. Average market price per common share during 2014 $32 e. Stock options were outstanding the entire year f. Stock options exercised during 2014 None Instructions Calculate basic and diluted earnings per share for 2014.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 17-54 Basic EPS = $560,000 ÷ 200,000 = $2.80 Net Security Income Com. Shares $560,000 Options 560,000 Conv. Bonds 560,000 a

Adjust -ment — — $12,600b

Adjusted Net Income $560,000 560,000 572,600

Adjust -ment — 6,000a 15,000

Shares 200,000 200,000 206,000

Adjusted Diluted Shares EPS 200,000 $2.80 206,000 2.72 221,000 2.59

16,000

320,000 = 32

(10,000) 6,000 SA

$300,000 × .06 × .7 = $12,600;

$12,600 = $.84 15,000

Pr. 17-55 Basic and diluted earnings per share Deering Inc., a publicly accountable corporation, has a July 31 year end. For the 2014 fiscal year, there were 100,000 common shares outstanding all year. Net income for the year ended July 31, 2014 was $950,000. Their income tax rate is 30%. Part A During the 2013 fiscal year, Deering issued at par a 5% convertible bond, face value $5,000,000. Each $1,000 bond is convertible into 20 common shares. No bonds were converted in 2013, however, on March 31, 2014, 50% of the bonds were converted into common shares. Part B On August 1, 2013, Deering issued 100,000, $2, cumulative, convertible preferred shares. Two preferred shares are convertible into one common share. On September 30, 2013, 20% of these preferred shares were converted to common shares. The preferred share dividend was declared and paid on June 15, 2014. Instructions Treating each part independently, calculate basic and diluted earnings per share for fiscal 2014. Solution 17-55 Part A Weighted average common shares and basic EPS: Date Aug 1, 2013 Mar 31, 2014 Total

# shares 100,000 150,000

Fraction of year 8/12 4/12

66,667 50,000 116,667

Basic EPS = $950,000 ÷ 116,667 = $8.14 Diluted EPS Calculation: Effect of conversion rights Interest expense for year on convertible bond—$5,000,000 x 5% Income tax reduction due to interest—30%

$250,000 (75,000)

Earnings Per Share

Interest expense avoided, net of tax Number of common shares issued assuming conversion on Aug 1 Less: Portion actually converted on Mar 31 Incremental effect of conversion option Per share effect = $175,000 ÷ 83,333

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175,000 100,000 (16,667) 83,333 2.10

Therefore, potentially dilutive Recalculate EPS: Income available to common shareholders Basic EPS $950,000 5% convertible bond 175,000 Total 1,125,000 Therefore, diluted EPS is $1,125,000 ÷ 200,000 = $5.63

WACS 116,667 83,333 200,000

Part B Weighted average common shares and basic EPS: Date Aug 1, 2013 Sep 30, 2013 Total

# shares 100,000 110,000

Fraction of year 2 ÷ 12 10 ÷ 12

WACS 16,667 91,667 108,333

Basic EPS = ($950,000 – ($2 x 80,000)) ÷ 108,333 = $7.29 Diluted EPS Calculation: Effect of conversion rights Preferred share dividend for year avoided Number of common shares issued assuming conversion on Aug 1 (100,000 ÷ 2) Less: Portion actually converted on Sep 30/13 Incremental effect of conversion option Per share effect = 160,000 ÷ 40,000 =

$160,000 50,000 (10,000) 40,000 4.00

Therefore, potentially dilutive Recalculate EPS: Income available to common shareholders Basic EPS $790,000 Convertible preferred shares 160,000 Total 950,000 Therefore, diluted EPS is $950,000 ÷ 148,333 = $6.40

Pr 17-56 Basic and diluted earnings per share The following data are presented by Waxman Ltd. for calendar 2014: Net income Common shares outstanding, 1,000,000 shares 10%, cumulative preferred shares, convertible into 120,000 common shares 8% convertible bonds; convertible into 105,000 common shares 360,000 call options exercisable at $25 per share

WACS 108,333 40,000 148,333

$4,500,000 $1,600,000 $7,500,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Additional information: 1. The common and preferred shares and the convertible bonds were outstanding from the beginning of the year. 2. In 2014, a $500,000 dividend was declared and distributed, however, no dividends were declared in 2013. 3. The average market price of the common shares in 2014 was $30. The stock price was $27 on January 1, 2014, and $35 on December 31, 2014. 4. The convertible bonds were sold at par. 5. The income tax rate for 2014 is 30%. Instructions a. Calculate basic EPS. b. Calculate diluted EPS. c. Briefly discuss the usefulness of the EPS measure in general. What is the additional importance of reporting diluted EPS? Solution Pr 17-56 a. Basic EPS = (4,500,000 – 160,000) ÷ 1,000,000 = $4.34 b. Start Options EPS after step 1 Convertible preferred shares EPS after step 2 Convertible bonds

Denominator 1,000,000 60,000* 1,060,000 120,000 1,180,000 105,000 1,285,000

Numerator $4,340,000 0 4,340,000 160,000 4,500,000 420,000** $4,920,000

EPS $4.34 4.09 1.33 3.81 4.00 3.83

antidilutive!

* 360,000 – (25 ÷ 30 × 360,000) = 60,000 ** ($7,500,000 × .08) × (1 – .30) = 420,000 Since the bonds are antidilutive, they are not included in the calculation, and diluted EPS = $4,500,000 ÷ 1,180,000 = $3.81 c. EPS in general provides investors with the information on how much of the earnings each common share earned in the current year. This informs investors how much of the firm’s earnings they “own” and will help them in predicting future dividend payouts. Diluted EPS provides shareholders with a more realistic picture of the future EPS as it also considers complex financial instruments that are not common shares yet, but are likely to be converted into common shares, which will lower the current shareholder’s share of the earnings. Diluted EPS can also be viewed as a “worst case” scenario for the current shareholders.

Earnings Per Share

17 - 31

CHAPTER 18 INCOME TAXES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

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

2 2 2 2 2 2

E E E E E M

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

25. 26. 27. 28.

2 2 2 3

H M H M

29. 30. 31. 32.

41. 42. 43.

2 2 2

H H M

44. 45. 46.

51. 52. 53.

2 2 2,3,4

M M M

54. 55. 56.

61. 62.

2 2,3

E M

63. 64.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 2 E 13. 4 M 2 E 14. 4 M 2 M 15. 4 M 3 M 16. 5 M 3 M 17. 5 M 3 M 18. 5 M Multiple Choice–Computational 3 M 33. 4 M 3 M 34. 4 M 3 H 35. 4 M 3 M 36. 4 M Multiple Choice–CPA Adapted 2,3 H 47. 2,3 H 2,3 M 48. 2,4 M 2,3 M 49. 3 M Exercises 2,3,4 H 57. 3,4 M 2,3,4 M 58. 4 M 2,3,4 M 59. 8 H Problems 2,3,4 M 65. 2–6 H 2,3,4 H 66. 2,3,4,10 H

M = Medium

Item

LOD

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

5 5 6 6 7 10

M M M M M M

37. 38. 39. 40.

7 7 7 8

M H M M

50.

60.

67.

2,3,4,6,10

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

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

MC MC MC MC MC MC

7. 8. 9. 25. 26. 27.

MC MC MC MC MC MC

10. 11. 12. 28. 29.

MC MC MC MC MC

30. 31. 32. 44. 45.

MC MC MC MC MC

13. 14. 15. 33.

MC MC MC MC

34. 35. 36. 48.

MC MC MC MC

16.

17.

21.

22.

23.

37.

40.

59.

24.

66.

MC = Multiple Choice

Item Type Item Type Learning Objective 2 41. MC 47. MC 42. MC 48. MC 43. MC 51. Ex 44. MC 52. Ex 45. MC 53. Ex 46. MC 54. Ex Learning Objective 3 46. MC 54. Ex 47. MC 55. Ex 49. MC 56. Ex 50. MC 57. Ex 53. Ex 62. Pr Learning Objective 4 53. Ex 57. Ex 54. Ex 58. Ex 55. Ex 63. Pr 56. Ex 64. Pr Learning Objective 5 18. MC 19. MC Learning Objective 6 65. Pr 67. Pr Learning Objective 7 38. MC 39. MC Learning Objective 8 60. Ex Learning Objective 10 67. Pr Ex = Exercise

Item

Type

Item

Type

55. 56. 61. 62. 63. 64.

Ex Ex Pr Pr Pr Pr

65. 66. 67.

Pr Pr Pr

63. 64. 65. 66. 67.

Pr Pr Pr Pr Pr

65. 66. 67.

Pr Pr Pr

20.

65.

Pr = Problem

Income Taxes

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CHAPTER STUDY OBJECTIVES 1. Understand the importance of income taxes from a business perspective. When a company decides where to set up its operations, a major consideration is the tax rate that it will face on its profits. The fact that corporate taxes can slow growth may help to explain why governments in Canada have steadily reduced corporate tax rates over time. For example, the combined federal and provincial tax rate declined from an average of approximately 43% to approximately 28% between 2000 and 2012.

2. Explain the difference between accounting income and taxable income, and calculate taxable income and current income taxes. Accounting income is calculated in accordance with generally accepted accounting principles. Taxable income is calculated in accordance with prescribed tax legislation and regulations. Because tax legislation and GAAP have different objectives, accounting income and taxable income often differ. To calculate taxable income, companies start with their accounting income and then add and deduct items to adjust the GAAP measure of income to what is actually taxable and tax deductible in the period. Current tax expense and income taxes payable are determined by applying the current tax rate to taxable income.

3. Explain what a taxable temporary difference is, determine its amount, and calculate deferred tax liabilities. A taxable temporary difference is the difference between the carrying amount of an asset or liability and its tax base with the consequence that, when the asset is recovered or the liability is settled in the future for an amount equal to its carrying value, the taxable income of that future period will be increased. Because taxes increase in the future as a result of temporary differences that exist at the balance sheet date, the future tax consequences of these taxable amounts are recognized in the current period as a deferred tax liability.

4. Explain what a deductible temporary difference is, determine its amount, and calculate deferred tax assets. A deductible temporary difference is the difference between the carrying amount of an asset or liability and its tax base with the consequence that, when the asset is recovered or the liability is settled in the able income of that future period will be reduced. Because taxes are reduced in the future as a result of temporary differences that exist at the balance sheet date, the future tax consequences of these deductible amounts are recognized in the current period as a deferred tax asset.

5. Prepare analyses of deferred tax balances and record deferred tax expense. The following steps are taken: (1) identify all temporary differences between the carrying amounts and tax bases of assets and liabilities at the balance sheet date; (2) calculate the correct net deferred tax asset or liability balance at the end of the period; (3) compare the balance in the deferred tax asset or liability before the adjustment with the correct balance at the balance sheet date—the difference is the deferred tax expense/benefit; and (4) make the journal entry, which is based on the change in the amount of the net deferred tax asset or liability.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

6. Explain the effect of multiple tax rates and tax rate changes on income tax accounts, and calculate current and deferred tax amounts when there is a change in substantively enacted tax rates. Tax rates other than the existing rates can be used only when the future tax rates have been enacted into legislation or substantively enacted. Deferred tax assets and liabilities are measured at the tax rate that applies to the specific future years in which the temporary difference is expected to reverse. When there is a change in the future tax rate, its effect on the future tax accounts is recognized immediately. The effects are reported as an adjustment to deferred tax expense in the period of the change.

7. Account for a tax loss carryback. A company may carry a taxable loss back three years and receive refunds to a maximum of the income taxes paid in those years. Because the economic benefits related to the losses carried back are certain, they are recognized in the period of the loss as a tax benefit on the income statement and as an asset (income tax receivable) on the balance sheet.

8. Account for a tax loss carryforward, including any note disclosures. A post-2009 tax loss can be carried forward and applied against the taxable incomes of the next 20 years. If the economic benefits related to the tax loss are more likely than not to be realized during the carryforward period, they are recognized in the period of the loss as a deferred tax benefit in the income statement and as a deferred tax asset on the balance sheet. Otherwise, they are not recognized in the financial statements. Alternatively, ASPE also allows the use of a contra valuation allowance account, but this approach is not envisaged under current IFRS. Disclosure is required of the amounts of tax loss carryforwards and their expiry dates. If previously unrecorded tax losses are subsequently used to benefit a future period, the benefit is recognized in that future period.

9. Explain why the Deferred Tax Asset account is reassessed at the statement of financial position date, and account for the deferred tax asset with and without a valuation allowance account. Every asset must be assessed to ensure that it is not reported at an amount higher than the economic benefits that are expected to be received from the use or sale of the asset. The economic benefit to be received from the deferred tax asset is a reduction in deferred taxes payable. If it is unlikely that sufficient taxable income will be generated in the future to allow the future deductions, the income tax asset may have to be written down. If previously unrecognized amounts are now expected to be realizable, a deferred tax asset is recognized. These entries may be made directly to the deferred tax asset account or through a valuation allowance contra account.

10. Identify and apply the presentation and disclosure requirements for income tax assets and liabilities, and apply intraperiod tax allocation. Under all methods, current income taxes payable or receivable are reported separately as a current liability or current asset. Under ASPE and assuming a single tax authority, future income tax assets and liabilities are classified as one net current amount and one net non-current amount based on the classification of the asset or liability to which the temporary difference relates. Other future tax accounts are classified according to when the temporary differences are expected to reverse. Under IFRS, the deferred tax accounts are all classified as non-current. Current and deferred tax expense is reported separately with income before discontinued operations, discontinued operations, items in OCI, retained earnings, and other capital. Separate disclosure is required of

Income Taxes

18- 5

the amounts and expiry dates of unused tax losses, and the amount of deductible temporary differences for which no deferred tax asset has been recognized. ASPE calls for limited disclosures, but under IFRS, additional disclosures are required about temporary differences and unused tax losses, the major components of income tax expense, and the reasons for the difference between the statutory tax rate and the effective rate indicated on the income statement.

11. Identify the major differences between ASPE and IFRS for income taxes. ASPE allows an accounting policy choice—either the taxes payable method or the future income taxes method—while IFRS requires use of a method consistent with the future income taxes method, the temporary difference approach. The current differences relate to terminology, the balance sheet classification of deferred/future tax assets and liabilities, use of a valuation allowance, and the extent of disclosure.

12. Apply the temporary difference approach (future income taxes method) of accounting for income taxes in a comprehensive situation. In a comprehensive situation, take the following steps. (1) Calculate the current tax expense and payable; (2) determine the taxable and deductible temporary differences as the difference between the carrying amounts and tax bases of the assets and liabilities; calculate the correct balance of the deferred tax asset or liability account; (3) determine the deferred tax expense as the adjustment needed to the existing balance; (4) Make an adjusting entry to restate the deferred tax asset or liability amounts if a change in the future tax rates has been substantively enacted; and (5) Classify the net deferred/future tax asset or liability according to the accounting standards being applied.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer b c d c d a b c b a d a b c c a a b b a c b d b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24.

Description IFRS terminology Differences between taxable and accounting income ASPE income tax methods allowed IFRS income tax methods allowed Identify reversible difference Definition of the tax base of a liability Definition of a temporary difference Identify a permanent difference Identify incorrect statement Depreciation and temporary differences Definition of deferred tax liability Composition of total income tax expense Difference due to unrealized loss on short-term securities Definition of deferred tax asset AJE to credit deferred tax asset account Objective of interperiod tax allocation Result of interperiod tax allocation Calculation of effective tax rate Differences between taxable and accounting income Definition of intraperiod tax allocation Appropriate tax rate for deferred income tax amounts Recognition of tax benefits of a loss carryforward Financial statement presentation of a tax benefit from loss carryforward IFRS statement of financial position presentation of deferred tax assets and liabilities

Income Taxes

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MULTIPLE CHOICE—Computational Answer d b a a d a a a d c b d b c d b

No. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

Description Calculate CCA claimed. Calculate current income tax payable for the year. Calculate instalment accounts receivable. Calculate deferred tax liability. Calculate deferred tax liability with changing tax rates. Calculate deferred tax liability. Calculate income tax expense for the year. Calculate deferred tax liability. Calculate deferred tax asset. Calculate deferred tax asset. Calculate deferred tax asset or liability. Calculate deferred tax asset or liability. Calculate loss to be reported after loss carryback. Calculate loss to be reported after loss carryback. Calculate income tax refund following a loss carryback. Calculate loss to be reported after loss carryforward.

MULTIPLE CHOICE—CPA Adapted Answer a d b c a d a c c d

No. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50.

Description Calculate current income tax liability. Calculate current income tax liability. Calculate current income tax expense. Calculate deferred tax liability and current income taxes payable. Deferred tax liability from instalment sales Deferred tax liability from depreciation/CCA differences Deferred tax liability from depreciation and warranty differences Deferred tax asset from warranty expenses Deferred tax liability from reversible and permanent differences Deferred tax liability when using equity method of accounting

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E18-51 E18-52 E18-53 E18-54 E18-55 E18-56 E18-57 E18-58 E18-59 E18-60

Description Temporary differences Permanent and reversible differences Permanent and reversible differences Reversible differences Calculation of taxable income Future income taxes Deferred income taxes Deferred tax asset Taxable loss carryforward without valuation allowance (IFRS) Taxable loss carryforward with valuation allowance (ASPE)

PROBLEMS Item P18-61 P18-62 P18-63 P18-64 P18-65 P18-66 P18-67

Description Taxable income and accounting income Taxable temporary difference Differences between accounting and taxable income and effect on future income taxes Multiple reversible differences Interperiod tax allocation with change in enacted tax rates Deferred tax asset Comprehensive income tax situation with multiple differences (ASPE)

Income Taxes

18- 9

NOTE TO INSTRUCTOR: Except where ASPE is specifically noted, it is assumed that all questions are to be solved using current IFRS pronouncements. MULTIPLE CHOICE—Conceptual 1. Under IFRS, accounting income and taxable income are referred to as Accounting Income Taxable Income a. Accounting profit Income for tax purposes b. Accounting profit Taxable profit c. Income before taxes Taxable profit d. Pre-tax profit Taxable income

2. When calculating income tax expense, taxable income of a corporation differs from pre-tax accounting income because of Permanent Reversible Differences Differences a. No No b. No Yes c. Yes Yes d. Yes No

3. For calculating income tax expense, ASPE allows the use of a. any method as long as the CRA approves it. b. the taxes payable method only. c. the future income taxes method only. d. either the taxes payable method or the future income taxes method.

4. For calculating income tax expense, IFRS requires the use of a. any method as long as the CRA approves it. b. the taxes payable method only. c. the temporary difference approach only. d. either the taxes payable method or the temporary difference approach.

5. Which of the following will NOT result in a reversible difference? a. product warranty liabilities b. unrealized holding losses c. instalment sales d. fines and penalties

6. The tax base of a liability is its carrying amount on the statement of financial position a. reduced by any amount that will be deductible for tax purposes in future periods. b. increased by any amount that will be deductible for tax purposes in future periods. c. less any amount that will not be taxable in the future.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. plus any amount that will not be taxable in the future.

7. The difference between the tax base of an asset or liability and its reported amount on the statement of financial position is called a a. permanent difference. b. temporary difference. c. current difference. d. future income tax expense.

8. Alabama Corp.'s taxable income differed from its accounting income for 2014. An item that would create a permanent difference in accounting and taxable incomes for the corporation would be a. a balance in the Unearned Rent account at year end. b. using CCA for tax purposes and straight-line depreciation for book purposes. c. a payment of the golf club dues for the president’s membership. d. making instalment sales during the year.

9. In regard to reconciling income reported on the financial statements to taxable income, which of the following statements is INCORRECT? a. All differences between accounting income and taxable income are considered. b. Only reversible differences are considered. c. Only those that result in temporary differences are considered when determining deferred tax amounts for the statement of financial position. d. Permanent differences may be added back to or deducted from accounting income.

10. Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in Taxable Temporary Deductible Temporary Differences Differences a. Yes Yes b. Yes No c. No Yes d. No No

11. A deferred tax liability is the a. current tax consequence of a taxable temporary difference. b. current tax consequence of a deductible temporary difference. c. future tax consequence of a deductible temporary difference. d. future tax consequence of a taxable temporary difference.

12. Total income tax expense for a corporation consists of a. current tax expense and deferred tax expense. b. current tax expense only. c. deferred tax expense only. d. The deferred tax asset minus any deferred tax liability.

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13. A corporation records an unrealized loss on short-term securities. This would result in what type of difference and in what type of deferred tax account? Type of Difference Deferred tax a. Reversible Liability b. Reversible Asset c. Permanent Liability d. Permanent Asset

14. A deferred tax asset is the a. current tax consequence of a taxable temporary difference. b. current tax consequence of a deductible temporary difference. c. future tax consequence of a deductible temporary difference. d. future tax consequence of a taxable temporary difference.

15. If a corporation prepares an adjusting entry to credit the deferred tax asset account, this should represent a. additional future income taxes payable. b. a transfer to the deferred tax liability account. c. the reversal of a deferred tax benefit that originated in a prior year. d. the reversal of a deferred tax expense that originated in a prior year.

16. One objective of interperiod tax allocation is to a. recognize the tax effects in the accounting period when the transactions and events are recognized for financial reporting purposes. b. recognize a distribution of earnings to the shareholders. c. reconcile the tax consequences of permanent and reversible differences appearing on the current year's financial statements. d. adjust income tax expense on the income statement to be in agreement with income taxes payable on the statement of financial position.

17. Interperiod tax allocation causes a. the income tax expense reported on the income statement to equal the amount of income taxes payable for the current year plus or minus the change in the deferred tax asset or liability balances for the year. b. the income tax expense reported on the income statement to bear a normal relation to the tax liability. c. the income tax liability reported on the statement of financial position to bear a normal relation to the income before tax reported on the income statement. d. the income tax expense reported on the income statement to be presented with the specific revenues causing the tax.

18. The effective tax rate for a period is calculated by dividing a. total income tax expense by taxable income. b. total income tax expense by the pre-tax income on the income statement.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. taxable income by total income tax expense. d. taxable income by the pre-tax income on the income statement.

19. Taxable income of a corporation a. differs from accounting income due to differences in intraperiod allocation between the two methods of income determination. b. differs from accounting income due to differences in interperiod allocation and permanent differences between the two methods of income determination. c. is based on generally accepted accounting principles. d. is reported on the corporation's income statement.

20. Allocating income tax expense or benefit for the period (both current and deferred) to the income and other statements to reflect transactions that attract income tax is known as a. intraperiod tax allocation. b. interperiod tax allocation. c. current tax allocation. d. reconcilation approach.

21. Tax rates other than the current tax rate may be used to calculate the future income tax amount on the statement of financial position if a. it is probable that a future income tax rate change will occur. b. it appears likely that a future income tax rate will be higher than the current tax rate. c. the future income tax rates have been enacted or substantively enacted into law. d. it appears likely that a future income tax rate will be less than the current tax rate.

22. Recognition of tax benefits in a loss year due to a loss carryforward requires a. the establishment of a deferred tax liability. b. the establishment of a deferred tax asset. c. the establishment of an income tax receivable. d. only a note to the financial statements.

23. Alaska Inc. incurred an accounting and taxable loss for 2014. The corporation therefore decided to use the carryback provisions as it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2014 financial statements? a. The reduction of the loss should be reported as an adjustment to retained earnings. b. The refund claimed should be reported as a future charge and amortized over five years. c. The refund claimed should be reported as revenue in the current year. d. The refund claimed should be shown as a reduction of the loss in 2014.

24. Under IFRS, how are deferred tax asset and liability accounts presented on the statement of financial position? a. They must be segregated into current and noncurrent items. b. They must be shown as noncurrent assets or liabilities. c. They must be shown as current assets or liabilities. d. They must be reported as a reduction of the related asset or liability accounts.

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MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4.

Ans.

b c d c

Item

5. 6. 7. 8.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

d a b c

9. 10. 11. 12.

b a d a

13. 14. 15. 16.

b c c a

17. 18. 19. 20.

a b b a

21. 22. 23. 24.

c b d b

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 25. Arkansas Corp.'s partial income statement for its first year of operations is as follows: Income before income taxes $1,750,000 Income tax expense Current $483,000 Deferred 42,000 525,000 Net income $1,225,000 Arkansas uses straight-line depreciation for financial reporting purposes and CCA for tax purposes. The depreciation expense for the year was $700,000. Except for depreciation, there were no other differences between accounting income and taxable income. Assuming a 30% tax rate, what amount was claimed for CCA on the corporation's tax return for the year? a. $560,000 b. $665,000 c. $700,000 d. $840,000

26. At the end of 2014, its first year of operations, Connecticut Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $ 800,000 Estimated lawsuit expense 400,000 Excess CCA for tax purposes (900,000) Taxable income $ 300,000 The estimated lawsuit expense of $400,000 will be deductible in 2015 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $300,000 in each of the next three years. The income tax rate is 25% for all years. Connecticut adheres to IFRS requirements. The current income tax payable is a. $ 0. b. $ 75,000. c. $150,000. d. $200,000.

27. Georgia Inc. sells household furniture on an instalment basis. Customers make payments in equal monthly instalments over a two-year period, with no down payment required. Georgia's gross profit on instalment sales is 40% of the selling price. For book purposes, sales revenue is recognized at the time the sale is made. For income tax purposes, however, the instalment method is used. There are no other accounting and income tax accounting differences, and Georgia's income tax rate is 30%. If Georgia's December 31, 2014, statement of financial position includes a deferred tax liability of $90,000 arising from the difference between accounting and tax treatment of the instalment sales, it should also include instalment accounts receivable of a.$750,000. b.$300,000. c.$225,000. d.$90,000.

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18- 15

28. On January 2, 2013, Arizona Corp. purchased a depreciable asset for $600,000. The asset has an estimated 4 year life with no residual value. Straight-line depreciation is being used for financial statement purposes but the following CCA amounts will be deducted for tax purposes: 2013 $150,000 2016 $56,250 2014 225,000 2017 28,125 2015 112,500 2018 28,125 Assuming an income tax rate of 30% for all years, the deferred tax liability that should be reflected on Arizona's statement of financial position at December 31, 2014, should be a. $22,500. b. $33,750. c. $45,000. d. $50,625.

29. A reconciliation of California Corp.'s pre-tax accounting income with its taxable income for 2014, its first year of operations, is as follows: Pre-tax accounting income $3,000,000 Excess CCA (90,000) Taxable income $2,910,000 The excess CCA will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2014, 35% in 2015, and 30% in both 2016 and 2017. The total deferred tax liability to be reported on California's statement of financial position at December 31, 2014 is a. $36,000. b. $31,500. c. $30,000. d. $28,500.

30. At the end of 2014, its first year of operations, Colorado Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $300,000 Estimated lawsuit expense 750,000 Instalment sales (600,000) Taxable income $450,000 The estimated lawsuit expense of $750,000 will be deductible in 2016 when it is expected to be paid. The instalment sales will be realized at $300,000 in each of the next two years. The income tax rate is 30% for all years. The deferred tax liability to be recorded is a. $180,000. b. $ 90,000. c. $ 67,500. d. $ 45,000.

31. At the end of 2014, its first year of operations, Colorado Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $300,000 Estimated lawsuit expense 750,000 Instalment sales (600,000) Taxable income $450,000 The estimated lawsuit expense of $750,000 will be deductible in 2016 when it is expected to be

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

paid. The instalment sales will be realized at $300,000 in each of the next two years. The income tax rate is 30% for all years. The total income tax expense to be reported on the income statement is a. $90,000. b. $135,000. c. $150,000. d. $300,000.

32. At the end of 2014, its first year of operations, Connecticut Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $ 800,000 Estimated lawsuit expense 400,000 Excess CCA for tax purposes (900,000) Taxable income $ 300,000 The estimated lawsuit expense of $400,000 will be deductible in 2015 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $300,000 in each of the next three years. The income tax rate is 25% for all years. Connecticut adheres to IFRS requirements. The deferred tax liability to be recorded is a. $225,000. b. $200,000. c. $100,000. d. $ 0.

33. At the end of 2014, its first year of operations, Colorado Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $300,000 Estimated lawsuit expense 750,000 Instalment sales (600,000) Taxable income $450,000 The estimated lawsuit expense of $750,000 will be deductible in 2016 when it is expected to be paid. The instalment sales will be realized at $300,000 in each of the next two years. The income tax rate is 30% for all years. The deferred tax asset to be recorded is a. $ 0. b. $45,000. c. $90,000. d. $225,000.

34. At the end of 2014, its first year of operations, Connecticut Corp. prepared the following reconciliation between pre-tax accounting income and taxable income: Pre-tax accounting income $ 800,000 Estimated lawsuit expense 400,000 Excess CCA for tax purposes (900,000) Taxable income $ 300,000 The estimated lawsuit expense of $400,000 will be deductible in 2015 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $300,000 in each of the next three years. The income tax rate is 25% for all years. Connecticut adheres to IFRS requirements. The deferred tax asset to be recorded is a. $200,000.

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b. $160,000. c. $100,000. d. $ 60,000.

35. Delaware Corp. reported the following results for calendar 2014, its first year of operations: Pre-tax accounting income $250,000 Taxable income 400,000 The difference between accounting income and taxable income is due to a temporary difference, which will reverse in 2015. Assuming that the enacted tax rates in effect are 30% in 2014 and 25% in 2015, what amount should Delaware record as the deferred tax asset or liability for calendar 2014? a. $45,000 deferred tax liability b. $37,500 deferred tax asset c. $45,000 deferred tax asset d. $37,500 deferred tax liability

36. In 2014, Florida Ltd. accrued, for book purposes, estimated losses on disposal of unused plant facilities of $750,000. The facilities were sold in March 2015 and a $750,000 loss was recognized for tax purposes. Also in 2014, Florida paid $50,000 in premiums for a two-year life insurance policy in which the company was the beneficiary. Assuming that the enacted tax rate is 25% in both 2014 and 2015, and that Florida paid $390,000 in income taxes in 2014, the amount reported as the deferred tax asset or liability on Florida's statement of financial position at December 31, 2014, should be a a. cannot be determined from the information given. b. $175,000 asset. c. $187,500 liability. d. $187,500 asset.

37. Idaho Inc. reported a taxable and accounting loss of $130,000 for 2014. Its pre-tax accounting income for the last two years was as follows: 2012 $60,000 2013 80,000 The amount that Idaho reports as a net loss for financial reporting purposes in 2014, assuming that it uses the carryback provisions, and that the tax rate is 25% for all years involved, is a.$ 0. b.$ 97,500. c.$105,000. d.$130,000.

38. Illinois Corporation reported the following results for its first three years of operations: 2013 income (before income taxes) $ 40,000 2014 loss (before income taxes) (360,000) 2015 income (before income taxes) 400,000 There were no permanent or reversible differences during these three years. Assume an income tax rate of 30% for 2013 and 2014, and 40% for 2015, and that any deferred tax asset recognized is more likely than not to be realized. If Illinois elects to use the carryback provisions, what income (loss) is reported for 2014?

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

a. $(360,000) b. $(348,000) c. $(220,000) d. $ 0

39. Indiana Inc. reports a taxable and pre-tax accounting loss of $150,000 for 2014. The corporation's taxable and pre-tax accounting income and tax rates for the last two years were: 2012 $200,000 20% 2013 200,000 25% The 2014 tax rate is 30%. If Indiana elects to use the carryback provisions, the amount that should be reported as income tax receivable for 2014 is a. $50,000. b. $45,000. c. $35,000. d. $30,000.

40. Illinois Corporation reported the following results for its first three years of operations: 2013 income (before income taxes) $ 40,000 2014 loss (before income taxes) (360,000) 2015 income (before income taxes) 400,000 There were no permanent or reversible differences during these three years. Assume an income tax rate of 30% for 2013 and 2014, and 40% for 2015, and that any deferred tax asset recognized is more likely than not to be realized. If Illinois elects to use the carryforward provisions and NOT the carryback provisions, what income (loss) is reported for 2014? a. $ 0 b. $(216,000) c. $(232,000) d. $(360,000)

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Income Taxes

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

25. 26. 27.

d b a

28. 29. 30.

a d a

31. 32. 33.

a a d

34. 35. 36.

c b d

37. 38. 39.

b c d

40.

DERIVATIONS—Computational No. Answer 25. d

26. 27.

b a

28.

29. 30. 31.

d a a

32. 33. 34. 35. 36. 37. 38.

a d c b d b c

39. 40.

d b

Derivation 30% × Temporary Difference = $42,000; Temporary Difference = $42,000 ÷ 30% = $140,000; $700,000 + $140,000 = $840,000 $300,000 × 25% = $75,000 $90,000 ÷ 30% = $300,000 temporary difference $300,000 ÷ 40% = $750,000 ($600,000 – $150,000 – $150,000) – ($600,000 – $150,000 – $225,000) $75,000 × 30% = $22,500 ($30,000 × 35%) + ($30,000 × 30%) + ($30,000 × 30%) = $28,500 $600,000 × 30% = $180,000 Income tax payable = $450,000 × 30% = $135,000 Change in deferred tax liability = $600,000 × 30% = $180,000 Change in deferred tax asset = $750,000 × 30% = $225,000 $135,000 + $180,000 – $225,000 = $90,000 $900,000 × 25% = $225,000 $750,000 × 30% = $225,000 $400,000 × 25% = $100,000 ($400,000 – $250,000) × 25% = $37,500 $750,000 × 25% = $187,500 $130,000 – (25% × $130,000) = $97,500. $40,000 × 30% = $12,000; $320,000 × 40% = $128,000; $360,000 – $12,000 – $128,000 = $220,000 $150,000 × 20% = $30,000 $360,000 × 40% = $144,000; $360,000 – $144,000 = $216,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 41. Iowa Corp. reported pre-tax accounting income of $300,000 for calendar 2014. To calculate the income tax liability, the following data were considered: Life insurance proceeds on the death of the CEO $130,000 CCA in excess of depreciation 20,000 Instalment tax payments made during 2014 25,000 Enacted income tax rate for 2014 30% What amount should Iowa report as its current income tax liability on its December 31, 2014 statement of financial position? a. $20,000 b. $26,000 c. $45,000 d. $51,000

42. Kansas Corp. reported pre-tax accounting income of $750,000 for calendar 2014. To calculate the income tax liability, the following data were considered: Non-taxable portion of capital gains $30,000 CCA in excess of depreciation 60,000 Instalment tax payments made during 2014 150,000 Enacted income tax rate for 2014 30% What amount should Kansas report as its current income tax liability on its December 31, 2014 statement of financial position? a. $198,000 b. $75,000 c. $66,000 d. $48,000

43. For calendar 2014, Louisiana Corp. prepared the following reconciliation of accounting income to taxable income: Pre-tax accounting income $750,000 Add reversible difference Construction contract revenue which will reverse in 2015 100,000 Deduct reversible difference Depreciation expense, which will reverse in equal amounts in each of the next four years (400,000) Taxable income $450,000 Louisiana's income tax rate is 25% for 2014. What amount should the corporation report in its 2014 income statement as current income tax expense? a. $ 25,000 b. $112,500 c. $187,500 d. $212,500

44. For calendar 2014, its first year of operations, Kentucky Ltd. reported pre-tax accounting income of $100,000. Kentucky uses CCA for tax purposes and straight-line depreciation for

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financial reporting. The differences between depreciation and CCA over the five-year life of their assets, and the enacted tax rates for 2014 to 2018 are as follows: Depreciation Over (Under) CCA Tax Rates 2014 $(20,000) 35% 2015 (26,000) 30% 2016 (6,000) 30% 2017 24,000 30% 2018 28,000 30% There are no other reversible differences. On Kentucky's December 31, 2014 statement of financial position, the deferred tax liability and the current income taxes payable should be Deferred Current Income Tax Liability Taxes Payable a. $15,600 $20,000 b. $15,600 $28,000 c. $ 6,000 $28,000 d. $ 6,000 $24,000

45. Maryland Inc. uses the accrual method of accounting for financial reporting purposes and the instalment method of accounting for income tax purposes. Instalment income of $930,000 will be collected in the following years when the enacted tax rates are: Collection of Income Enacted Tax Rates 2014 $ 120,000 35% 2015 180,000 30% 2016 270,000 30% 2017 360,000 25% The instalment income is Maryland's only reversible difference. What amount should be included as the deferred tax liability on their December 31, 2014 statement of financial position? a. $225,000 b. $243,000 c. $256,500 d. $315,000

46. On January 1, 2014, Massachusetts Inc. purchased a machine for $270,000 which will be depreciated $27,000 annually for book purposes. For income tax reporting, the asset is a Class 8 asset with a CCA rate of 20%, subject to the half year rule for 2014. Assume a present and future enacted income tax rate of 30%. What amount should be added to Massachusetts's deferred tax liability for the difference between depreciation and CCA at December 31, 2014? a. $16,200 b. $ 9,000 c. $ 8,100 d. $ 0

47. For calendar 2014, Minnesota Corp. reported depreciation expense of $800,000 on its income statement, but on its 2014 income tax return, Minnesota claimed CCA of $1,200,000. The 2014 income statement also included $150,000 in accrued warranty expense that will be deducted for tax purposes when paid. Minnesota's income tax rates are 30% for 2014 and 2015, and 24% for 2016 and 2017. The depreciation difference and warranty expense will

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

reverse over the next three years as follows: Depreciation Difference Warranty Expense 2015 $160,000 $ 30,000 2016 140,000 50,000 2017 100,000 70,000 $400,000 $150,000 These were Minnesota's only reversible differences. At December 31, 2014, Minnesota’s deferred tax liability should be a. $ 67,800. b. $ 73,200. c. $ 75,000. d. $133,800.

48. For calendar 2014, its first year of operations, Missouri Corp. reported pre-tax accounting income of $330,000 and taxable income of $600,000. The only reversible difference is accrued warranty costs, which are expected to be paid as follows: 2015 $90,000 2016 45,000 2017 45,000 2018 90,000 The enacted income tax rates are 35% for 2014, 30% for 2015, 2016 and 2017, and 25% for 2018. The deferred tax asset reported on Missouri’s December 31, 2014 statement of financial position should be a. $54,000. b. $63,000. c. $76,500. d. $94,500. 49. In its 2014 income statement, it’s first year of operations, Maine Corp. reported depreciation of $525,000 and interest revenue from a Canadian corporation of $105,000. For 2014 income tax purposes, Maine claimed CCA of $825,000. The difference in depreciation/CCA will reverse in equal amounts over the next three years. Maine's income tax rates are 35% for 2014, 30% for 2015, and 25% for both 2016 and 2017. What amount should be included as the deferred tax liability on Maine's December 31, 2014 statement of financial position? a. $99,000 b. $90,000 c. $80,000 d. $75,000

50. On January 1, 2014, Lake Corp., a publicly accountable enterprise, purchased 40% of the common shares of Michigan Inc. and accounts for this investment by the equity method. During 2014, Michigan reported earnings of $900,000 and paid dividends of $300,000. Lake assumes that all of Michigan's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 20%. Lake's current income tax rate is 25%. The increase in Lake's deferred tax liability for this temporary difference is a. $120,000. b. $100,000. c. $ 60,000.

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d. $ 48,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

41. 42.

a d

43. 44.

b c

45. 46.

a d

47. 48.

a c

49. 50.

c d

DERIVATIONS—CPA Adapted No. Answer 41. a 42.

43. 44. 45. 46. 47.

b c a d a

48.

49.

50.

Derivation ($300,000 – $130,000 – $20,000) × 30% = $45,000; $45,000 – $25,000 = $20,000 ($750,000 – $30,000 – $60,000) × 30% = $198,000; $198,000 – $150,000 = $48,000 $450,000 × 25% = $112,500 $20,000 × 30% = $6,000; $100,000 – $20,000 × 35% = $28,000 ($180,000 × 30%) + ($270,000 × 30%) + ($360,000 × 25%) = $225,000 $270,000 × 20% × 1 ÷ 2 = $27,000. There is no reversible difference in 2014. ($160,000 – $30,000) × 30% = $39,000; ($140,000 – $50,000) × 24% = $21,600; ($100,000 – $70,000) × 24% = $7,200; $39,000 + $21,600 + $7,200 = $67,800 ($90,000 + $45,000 + $45,000) × 30% = $54,000; $90,000 × 25% = $22,500; $54,000 + $22,500 = $76,500 $825,000 - $525,000 = $300,000 ($100,000 × 30%) + ($100,000 × 25%) + ($100,000 × 25%) = $80,000 ($900,000 – $300,000) × 40% = $240,000 (earnings from associate, not income for tax purposes); $240,000 × 20% = $48,000

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EXERCISES Ex. 18-51 Temporary differences Explain the difference between a taxable temporary difference and a deductible temporary difference. Solution 18-51 Temporary differences are differences between the tax base of an asset or liability and its reported amount in the financial statements, which will result in taxable amounts or deductible amounts in future years. Taxable temporary differences increase taxable income in future years and cause a deferred tax liability to be recorded. Deductible temporary differences decrease taxable income in future years and cause a deferred tax asset to be recorded.

Ex. 18-52 Permanent and reversible differences Explain whether each of the following independent situations should be treated as a reversible difference or a permanent difference. 1. For accounting purposes, Aye Corp. reports revenue from instalment sales on the accrual basis. For income tax purposes it reports the revenues by the instalment method, deferring recognition of gross profit until cash is collected. 2. Pre-tax accounting income and taxable income differ because dividends received from Canadian corporations were not included in Bee Corp.’s taxable income, while 100% of the dividends received were included as revenue for financial statement purposes. 3. Cee Corp.’s estimated warranty costs (covering a three-year period) are expensed for accounting purposes at the time of sale, but deducted for income tax purposes only when paid. Solution 18-52 1. Reversible difference. This difference in the timing of revenue recognition between pre-tax accounting income and taxable income will initially increase pre-tax accounting income, but will not increase taxable income by the amount of future gross profits until cash is collected in subsequent years. Assuming the estimate as to collectibility of instalment receivables is valid, the total amounts reported as gross profits for accounting purposes and for tax purposes will be equal over the life of a group of instalment receivables. The time lag between the accrual for accounting purposes and the recognition for tax purposes will increase the deferred tax liability as long as instalment sales are level or increasing. The deferred tax liability will be reduced as the receivables are collected. 2.

Permanent difference. This difference in pre-tax accounting income and taxable income will never reverse because present tax laws allow a corporation that owns shares in another Canadian corporation to exclude the dividends it receives from that corporation. Thus there are no tax consequences for such dividends, even though they are recognized as income for accounting purposes. [Note from author: this is not exactly correct. It is true such dividends are not subject to Part I (“regular” income tax) but they may be subject to Part IV tax]

Reversible difference. The full estimated three years of warranty expense reduces the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

current year's pre-tax accounting income, but will reduce taxable income in varying amounts each year as the costs are paid. Assuming the warranty estimate is valid, the total amounts deducted for accounting and for tax purposes will be equal over the three-year period. This is an example of an expense that, in the first year, reduces pre-tax accounting income more than it does the taxable income and, in later years, reverses and reduces taxable income without affecting pre-tax accounting income.

Ex. 18-53 Permanent and reversible differences Listed below are items that are treated differently for accounting purposes than they are for tax purposes. Indicate whether the items are permanent differences or reversible differences. For reversible differences, indicate whether they will create deferred tax assets or deferred tax liabilities. 1. Investments accounted for by the equity method 2. Advance rental receipts 3. Membership costs for executives at a local golf club 4. Estimated future warranty costs 5. Excess of pension contributions over pension expense 6. Expenses incurred in obtaining tax-exempt revenue 7. Instalment sales 8. Excess CCA over accounting depreciation 9. Long-term construction contracts 10. Premiums paid on life insurance of officers (company is the beneficiary) 11. Penalty assessed by CRA for late submission of income tax return Solution 18-53 1. Reversible difference, deferred tax liability 2.

Reversible difference, deferred tax asset

Permanent difference

Reversible difference, deferred tax asset

Reversible difference, deferred tax liability

Permanent difference

Reversible difference, deferred tax liability

10. Permanent difference 11. Permanent difference

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Ex. 18-54 Reversible differences There are four types of reversible differences. For each type: indicate the cause of the difference, give some examples, and indicate whether the difference will create a taxable or deductible amount in the future. Solution 18-54 1. Revenues or gains taxable after they are recognized in pre-tax accounting income. Examples are instalment sales, long-term construction contracts, and the equity method of accounting for investments. They result in future taxable amounts. 2.

Revenues or gains taxable before they are recognized in pre-tax accounting income. Examples are subscriptions received in advance and rents received in advance. They result in future deductible amounts.

Expenses or losses deductible before they are recognized in pre-tax accounting income. Examples are the use of CCA for tax purposes, prepaid expenses, and pension funding in excess of pension expense. They result in future taxable amounts.

Expenses or losses deductible after they are recognized in pre-tax accounting income. Examples are warranty expenses, estimated lawsuit losses, and unrealized losses on investments. They result in future deductible amounts.

Ex. 18-55 Calculation of taxable income The records for Montana Inc. show the following data for calendar 2014: 1. Gross profit on instalment sales recorded on the books was $200,000. Gross profit from collections of instalment receivables was $150,000. 2. Golf club dues were $3,800. 3. Machinery was acquired in January 2014 for $300,000. Montana uses straight-line depreciation over a ten-year life (no residual value). For tax purposes, Montana uses CCA at 14% for 2014. 4. Dividends received from a Canadian corporation were $9,000. 5. The estimated warranty liability related to 2014 sales was $19,600. Warranty repair costs paid during 2014 were $13,600. The remainder will be paid in 2015. 6. Pre-tax accounting income is $250,000. The enacted income tax rate is 25%. Instructions a. Prepare a schedule (starting with pre-tax accounting income) to calculate taxable income. b. Prepare the required adjusting journal entries to record income taxes for 2014. Solution 18-55 a. Pre-tax financial income ................................................................ Permanent differences Golf dues (add back) .............................................................. Dividends (deduct) ................................................................. Reversible differences Instalment sales ($200,000 – $150,000)................................. CCA ($42,000 – $30,000)....................................................... Warranty expense ($19,600 – $13,600) .................................

$250,000 3,800 (9,000) (50,000) (12,000) 6,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Taxable income .............................................................................

$188,800

Current Tax Expense .................................................................... Income Tax Payable 25% × $188,800 ....................................

47,200

Deferred Tax Expense ................................................................. Deferred Tax Asset 25% × $6,000 ................................................ Deferred Tax Liability 25% × ($50,000 + $12,000)..................

14,000 1,500

47,200

15,500

Ex. 18-56 Future income taxes Nevada Corp., at the end of 2014, its first year of operations, prepared a reconciliation between pre-tax accounting income and taxable income as follows: Pre-tax accounting income $300,000 Estimated warranty expenses deductible when paid 800,000 Excess CCA (600,000) Taxable income $500,000 Estimated warranty expenses of $530,000 will be deductible in 2015, $200,000 in 2016, and $70,000 in 2017. The use of the depreciable assets will result in taxable amounts of $200,000 in each of the next three years. The enacted tax rate is 30% and is not expected to change. Instructions a. Prepare a schedule of the future taxable and deductible amounts. b. Prepare the required adjusting journal entries to record income taxes for 2014. Solution 18-56 a. Future taxable (deductible) amounts Warranties Excess CCA b.

2015

2016

$(530,000) 200,000

$(200,000) 200,000

2017

Total

$(70,000) $(800,000) 200,000 600,000

Current Tax Expense $500,000 x 30% .......................................... Income Tax Payable ..............................................................

150,000

Deferred Tax Asset 800,000 x 30% ............................................... Deferred Tax Liability $600,000 × 30% ................................... Deferred Tax Expense............................................................

240,000

150,000

180,000 60,000

Ex. 18-57 Deferred income taxes Nebraska Ltd., at the end of 2014, its first year of operations, prepared a reconciliation between pre-tax accounting income and taxable income as follows: Pre-tax accounting income Excess CCA claimed for tax purposes Estimated expenses deductible when paid Taxable income

$300,000 (600,000) 500,000 $200,000

Use of the depreciable assets will result in taxable amounts of $200,000 in each of the next

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Income Taxes

three years. The estimated expenses of $500,000 will be deductible in 2017 when settlement is expected to be made. The enacted tax rate is 25% and is not expected to change. Instructions a. Prepare a schedule of the deferred taxable and deductible amounts. b. Prepare the required adjusting journal entries to record income taxes for 2014. Solution 18-57 a. Future taxable (deductible) amounts CCA Expenses b.

2015

2016

2017

Total

$200,000

$200,000 (500,000)

$600,000 (500,000)

Current Tax Expense $200,000 × 25%....................................... Income Tax Payable ............................................................

50,000

Deferred Tax Expense ............................................................... Deferred Tax Asset $500,000 × 25% ......................................... Deferred Tax Liability $600,000 × 25% ................................

25,000 125,000

50,000

150,000

Ex. 18-58 Deferred tax asset a. Describe a deferred tax asset. b. Under IFRS, when should a deferred tax asset be recognized? Solution 18-58 a. A deferred tax asset is the future income tax consequences attributable to deductible temporary differences and loss carryforwards. b.

IFRS (IAS 12) permits a deferred tax asset to be recognized only to the extent that it is probable that it will be realized in the future. Note that IFRS does not use a valuation account (although ASPE does).

Ex. 18-59 Taxable loss carryforward without valuation allowance (IFRS) In 2014, its first year of operations, Hampshire Inc. reported a $500,000 loss for tax purposes. However, in 2015, Hampshire reported $200,000 taxable income. The tax rate is 30%, and is likely to remain at this rate for the foreseeable future. Hampshire reports under IFRS. Assume that, at the end of 2014, because it is a new company, Hampshire’s management thought that it was probable that the loss carryforward would not be realized in the near future. However, by the end of 2015, management feels it is now probable that there will be future taxable incomes against which the 2014 loss could be applied. Instructions a. What entries (if any) would be prepared in 2014 to record the loss carryforward? b. What entries (if any) would be prepared in 2015 to record current and deferred taxes and to recognize the loss carryforward?

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 18-59 a. Since management feels it is probable that the loss carryforward would not be realized in the near future, no journal entry is required. b.

Current Tax Expense ($200,000 × 30%) ....................................... Deferred Tax Benefit ..............................................................

60,000

Deferred Tax Asset ....................................................................... Deferred Tax Benefit ($300,000 × 30%) .................................

90,000

60,000

90,000

Ex. 18-60 Taxable loss carryforward with valuation allowance (ASPE) In 2014, its first year of operations, Jersey Inc. reported a $200,000 loss for tax purposes. However, in 2015, Jersey reported $250,000 taxable income. The tax rate is 20%, and is likely to remain at this rate for the foreseeable future. Jersey is a private corporation reporting under ASPE. Assume Jersey’s management thinks, at the end of 2014, that it is likely that the loss carryforward will not be realized in the near future. Jersey chooses to use the valuation allowance method for loss carryforwards. Instructions a. What entries (if any) would be prepared in 2014 to record the loss carryforward? b. What entries (if any) would be prepared in 2015 to record the current and future income taxes and to recognize the loss carryforward? Solution 18-60 a. Future Income Tax Asset $200,000 × 20% .................................. Future Income Tax Benefit .....................................................

40,000 40,000

Future Income Tax Expense ......................................................... Allowance to Reduce Future Income Tax Asset to Expected Realizable Value .......................................

40,000

Current Income Tax Expense $50,000 × 20% .............................. Income Tax Payable ...............................................................

10,000

Future Income Tax Expense ......................................................... Future Income Tax Asset .......................................................

40,000

Allowance to Reduce Future Income Tax: Asset to Expected Realizable Value .............................................. Future Income Tax Benefit .....................................................

40,000

10,000

40,000

40,000 40,000

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PROBLEMS Pr. 18-61 Taxable income and accounting income Explain the difference between accounting income and taxable income. Solution 18-61 Accounting income is calculated in accordance with generally accepted accounting principles. Taxable income is calculated in accordance with prescribed tax legislation and regulations. Because tax legislation and GAAP have different objectives, accounting income and taxable income often differ.

Pr. 18-62 Taxable temporary difference Explain what a taxable temporary difference is and why a deferred tax liability is recognized. Solution 18-62 A taxable temporary difference is the difference between the carrying value of an asset or liability and its tax base. When the asset is recovered or liability is settled in the future for an amount equal to its carrying value, taxable income of that future period will be increased. Because taxes arise in the future as a result of reversible differences existing at the statement of financial position date, the future income tax consequences of these taxable amounts are recognized in the current period as a deferred tax liability.

Pr. 18-63 Differences between accounting and taxable income and the effect on future income taxes The following differences apply to the reconciliation of accounting income and taxable income of Mexico Inc. for calendar 2014, its first year of operations. The enacted income tax rate is 30% for all years. Pre-tax accounting income $450,000 Excess CCA (240,000) Lawsuit accrual 35,000 Unearned rent revenue deferred on the books but correctly included in taxable income 25,000 Dividend income from Canadian corporations (10,000) Taxable income $260,000 1. 2. 3.

Excess CCA will reverse equally over a four-year period, 2015–2018. It is estimated that the lawsuit accrual will be paid in 2018. Unearned rent revenue will be recognized as earned equally over a four year period, 2015– 2018.

Instructions a. Prepare a schedule of future taxable and deductible amounts. b. Prepare a schedule of any deferred tax asset and/or deferred tax liability. c. Since this is the first year of operations, there is no beginning deferred tax asset or liability. Calculate the net deferred tax expense (benefit). d. Prepare the adjusting journal entries to record income tax expense, deferred taxes, and

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

income taxes payable for 2014. Solution 18-63 a. Future taxable (deductible) amounts: CCA Lawsuit Unearned rent b. Reversible Differences CCA Lawsuit Unearned rent Totals

2015

2016

2017

$60,000

(6,250)

Future Taxable (Deductible) Amounts Tax Rate $240,000 30% (35,000) 30% (25,000) 30% $180,000

2018

Total

$60,000 $240,000 (35,000) (35,000) (6,250) (6,250) (25,000)

Deferred Tax Asset Liability $72,000 $(10,500) ( 7,500) $(18,000) $72,000

Deferred tax expense Deferred tax benefit Net deferred tax expense

$72,000 (18,000) $54,000

Current Tax Expense ($260,000 x 30%) .................................... Income Tax Payable ............................................................

78,000

Deferred Tax Expense ............................................................... Deferred Tax Asset .................................................................... Deferred Tax Liability .......................................................

54,000 18,000

78,000

72,000

Pr. 18-64 Multiple reversible differences The following information is available for the first three years of operations for York Corporation: 1. Year Taxable Income 2014 $250,000 2015 180,000 2016 200,000 2. On January 2, 2014, equipment was purchased for $500,000. The equipment had an estimated service life of 5 years and no residual value. Straight-line depreciation is used for book purposes and CCA at 30% is used for tax purposes (subject to the half year rule for the first year). 3. On January 2, 2015, $210,000 was collected in advance for the rental of a building for three years. The entire $210,000 was included in taxable income in 2015, but two-thirds of the $210,000 was reported as unearned revenue at December 31, 2015 for book purposes. 4. The enacted tax rate is 40% for all years. Instructions a. Prepare a schedule comparing depreciation for book purposes with CCA for tax purposes. b. Determine the deferred tax asset or liability at the end of 2014. c. Prepare a schedule of future taxable and deductible amounts at the end of 2015. d. Prepare a schedule of the deferred tax asset and/or liability at the end of 2015.

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Income Taxes

e. f.

Calculate the net deferred tax expense or benefit for 2015. Prepare the adjusting journal entries to record income tax expense, deferred taxes, and income tax payable for 2015.

Solution 18-64 a. Year 2014 2015 2016 2017 2018 Remainder

Depreciation for Book Purposes $100,000 100,000 100,000 100,000 100,000 -0$500,000

2015 Future taxable (deductible) amounts: CCA ($27,500)

CCA for Tax Purposes $ 75,000 127,500 89,250 62,475 43,733 102,042 $500,000

Reversible Difference $ 25,000 (27,500) 10,750 37,525 56,267 (102,042) $ -0-

2016

2017

2018

Remainder

Total

$10,750

$37,525

$56,267

($102,042)

$25,000

Deferred tax asset: $25,000 × 40% = $10,000 at the end of 2014. c. Future taxable (deductible) amounts: CCA Rent d. Reversible Differences CCA Rent Totals e.

2016

2017

2018

Remainder

Total

$10,750 (70,000)

$37,525 (70,000)

$56,267

($102,042)

$2,500 (140,000)

Future Taxable (Deductible) Amounts $ 2,500 (140,000) $ (137,500)

Tax Rate 40% 40%

Deferred tax asset at end of 2015 Deferred tax asset at beg. of 2015 Deferred tax (benefit)

$(56,000) -0$(56,000)

Deferred tax liability at end of 2015 Deferred tax asset at beg. of 2015 Deferred tax expense

$ 1,000 (10,000) $ 11,000

Deferred tax (benefit) Deferred tax expense Net deferred tax (benefit) for 2015

$(56,000) 11,000 $(45,000)

Deferred tax Asset Liability $1,000 $(56,000) $(56,000) $1,000

Current Tax Expense ($180,000 x 40%) ....................................... Income Tax Payable ...............................................................

72,000 72,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Deferred Tax Asset ....................................................................... Deferred Tax Benefit .............................................................. Deferred Tax asset ................................................................. Deferred Tax liability ...............................................................

56,000 45,000 10,000 1,000

Pr. 18-65 Interperiod tax allocation with change in enacted tax rates Carolina Corp. purchased equipment for $180,000 on January 2, 2014, its first day of operations. For book purposes, the equipment will be depreciated straight-line over three years with no residual value. Pre-tax accounting incomes and taxable incomes are as follows:

Pre-tax accounting income Taxable income

2014 $124,000 100,000

2015 $140,000 140,000

2016 $150,000 174,000

The reversible difference between pre-tax accounting income and taxable income is due solely to the use of CCA for tax purposes. Instructions a. Prepare the adjusting journal entries to record income taxes for all three years (expense, deferred tax assets/liabilities, etc.), assuming that the enacted income tax rate for all three years is 30%. b. Prepare the adjusting journal entries to record income taxes for all three years (expense, deferred tax assets/liabilities, etc.), assuming that the enacted income tax rate for 2014 is 30% but that in the middle of 2015, Parliament raises the income tax rate to 35%, retroactive to the beginning of 2015. Solution 18-65 a. Book depreciation CCA Reversible difference

2014 $ 60,000 84,000 $(24,000)

2015 $60,000 60,000 $ -0-

2016 $60,000 36,000 $24,000

2014 Current Tax Expense ($100,000 x 30%) ....................................... Income Tax Payable ............................................................... Deferred Tax Expense ($24,000 x 30%) ....................................... Deferred Tax Liability .............................................................

Total $180,000 180,000 $ -0-

30,000 30,000 7,200 7,200

2015 Current Tax Expense ($140,000 × 30%) ....................................... Income Tax Payable ...............................................................

42,000

2016 Current Tax Expense ($174,000 × 30%) ....................................... Income Tax Payable ...............................................................

52,200

Deferred Tax Liability ($24,000 x 30%) .........................................

7,200

42,000

52,200

Income Taxes

Deferred Tax Expense............................................................ b. 2014 Current Tax Expense ($100,000 × 30%) .................................... Income Tax Payable ........................................................ Deferred Tax Expense ($24,000 × 30%) .................................... Deferred Tax Liability ....................................................... 2015 Current Tax Expense ($140,000 × 35%) .................................... Income Tax Payable ........................................................ Deferred Tax Expense ............................................................... Deferred Tax Liability ....................................................... *Future taxable amount Deferred tax @ 30% Deferred tax @ 35% Adjustment required

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7,200

30,000 30,000 7,200 7,200

49,000 49,000 1,200 1,200*

$24,000 7,200 8,400 $ 1,200

2016 Current Tax Expense ($174,000 × 35%) .................................... Income Tax Payable ........................................................ Deferred Tax Liability ($24,000 x 35%) ...................................... Deferred Tax Expense .....................................................

60,900 60,900 8,400 8,400

Pr. 18-66 Deferred tax asset Dakota Ltd. began operations on January 1, 2014, and adheres to IFRS. Its pre-tax accounting income for the first two years was as follows: 2014 $ 80,000 2015 150,000 The following items caused the only differences between pre-tax accounting income and taxable income. 1. In 2014, the company collected $75,000 in rental revenue; of this amount, $25,000 was earned in 2014; the other $50,000 will be earned equally during 2015 and 2016. The full $75,000 was included in taxable income in 2014. 2. The company pays $5,000 a year for membership in a local golf club. 3. In 2015, the company terminated a top executive and agreed to pay $30,000 severance pay. This will be paid $10,000 each year for three years, starting in 2015. The 2015 payment was made as scheduled. The entire $30,000 was expensed in 2015 for book purposes. For tax purposes, the severance pay is deductible only when it is paid. The enacted tax rates at December 31, 2014 are: 2014 30% 2016 40% 2015 35% 2017 40%

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Instructions a. Calculate taxable income for 2014 and 2015. b. Calculate the deferred tax asset and/or liability at the end of 2014, and prepare the adjusting journal entries to record income taxes for 2014. c. Prepare a schedule of future taxable and deductible amounts at the end of 2015. d. Prepare a schedule of the deferred tax asset and/or liability at the end of 2015. e. Calculate the deferred tax expense (benefit) for 2015. f. Prepare the adjusting journal entries to record income taxes for 2015 (both current and deferred). g. Show how the deferred tax asset or liability should be reported on the statement of financial position at December 31, 2015. Solution 18-66 a. Pre-tax accounting income Permanent difference: Golf club membership Reversible differences: Rent Severance pay Taxable income b.

2014 $80,000

2015 $150,000

5,000 85,000

5,000 155,000

50,000 -0$135,000

(25,000) 20,000 $150,000

2015 Future taxable (deductible) amounts: Rent $(25,000) Tax rate 35% Future income tax (asset) liability $ (8,750)

Total

$(25,000) 40% $(10,000)

$(50,000) $(18,750) at end of 2014

Current Tax Expense ($135,000 × 30%) .................................... Income Tax Payable ............................................................

40,500

Deferred Tax Asset .................................................................... Deferred Tax Benefit ...........................................................

18,750

c. Future taxable (deductible) amounts: Rent Severance pay d. Reversible Difference Rent Severance pay Totals e.

2016

18,750

2016

2017

Total

$(25,000) (10,000)

$(10,000)

$(25,000) (20,000)

Future Taxable (Deductible) Amounts $(25,000) (20,000) $(45,000)

Deferred tax asset at end of 2015 Deferred tax asset at beg. of 2015

40,500

Tax Rate 40% 40%

Deferred tax Asset Liability $(10,000) (8,000) $(18,000)

$(18,000) (18,750)

Income Taxes

Deferred income tax (benefit) for 2015 f.

18- 37

(750)

Current Tax Expense ($150,000 × 35%) .................................... Income Tax Payable ............................................................

52,500

Deferred Tax Expense ............................................................... Deferred Tax Asset .............................................................

750

Noncurrent assets: Deferred Tax Asset ($45,000 × 40%) .........................................

52,500

750

$18,000

Pr. 18-67 Comprehensive income tax situation with multiple differences (ASPE) Ohio Ltd., a private corporation which follows ASPE, is in the process of preparing its financial statements for its second year of operations ending December 31, 2014. Pertinent information follows: 1. Accounting income before tax is $1,500,000. 2. Depreciation on property, plant and equipment (PPE) in the books is $150,000 and CCA claimed will be $250,000. At the beginning of the year, the book value of the PPE was $1,200,000. 3. Ohio sells a product with a 2-year warranty. The estimated warranty cost is $100 per unit. At the beginning of 2014, the balance in the warranty liability account was $400,000. During 2014, Ohio sold 5,000 units of the product and paid out $200,000 in warranty costs. They expect that the adjusted warranty liability balance at the end of 2014 to be spent evenly over 2015 and 2016. At the end of 2013, Ohio had also expected the adjusted warranty liability amount to be paid evenly over 2014 and 2015. 4. The beginning balance of the future income tax liability account related to the PPE was $60,000. The beginning balance of the future income tax asset account related to the warranty was $160,000. 5. The accounting income before tax included $50,000 in entertainment expenses, of which only 50% can be deducted for income tax purposes. 6. At the beginning of 2014, the enacted income tax rate went down from 40% to 35%. 7. On December 31, 2014, the company received three years advance rent income (for 2015 through 2017) of $90,000, which was recorded as unearned revenue for book purposes, but which must be reported as 2014 revenue for income tax purposes. Instructions a. Reconcile accounting income before tax to taxable income for 2014. b. Prepare the required income tax related journal entries for 2014. c. Prepare the bottom section of the 2014 income statement, beginning with income before income taxes. d. What are the amounts and the statement of financial position classifications of the future income tax asset and liability accounts at December 31, 2014? Solution Pr 18-67 a. Reconciliation: Accounting income before tax ........................................... Add back 50% of entertainment expense .......................... Warranty expense .............................................................

1,500,000 25,000 500,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Warranty costs allowable .................................................. Depreciation expense .......................................... CCA for tax purpose ......................................................... Rent received in advance .................................................. Taxable income for 2014................................................... Tax payable ......................................................................

200,000 300,000 150,000 250,000 (100,000) 90,000 1,815,000 635,250

b. Before recording the journal entries, we need to calculate the change in deferred tax assets and liabilities. Future income taxes related to PPE Future income tax liability Dec 31, 2013 ............................................... 60,000 Enacted tax rate in 2013 ...................................................................... 40% Reversible difference due to PPE in 2013 ............................................ 150,000 Reversible difference due to PPE in 2014 ............................................ 100,000 Accumulated reversible differences to end of 2014 .............................. 250,000 Enacted tax rate in 2014 ...................................................................... 35% Future income tax liability Dec 31, 2014 ............................................... 87,500 Increase in future income tax liability in 2014 ....................................... 27,500 Future income taxes related to warranty Reversible difference due to warranty in 2013 ..................................... Enacted tax rate in 2013 ...................................................................... Future income tax asset Dec 31, 2013 ................................................. Reversible difference due to warranty in 2014 ..................................... Accumulated reversible differences to end of 2014 .............................. Enacted tax rate in 2014 ...................................................................... Future income tax asset Dec 31, 2014 ................................................. Increase in future income tax asset in 2014 .........................................

400,000 40% 160,000 300,000 700,000 35% 245,000 85,000

Future income taxes related to unearned rent Rent received in advance ..................................................................... Enacted tax rate ................................................................................... Increase in future income tax asset due to unearned rent ....................

90,000 35% 31,500

Journal entries: Future income tax asset ................................................................ Future income tax liability ....................................................... Future income tax benefit ....................................................... Current tax expense ...................................................................... Income taxes payable ............................................................

Bottom section of the income statement for 2014: Income before tax ......................................................................... Income tax expense Current ................................................................................... Future..................................................................................... Net income ....................................................................................

116,500 27,500 89,000 635,250 635,250

1,500,000 635,250 (89,000) (546,250) $ 953,750

Statement of financial position presentation of future income tax accounts:

Income Taxes

Current Assets Future income tax asset ((245,000 x ½) + (31,500 x 1÷3)) = Non-Current Assets Future income tax asset ((245,000 x ½) + (31,500 x 2÷3)) = Future income tax liability

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133,000

143,500 87,500 56,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 19 PENSIONS AND OTHER EMPLOYEE FUTURE BENEFITS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

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

1 1,4 2 3 3 3 3 3

M E E E M M M H

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

31. 32. 33. 34. 35. 36. 37.

5 5 7 7 7 7 7

M M M M M H E

38. 39. 40. 41. 42. 43. 44.

58. 59. 60.

4 4,7 5

M M M

61. 62. 63.

68. 69. 70. 71.

4 4,5 4,5 4,5,7

M M M M

72. 73. 74. *75.

81. 82.

4,5,7 4,6,7

M M

83. *84.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 4 H 17. 7 M 4 M 18. 7 M 4 M 19. 7 M 4 M 20. 7 M 4 M 21. 7 M 5 M 22. 7 M 5 M 23. 7 M 6 E 24. 7,9 M Multiple Choice–Computational 7 M 45. 7 M 7 E *46. 11 M 7 H *47. 12 H 7 M *48. 12 H 7 H *49. 12 H 7 M *50. 12 H 7 M *51. 12 M Multiple Choice–CPA Adapted 5 M 64. 7 M 7 E 65. 7 E 7 M *66. 12 M Exercises 7 M *76. 12 M 7 M *77. 12 H 7 M *78. 12 M 12 M *79. 12 M Problems 7 M *85. 12 M 12 M

M = Medium

Item

LOD

25. 26. 27. 28. *29. *30.

8 8 8,9 9 12 12

M M M H M M

*52. *53. *54. *55. *56. *57.

12 12 12 12 12 12

M M H M M H

*67.

*80.

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type 1.

Item

Type

Item Type Item Type Learning Objective 1

Item

Type

Item

Type

81. 82.

Pr Pr

71. 81.

Ex Pr

65. 71. 72. 73. 74. 81.

MC Ex Ex Ex Ex Pr

82. 83.

Pr Pr

*76. *77. *78. *79.

Ex Ex Ex Ex

*80. *84. *85.

Ex Pr Pr

Learning Objective 2 3.

2. 9. 10.

MC MC MC

11. 12. 13.

MC MC MC

14. 15.

MC MC

31. 32.

MC MC

16.

82.

17. 18. 19. 20. 21. 22.

MC MC MC MC MC MC

23. 24. 34. 35. 36. 37.

MC MC MC MC MC MC

25.

26.

24.

27.

46.

*29. *30. *47. *48.

MC MC MC MC

Learning Objective 3 6. MC 7. MC Learning Objective 4 58. MC 69. Ex 59. MC 70. Ex 68. Ex 71. Ex Learning Objective 5 60. MC 69. Ex 61. MC 70. Ex Learning Objective 6 Learning Objective 7 38. MC 44. MC 39. MC 45. MC 40. MC 59. MC 41. MC 62. MC 42. MC 63. MC 43. MC 64. MC Learning Objective 8 27. MC Learning Objective 9 Learning Objective 11

Note:

*49. *50. *51. *52.

MC MC MC MC

MC = Multiple Choice

Learning Objective 12 *53. MC *57. MC *54. MC *66. MC *55. MC *67. MC *56. MC *75. Ex Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Pensions and Other Employee Future Benefits

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CHAPTER STUDY OBJECTIVES 1. Understand the importance of pensions from a business perspective. A pension plan, together with post-retirement health care, is often part of an employee’s overall compensation package. The size of these plans, in terms of both the number of employees and cost of benefits, has made their costs very large (on average) in relation to companies’ financial position, results of operations, and cash flows. With the vast majority of defined benefit plans being underfunded, more and more companies are moving toward defined contribution plans.

2. Identify and account for a defined contribution benefit plan. Defined contribution plans are plans that specify how contributions are determined rather than what benefits the individual will receive. They are accounted for similar to a cash basis.

3. Identify and explain what a defined benefit plan is and the related accounting issues. Defined benefit plans specify the benefits that the employee is entitled to. Defined benefit plans whose benefits vest or accumulate typically provide for the benefits to be a function of the employee’s years of service and, for pensions, compensation level. In general, the employer’s obligation for such a plan and the associated cost is accrued as an expense as the employee provides the service. An actuary usually determines the required amounts. 4. Explain what the employer’s benefit obligation is, identify alternative measures for this obligation, and prepare a continuity schedule of transactions and events that change its balance. The employer’s benefit obligation is the actuarial present value of the benefits that have been earned by employees for services they have provided up to the date of the statement of financial position. The vested benefit method, accumulated benefit method, and projected benefit method are three methods that could be used to measure companies’ obligations. The third method is the one used to determine the defined benefit obligation, basing the calculation of the deferred compensation amount on both vested and non-vested service using future salaries. This last method is used under both IFRS and the deferral and amortization approach under ASPE. The funding approach specified by legislation is the measurement of the obligation under ASPE’s immediate recognition approach. The DBO is increased by current service cost, interest cost, plan amendments that usually increase employee entitlements for prior services, and by actuarial losses. It is reduced by payment of pension benefits and by actuarial gains.

5. Identify transactions and events that change benefit plan assets, and calculate the balance of the assets. Plan assets are increased by company and employee contributions and the actual return that is earned on fund assets (including realized and unrealized gains and losses), and are reduced by pension benefits paid to retirees. 6. Explain what a benefit plan’s funded status is, calculate it, and identify what transactions and events change its amount. A plan’s funded status is the difference between the defined benefit obligation and the plan assets at a point in time. It tells you the extent to which a company has a net obligation (underfunded) or a surplus (overfunded) relative to the benefits that are promised. All items that change the plan assets and DBO with the exception of the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

payments to retirees change the funded status.

7. Identify the components of pension expense, and account for a defined benefit pension plan under the immediate recognition approach. Pension expense under the immediate recognition approach is a function of: (1) service cost, (2) interest on the liability, (3) actual return on plan assets, (4) past service costs, and (5) net actuarial gains or losses. Under ASPE, all are immediately included in current expense in their entirety. The pension obligation amount is determined under a funding basis measure. Under IFRS, pension costs relating to current service, past service, and net interest on the net defined benefit obligation are included in pension expense. Actuarial gains and losses, and any return on plan assets excluding amounts included in the net interest on the net defined benefit obligation (asset), are recognized in OCI.

8. Account for defined benefit plans with benefits that vest or accumulate other than pension plans. Under ASPE, any non-pension defined benefit plans with benefits that vest or accumulate are accounted for in the same way as defined benefit pension plans. Under IFRS, short-term employee benefits are generally recognized (without discounting) at the amount expected to be paid in exchange for the services provided. Other long-term benefits include items such as paid absences for long service, unrestricted sabbaticals, and long-term disability plans. IFRS requires the same recognition and measurement for these long-term benefits as for pension plans. Specifically, changes in the liabilities related to these benefits should be reflected in income. For termination benefits, IFRS requires the cost of the benefits to be recognized at the earlier of when the company can no longer withdraw an offer of employment and when it recognizes the related restructuring costs.

9. Identify the types of information required to be presented and disclosed for defined benefit plans, prepare basic schedules, and be able to read and understand such disclosures. ASPE requires a description of the plans, major changes made in the plans, dates of the actuarial valuations, the fair value of the plan assets, the ABO, and the funded status and how this relates to the balance sheet account. IFRS requires substantial information, such as reconciliations of changes in the DBO and plan assets, details of amounts included in net income, underlying assumptions and sensitivity analysis, and other information related to help determine cash flows.

10. Identify differences between the IFRS and ASPE accounting for employee future benefits and what changes are expected in the near future. IAS 19 is broader based and covers more employee benefits than does CICA Handbook, Part II, Section 3461. ASPE permits a choice of the immediate recognition approach or the deferral and amortization approach, whereas IFRS permits only the former approach, but with options within it. With recent changes to IAS 19, most companies are expected to recognize the net defined benefit liability (or asset) on the statement of financial position with items such as current service cost, past service cost and interest on the DBO and plan assets recognized in net income, and remeasurement changes and actuarial gains and losses reported in OCI. At the present time, ASPE still allows companies to use the deferral and amortization approach, although this option is expected to be eliminated eventually.

11. Explain and apply basic calculations to determine current service cost, the defined

Pensions and Other Employee Future Benefits

19- 5

benefit obligation, and past service cost for a one-person defined benefit pension plan. The current service cost is a calculation of the present value of the benefits earned by employees that is attributable to the current period. The defined benefit obligation is the present value of the accumulated benefits earned to a point in time, according to the pension formula and using projected salaries. Past service cost is the present value of the additional benefits granted to employees in the case of a plan amendment.

12. Identify the components of pension benefit cost, and account for a defined benefit pension plan when using the deferral and amortization approach under ASPE; determine the pension plan accounts reported in the financial statements and explain their relationship to the funded status of the plan. Pension cost under the deferral and amortization approach is a function of: (1) service cost, (2) interest on the liability, (3) expected return on plan assets, (4) past service costs, and (5) net actuarial gain or loss. Items (1) to (3) are included in current expense entirely, while items (4) and (5) are usually recognized through a process of amortization. The unamortized balances of items (4) and (5) are reported in the notes to the financial statements. An accrued benefit liability or asset is reported in the balance sheet. Under the deferral and amortization approach, the balance is equal to the funded status adjusted for any unamortized past service costs and unamortized actuarial gains and losses. The pension expense is reported in the income statement.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c d c b b c a d a d b c d a b b a c c b a c a c b c b c b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. *29.

*30.

Description Employee future benefits Pension funding and pension expense recognition Nature of a defined contribution plan Nature of a defined benefit plan Objective of accounting for defined benefit plans Meaning of funding a pension plan Accounting problems in pension plans Main purpose of an actuary Definition of defined benefit obligation Characteristics of vested benefits Increase in defined/accrued benefit obligation Definition of attribution period Definition of experience gain or loss Nature of plan assets Nature of return on plan assets Plan funded status Adjustment for actuarial valuations Application of immediate recognition approach Recognition of past service costs using immediate recognition approach Recognition of net defined benefit asset G/L accounts under immediate recognition approach Rationale for expensing past service costs using immediate recognition Advantage of immediate recognition approach Identify correct statement. Post-employment benefits Post-employment benefits Recording/disclosure of post-employment benefit obligations Disclosure of post-employment benefits Unrecognized actuarial gains/losses using deferral and amortization approach. Corridor amortization

*This topic is dealt with in an Appendix to the chapter.

Pensions and Other Employee Future Benefits

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MULTIPLE CHOICE—Computational Answer b a b c c d a b b d b b c b d c b b d c d c c b a b b

No. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. *46. *47. *48. *49. *50. *51. *52. *53. *54. *55. *56. *57.

Description Calculate fair value of plan assets. Calculate fair value of plan assets. Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate net defined benefit liability/asset. Calculate net defined benefit liability/asset. Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate defined benefit obligation. Calculate pension expense. Calculate defined benefit obligation. Calculate post-employment benefit expense. Calculate accrued pension liability/asset. Calculate actuarial gain/loss. Calculate accrued pension liability/asset. Calculate actuarial gain/loss. Calculate accrued benefit obligation. Calculate fair value of plan assets. Calculate interest cost. Calculate actual return on plan assets. Calculate unexpected gain/loss. Calculate corridor. Calculate unrecognized actuarial gain/loss to be amortized.

MULTIPLE CHOICE—CPA Adapted Answer b d c b a a c a d c

No. 58. 59. 60. 61. 62. 63. 64. 65. *66. *67.

Description Nature of interest cost included in pension cost Calculate defined benefit obligation. Calculate fair value of plan assets. Calculate fair value of plan assets. Calculate net defined benefit liability/asset. Calculate pension expense. Calculate pension expense. Reporting net defined benefit liability/asset Calculate accrued benefit liability/asset. Calculate pension plan funded status.

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E19-68 E19-69 E19-70 E19-71 E19-72 E19-73 E19-74 *E19-75 *E19-76 *E19-77 *E19-78 *E19-79 *E19-80

Description Pension accounting terminology Pension asset terminology Pension plan calculations Pension plan calculations and journal entries Approaches to accounting for pension expense Measuring and recording pension expense. Measuring the recording pension expense Corridor amortization Pension plan calculations and journal entries Corridor approach for amortization of actuarial gains and losses Pension reconciliation schedule Calculating and recording pension expense. Calculating accrued pension liability/asset.

PROBLEMS Item P19-81 P19-82 P19-83 *P19-84 *P19-85

Description Measuring and recording pension expense. Calculating pension expense and funded status. Preparation of a pension work sheet and pension entries Amortization of past service costs using EARSL Preparation of a pension work sheet and pension entries (deferral and amortization approach)

*This topic is dealt with in an Appendix to the chapter.

Pensions and Other Employee Future Benefits

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MULTIPLE CHOICE—Conceptual 1. Employee future benefits do NOT include a. post-employment pension plans. b. long-term severance benefits. c. regular vacation pay. d. unrestricted sabbatical leaves.

2. The relationship between the amount funded and the amount reported for pension expense is that a. pension expense must always equal the amount funded. b. pension expense will be less than the amount funded. c. pension expense will be more than the amount funded. d. pension expense may be greater than, equal to, or less than the amount funded.

3. In a defined contribution plan, a formula is used that a. defines the benefits that the employee will receive at retirement. b. ensures that pension expense and the cash funding amount will be different. c. requires an employer to contribute a certain sum each period based on the formula. d. ensures that employers are at risk to make sure funds are available at retirement.

4. In a defined benefit plan, a formula is used that a. requires that the benefit of gain or the risk of loss from the assets contributed to the pension plan be borne by the employee. b. defines the benefits that the employee will receive at retirement. c. requires that pension expense and the cash funding amount to be the same. d. defines the contribution the employer is to make; no promise is made concerning the ultimate benefits to be paid out to the employees.

5. The objective of accounting for defined benefit plans is to a. calculate the actual amounts employees will receive at retirement. b. recognize the appropriate expense and liability over the accounting periods in which the related services are provided by the employees. c. calculate the current service cost. d. determine which employees’ rights have vested. 6. In a defined benefit plan, for the employer, the term “funding” refers to a. being responsible for the assets of the pension plan. b. determining the defined benefit obligation. c. making periodic contributions to a funding agency to ensure that funds are available to meet retirees' claims. d. calculating the amount to report for pension expense.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

7. Accounting problems for all pension plans may include all the following EXCEPT a. determining the level of individual premiums. b. reporting the status and effects of the plan in the financial statements. c. allocating the cost of the plan to the proper periods. d. measuring the amount of pension obligation. 8. In pension accounting, the actuary’s main purpose is to a. make predictions about mortality rates and employee turnover. b. calculate the current pension cost. c. calculate the interest cost of the pension plan. d. ensure the employer has established an appropriate funding pattern to meet its pension obligations.

9. Under IFRS, the defined benefit obligation for accounting purposes is a. the present value of vested and non-vested benefits earned to the statement of financial position date, with the benefits measured using employees’ future salary levels. b. the present value of vested and non-vested benefits earned to the statement of financial position date, with the benefits measured using employees’ current salary levels. c. the present value of vested benefits only earned to the statement of financial position date, with the benefits measured using employees’ future salary levels. d. the present value of non-vested benefits only earned to the statement of financial position date, with the benefits measured using employees’ future salary levels.

10. Which statement is INCORRECT regarding vested benefits? a. They usually require a certain minimum number of years of service. b. The employee is entitled to receive such benefits even if s/he is fired. c. They are not contingent upon additional service under the plan. d. They are lost when the employee is terminated.

11. The defined benefit obligation (accrued benefit obligation under ASPE) is always increased by a. current service cost and payments to retirees. b. current service cost and interest cost. c. interest cost and actuarial gains. d. current service cost and past service costs.

12. For defined benefit plans, the attribution period for employees is the time between a. the hire date and the vesting date. b. the vesting date and the date the employee becomes eligible for full benefits. c. the hire date and the date the employee becomes eligible for full benefits. d. the hire date and the date the employee reaches 65.

13. An experience gain or loss is a. additional contributions made to the pension fund by the employer. b. additional contributions made to the pension fund by the employees. c. reduced payments made to retirees.

Pensions and Other Employee Future Benefits

19- 11

d. the difference between what has occurred and the previous actuarial assumptions.

14. Pension plan assets include a. contributions made by the employer and the employees in a contributory pension plan. b. plan assets under the control of the employer. c. only assets reported on the employer’s statement of financial position as the net defined benefit liability/asset. d. contribution by the employer/employees, less the actual return, plus benefits paid to retirees.

15. The return on plan assets a. is the change in the fair value of the plan assets during the year. b. includes interest, dividends, and gains or losses from the sale of investments. c. is the actual rate of return times the fair value of the plan assets at the beginning of the period. d. does not include unrealized gains and/or losses on the assets in the plan. 16. The difference between the defined (accrued) benefit obligation and the pension assets’ fair value at any point in time is known as the plan’s a. return on plan assets. b. funded status. c. experience gain or loss. d. actual return.

17. Under IFRS, the defined benefit obligation is adjusted to its most recent actuarial valuation, and the adjustment flows through a. other comprehensive income. b. net income. c. either other comprehensive income or net income. d. retained earnings.

18. In applying the immediate recognition approach under IFRS, any difference between the pension expense and the payments into the fund should be reflected in a. a contra account to the net defined benefit liability/asset. b. an accrued actuarial liability. c. the net defined benefit liability/asset. d. a note to the financial statements only.

19. Using the immediate recognition approach, any past service costs should be included in the a. pension expense of current and future periods. b. pension expense of past periods. c. pension expense of the current period. d. plan assets.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

20. Using the immediate recognition approach under IFRS, a net defined benefit asset is reported when a. the defined benefit obligation exceeds the fair value of pension plan assets. b. the fair value of pension plan assets exceeds the defined benefit obligation. c. the pension expense for the period is the same as the contributions made to the pension plan for the same period. d. the vested benefits exceed the fair value of pension plan assets.

21. Using the immediate recognition approach under IFRS, a. there is a general ledger account called net defined benefit liability/asset. b. there is a general ledger account called defined benefit obligation. c. there is a general ledger account called Pension Fund Assets. d. Pension Expense is included in other comprehensive Income.

22. Under the immediate recognition approach, all past service costs are expensed. The rationale for doing this is that a. they are usually immaterial. b. they relate to non-vested services, so there is no justification for deferring their recognition to future periods. c. they relate to past services, so there is no justification for deferring their recognition to future periods. d. CRA will not allow them to be deferred.

23. An advantage of the immediate recognition approach (IFRS) is that a. the Net Defined Benefit Liability/Asset account reflects the actual funded status of the pension plan. b. unrecognized past service costs are deferred and amortized over future periods. c. it averages out the pension expense from year to year. d. it does not recognize actuarial gains and losses.

24. Which of the following statements is INCORRECT? a. Most pension plan employers report their pension assets or liabilities in the appropriate long-term classifications. b. An employer with two or more defined benefit plans is required to measure the benefit cost of each plan separately. c. IFRS specifies how the components of pension benefit costs are to be reported on the income statement. d. Underlying assumptions, such as how the expected return on plan assets is determined, are required to be disclosed.

25. Post-employment benefits may include all of the following EXCEPT a. dental care. b. severance pay to laid-off employees. c. legal and tax services. d. tuition assistance.

Pensions and Other Employee Future Benefits

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26. Regarding post-employment health care benefits, a. they are generally funded. b. they are well-defined and level in dollar amount. c. the beneficiary is the retiree, spouse, and other dependents. d. benefits are payable monthly.

27. Accrued post-employment benefit obligations are a. recorded at their present value. b. recorded in the same manner as pension benefit obligations. c. not recognized in the financial statements. d. disclosed in the notes to the financial statements only.

28. Which of the following disclosures of post-employment benefits would NOT be required? a. the cost of post-employment benefits during the period b. a description of the accounting and funding policies followed c. the amount of the actuarial liability for short term benefits such as paternity leave d. the assumptions and rates used in calculating the benefit obligation

*29. Using the deferral and amortization approach, unrecognized net actuarial gains and losses should be a. recorded currently as an adjustment to pension expense in the period incurred. b. recorded currently and in the future by applying the corridor method which provides the amount to be amortized. c. amortized over a 15-year period. d. recorded only if a loss is determined.

*30. Corridor amortization for net actuarial gains and losses a. only applies when the immediate recognition approach is used. b. can be used for either the immediate recognition approach or the deferral and amortization approach. c. is only used by the actuary. d. amortizes the net accumulated gain or loss when its balance is considered too large.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4. 5.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

c d c b b

6. 7. 8. 9. 10.

c a d a d

11. 12. 13. 14. 15.

b c d a b

16. 17. 18. 19. 20.

b a c c b

21. 22. 23. 24. 25.

a c a c b

26. 27. 28. *29. *30.

c b c b d

Pensions and Other Employee Future Benefits

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MULTIPLE CHOICE—Computational 31. Presented below is information related to Peach Corporation’s defined benefit pension plan for calendar 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation, Jan 1 ................................ $200,000 Fair value of plan assets, Jan 1 .................................. 180,000 Current service cost ................................................... 27,000 Contributions to plan .................................................. 25,000 Actual and expected return on plan assets ................. 9,000 Benefits paid to retirees.............................................. 40,000 Interest (discount) rate ............................................... 10% The fair value of the plan assets at December 31, 2014 is a. $187,000. b. $174,000. c. $165,000. d. $149,000.

32. Presented below is information related to Kiwi Ltd. for calendar 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation, Jan 1 ................................ $720,000 Fair value of plan assets, Jan 1 .................................. 700,000 Current service cost ................................................... 90,000 Contributions to plan .................................................. 125,000 Actual and expected return on plan assets ................. 56,000 Past service costs (effective Jan 1) ............................ 10,000 Benefits paid to retirees.............................................. 96,000 Interest (discount) rate ............................................... 9% The fair value of the plan assets at December 31, 2014 is a. $785,000. b. $805,000. c. $819,000. d. $875,000.

33. Presented below is pension information related to Apple Inc. for the calendar year 2014. The corporation uses the immediate recognition approach. Current service costs ................................................. $288,000 Interest on accrued benefit obligation ......................... 216,000 Expected and actual return on plan assets ................. 72,000 Past service costs ...................................................... 48,000 The pension expense to be reported for 2014 is a. $432,000. b. $480,000. c. $576,000. d. $648,000.

34. Presented below is pension information related to Banana Inc. for the calendar year 2014.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

The corporation uses the immediate recognition approach under ASPE. Current service costs ................................................. $ 50,000 Contributions to the plan ............................................ 55,000 Actual return on plan assets ....................................... 45,000 Accrued benefit obligation (beginning of year) ............ 600,000 Fair value of plan assets (beginning of year) .............. 400,000 Interest cost on the obligation..................................... 10% The pension expense to be reported for 2014 is a. $110,000. b. $ 70,000. c. $ 65,000. d. $ 50,000.

35. Presented below is pension information related to Cantaloupe Ltd. for the calendar year 2014. The corporation uses the immediate recognition approach under ASPE. Current service costs ................................................. $450,000 Actual return on plan assets ....................................... 105,000 Interest on accrued benefit obligation ......................... 195,000 Actuarial experience loss ........................................... 45,000 Past service costs ...................................................... 82,500 The pension expense to be reported for 2014 is a. $757,500. b. $697,500. c. $667,500. d. $577,500.

36. At the end of 2014, Lime Inc. has determined the following adjusted information related to its defined benefit pension plan: Defined benefit obligation ........................................... $1,320,000 Fair value of pension plan assets ............................... 1,220,000 The corporation uses the immediate recognition approach under IFRS. Assume the net defined benefit liability/asset account at January 1, 2014 was nil. If the contribution to plan assets in 2014 is $410,000, the pension expense for 2014 is a. $100,000. b. $310,000. c. $410,000. d. $510,000.

Use the following information for questions 37–38. The following information is available for Figgy Enterprises Ltd. for calendar 2014. The corporation uses the immediate recognition approach under IFRS. Plan assets (at fair value), end of year ....................... $1,800,000 Dr Defined benefit obligation, end of year ....................... 1,920,000 Cr Pension expense........................................................ 360,000 Contributions for year ................................................. 324,000

Pensions and Other Employee Future Benefits

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37. The pension expense to be reported for 2014 is a. $360,000. b. $346,000. c. $324,000. d. $120,000.

38. The net defined benefit liability/asset that should be reported at December 31, 2014 is a. $120,000 asset. b. $120,000 liability. c. $204,000 asset. d. $360,000 liability.

39. Presented below is pension information related to Mango Ltd. at December 31, 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation ........................................... $3,500,000 Cr Plan assets (at fair value) ........................................... 2,500,000 Dr Past service costs ...................................................... 100,000 Contributions to plan .................................................. 200,000 The amount to be reported as the net defined benefit liability at December 31, 2014 is a. $1,100,000. b. $1,000,000. c. $ 900,000. d. $ 700,000.

40. Presented below is pension information related to Squash Corp. for the calendar year 2014. The corporation uses the immediate recognition approach under IFRS. Current service cost ................................................... $204,000 Discount (interest) rate ............................................... 9% Defined benefit obligation, Jan 1 ................................ $1,800,000 Benefits paid to retirees.............................................. 100,000 Past service cost (effective Jan 1) .............................. 50,000 The pension expense to be reported for 2014 is a. $266,000. b. $366,000. c. $416,000. d. $420,500.

41. Presented below is pension information related to Watermelon Corp. for the calendar year 2014. The corporation uses the immediate recognition approach under IFRS. Current service cost ................................................... $126,000 Discount (interest) rate ............................................... 10% Defined benefit obligation, Jan 1 ................................ $900,000 Actual & expected return on plan assets .................... 24,000 Actuarial loss.............................................................. 28,000 The pension expense to be reported for 2014 is a. $220,000. b. $192,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. $164,000. d. $130,000.

42. Daikon Ltd. received the following information from its pension plan trustee concerning their defined benefit pension plan for calendar 2014. The corporation uses the immediate recognition approach under ASPE. Jan 1, 2014 Dec 31, 2014 Fair value of plan assets $2,100,000 $2,250,000 Accrued benefit obligation 2,400,000 2,580,000 For 2014, the current service cost is $180,000. The interest rate on the liability is 10% and the actual rate of return on plan assets is 9%. The pension expense to be reported for 2014 is a. $265,500. b. $231,000. c. $216,000. d. $180,000. 43. Presented below is information related to Peach Corporation’s defined benefit pension plan for calendar 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation, Jan 1 ................................ $200,000 Fair value of plan assets, Jan 1 .................................. 180,000 Current service cost ................................................... 27,000 Contributions to plan .................................................. 25,000 Actual and expected return on plan assets ................. 9,000 Benefits paid to retirees.............................................. 40,000 Interest (discount) rate ............................................... 10% The balance of the defined benefit obligation at December 31, 2014 is a. $185,000. b. $187,000. c. $207,000. d. $245,000.

Use the following information for questions 44–45. Presented below is information related to Kiwi Ltd. for calendar 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation, Jan 1 ................................ $720,000 Fair value of plan assets, Jan 1 .................................. 700,000 Current service cost ................................................... 90,000 Contributions to plan .................................................. 125,000 Actual and expected return on plan assets ................. 56,000 Past service costs (effective Jan 1) ............................ 10,000 Benefits paid to retirees.............................................. 96,000 Interest (discount) rate ............................................... 9%

44. The pension expense to be reported for 2014 is a. $140,000. b. $109,700.

Pensions and Other Employee Future Benefits

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c. $108,800. d. $ 60,000.

45. The balance of the defined benefit obligation at December 31, 2014 is a. $724,000. b. $779,700. c. $778,800. d. $789,700.

*46. The following facts relate to the Tomato Inc. post-employment benefits plan for 2014. The company follows ASPE: Current service cost ................................................... $340,000 Discount (interest) rate ............................................... 8% Accrued benefit obligation, Jan 1, 2014 (transitional amount) .................................................. $2,000,000 Average remaining service to full eligibility ................. 20 years Average remaining service to expected retirement ..... 25 years The post-employment benefit expense for 2014 is a. $612,000. b. $600,000. c. $580,000. d. $420,000.

Use the following information for questions *47–*50. The following information relates to Gooseberry Corp. for their past two fiscal years. The corporation uses the deferral and amortization approach. 2013 2014 Plan assets (at fair value) ..................... $630,000 $912,000 Pension expense.................................. 285,000 225,000 Accrued benefit obligation .................... 810,000 942,000 Annual contribution to plan ................... 300,000 225,000 Unrecognized past service costs .......... 240,000 210,000

*47. The net amount to be recorded as accrued pension liability/asset at December 31, 2013 is a. $ -0-. b. $15,000 Dr. c. $15,000 Cr. d. $40,000 Dr.

*48. The amount of the actuarial gain/loss at December 31, 2013 is a. $45,000 loss. b. $45,000 gain. c. $60,000 gain. d. $180,000 loss.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*49. Assuming the amortization of past service costs is already included in the pension expense, the amount reported as the accrued pension liability/asset at December 31, 2014 is a. $ -0-. b. $30,000. c. $45,000. d. $15,000.

*50. The amount of the actuarial gain/loss at December 31, 2014 is a. $195,000 gain. b. $180,000 gain. c. $165,000 gain. d. $ 30,000 gain.

Use the following information for questions *51–*52. On January 1, 2014, Quince Inc. reported the following balances related to their defined benefit pension plan. The corporation uses the deferral and amortization approach. Accrued benefit obligation .......................................... $1,400,000 Fair value of plan assets ............................................ 1,250,000 The interest rate for the obligation and the plan assets is 10%. Other data related to the pension plan for 2014 are: Service cost ............................................................... $80,000 Amortization of unrecognized past service costs ........ 18,000 Contributions .............................................................. 90,000 Benefits paid .............................................................. 75,000 Actual return on plan assets ....................................... 88,000 Amortization of unrecognized net actuarial gains ....... 6,000

*51. The balance of the accrued benefit obligation at December 31, 2014 is a. $1,524,000. b. $1,530,000. c. $1,543,000. d. $1,545,000.

*52. The fair value of the plan assets at December 31, 2014 is a. $1,177,000. b. $1,263,000. c. $1,353,000. d. $1,428,000.

Use the following information for questions *53–*57. The following information relates to the defined benefit pension plan for the employees of Raspberry Ltd. The corporation uses the deferral and amortization approach. Jan 1/13 Dec 31/13 Dec 31/14

Pensions and Other Employee Future Benefits

Accrued benefit obligation Fair value of plan assets Unrecognized net actuarial gain Interest cost on ABO Expected rate of return

2,325,000 2,125,000 -0-

2,490,000 2,600,000 360,000 11% 8%

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3,335,000 2,870,000 400,000 11% 7%

Raspberry estimates that the employee average remaining service life (EARSL) is 16 years. In 2014, Raspberry contributed $315,000 to the pension fund, and the fund trustee paid $235,000 in benefits to retirees.

*53. The interest cost for 2014 is a. $224,100. b. $253,000. c. $273,900. d. $366,850.

*54. The actual return on plan assets in 2014 is a. $170,000. b. $190,000. c. $245,000. d. $270,000.

*55. The unexpected gain or loss on plan assets in 2014 is a. $ 8,000 gain. b. $16,400 loss. c. $63,600 gain. d. $89,400 gain.

*56. The corridor for 2014 is a. $258,000. b. $260,000. c. $282,500. d. $333,500.

*57. The amount of unrecognized net actuarial gain amortized in 2014 is a. $6,375. b. $6,250. c. $4,844. d. $4,157.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

31. 32. 33. 34. 35.

b a b c c

36. 37. 38. 39. 40.

d a b b d

41. 42. 43. 44. 45.

b b c b d

*46. *47. *48. *49. *50.

c b b d c

*51. *52. *53. *54. *55.

d c c b a

*56. *57.

b b

DERIVATIONS—Computational No. Answer 31. b 32. a 33. b 34. c 35. c 36. d 37. 38. 39. 40. 41.

a b b d b

42. 43. 44. 45.

b c b d

*46. *47. *48. *49. *50. *51. *52. *53. *54. *55. *56.

c b b d c d c c b a b

Derivation $180,000 + $9,000 + $25,000 - $40,000 = $174,000 $700,000 + $56,000 + $125,000 - $96,000 = $785,000 $288,000 + $216,000 + $48,000 – $72,000 = $480,000 $50,000 + ($600,000 × 10%) – $45,000 = $65,000 $450,000 + $195,000 + $45,000 + $82,500 – $105,000 = $667,500 funding minus pension expense = accrued pension asset/liab. $410,000 - X = $1,220,000 - $1,320,000; X = $510,000 $360,000 (given) $1,920,000 – $1,800,000 = $120,000 liability $3,500,000 – $2,500,000 = $1,000,000 $204,000 + [($1,800,000 + $50,000) X 9%)] + $50,000 = $420,500 $126,000 + ($900,000 x 10%) - $24,000 = $192,000 Note: the actuarial loss is not part of pension expense, but is charged to OCI $180,000 + ($2,400,000 × 10%) – ($2,100,000 × 9%) = $231,000 $200,000 + $27,000 + ($200,000 x 10%) - $40,000 = $207,000 $90,000 + [($720,000 + $10,000) x 9%] + $10,000 - $56,000 = $109,700 $720,000 + $10,000 + $90,000 + [($720,000 + $10,000) x 9%] - $96,000 = $789,700. $340,000 + ($2,000,000 X 8%) + ($2,000,000 ÷ 25) = $580,000 $285,000 – $300,000 = $15,000 debit $630,000 + $240,000 – $810,000 – $15,000 = $45,000 gain $15,000 + $225,000 – $225,000 = $15,000 $912,000 + $210,000 – $942,000 – $15,000 = $165,000 gain $1,400,000 + $80,000 – $75,000 + ($1,400,000 ×10%) = $1,545,000 $1,250,000 + $88,000 + $90,000 – $75,000 = $1,353,000 $2,490,000 × 11% = $273,900 ($2,870,000 – $2,600,000) – ($315,000 – $235,000) = $190,000 $190,000 – ($2,600,000 × 7%) = $8,000 gain $2,600,000 × 10%) = $260,000

Pensions and Other Employee Future Benefits

*57.

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($360,000 – $260,000) ÷ 16 = $6,250

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted 58. The interest cost included in the annual pension cost recorded by an employer sponsoring a defined benefit pension plan represents the a. difference between the expected and actual return on plan assets. b. increase in the defined (accrued) benefit obligation due to the passage of time. c. increase in the fair value of plan assets due to the passage of time. d. interest earned on the plan assets for the year.

59. The following information pertains to Rembrandt Inc.'s pension plan for calendar 2014: Defined benefit obligation at Jan 1/14 ........................ $96,000 Interest (discount) rate ............................................... 10% Current service costs ................................................. $24,000 Pension benefits paid retirees .................................... $20,000 The corporation uses the immediate recognition approach under IFRS. If no change in actuarial estimates occurred during 2014, Rembrandt's defined benefit obligation at December 31, 2014 would be a. $85,600. b. $100,000. c. $105,600. d. $109,600. 60. At January 1, 2014, Van Gogh Corp.’s defined benefit pension plan, for which they are using the immediate recognition approach under IFRS, had a defined benefit obligation of $100,000, while the fair value of the plan assets was $120,000. During 2014, the plan's current service cost was $150,000; past service costs were $80,000; Van Gogh contributed $110,000 to the plan; the actual and expected return on the plan assets was $9,000; and benefits paid to retirees were $95,000. What is the fair value of the plan assets at December 31, 2014? a. $239,000 b. $205,000 c. $144,000 d. $135,000

61. Bateman Corp. provides a defined benefit pension plan for its employees, and uses the immediate recognition approach under IFRS to account for it. The trustee administering the plan provided the following information for the year ended December 31, 2014: Fair value of plan assets, Jan 1 .................................. $1,200,000 Defined benefit obligation, Jan 1 ................................ 1,270,000 Current service cost ................................................... 300,000 Employer's contributions ........................................... 360,000 Past service cost (at Jan 1) ........................................ 30,000 Benefits paid retirees ................................................. 325,000 Actual and expected return ....................................... 60,000 Interest (discount) rate ............................................... 8% The fair value of the plan assets at December 31, 2014 would be a. $1,235,000.

Pensions and Other Employee Future Benefits

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b. $1,295,000. c. $1,335,000. d. $1,535,000.

62. At December 31, 2014, the following information was provided by the defined benefit pension plan administrator for Leonardo Corp.: Fair value of plan assets ............................................ $5,000,000 Defined benefit obligation ........................................... 6,200,000 The corporation uses the immediate recognition approach under IFRS. What is the net defined benefit liability/asset account that should be shown on Leonardo’s December 31, 2014 statement of financial position? a. $1,200,000 liability b. $1,200,000 asset c. $6,200,000 liability d. $5,000,000 asset

63. Thomson Corp. provides a defined benefit pension plan for its employees, and uses the immediate recognition approach under IFRS to account for it. The corporation's actuary has provided the following information for the year ended December 31, 2014: Defined benefit obligation, Dec 31 .............................. 525,000 Fair value of plan assets, Dec 31 ............................... 625,000 Current service cost ................................................... 240,000 Interest on defined benefit obligation .......................... 24,000 Past service costs ...................................................... 60,000 Expected and actual return on plan assets ................. 82,500 Contributions to plan .................................................. 200,000 The pension expense to be reported for 2014 is a. $241,500. b. $324,000. c. $406,500. d. $524,000.

64. Bateman Corp. provides a defined benefit pension plan for its employees, and uses the immediate recognition approach under IFRS to account for it. The trustee administering the plan provided the following information for the year ended December 31, 2014: Fair value of plan assets, Jan 1 .................................. $1,200,000 Defined benefit obligation, Jan 1 ................................ 1,270,000 Current service cost ................................................... 300,000 Employer's contributions ........................................... 360,000 Past service cost (at Jan 1) ........................................ 30,000 Benefits paid retirees ................................................. 325,000 Actual and expected return ....................................... 60,000 Interest (discount) rate ............................................... 8% The pension expense to be reported for 2014 is a. $270,000. b. $366,000. c. $374,000. d. $434,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

65. Magritte Inc. provides a defined benefit pension plan for its employees (for which the corporation uses the immediate recognition approach). At December 31, 2014, the fair value of the plan assets is less than the defined benefit obligation. In its statement of financial position at December 31, 2014, Magritte should report a net defined benefit liability/asset of the a. excess of the defined benefit obligation over the fair value of the plan assets. b. excess of the plan assets over the defined benefit obligation. c. defined benefit obligation. d. fair value of the plan assets.

Use the following information for questions *66–*67. Lautrec Corp. provides a defined benefit pension plan for its employees, and uses the deferral and amortization approach to account for it. The trustee administering the plan provided the following information for the year ended December 31, 2014: Fair value of plan assets, Dec 31 ............................... $1,200,000 Accrued benefit obligation, Dec 31 ............................. 1,335,000 Pension expense for year........................................... 300,000 Employer's contribution for year ................................. 360,000 Unrecognized past service costs ................................ 30,000 On December 31, 2013, the accrued benefit liability/asset account had a debit balance of $45,000.

*66. At December 31, 2014, what is the amount of accrued benefit liability/asset? a. $ 15,000 b. $ 60,000 c. $ 90,000 d. $105,000 *67. In the December 31, 2014 financial statements, how much would be reported as the plan’s funded status (liability)? a. $ 60,000 b. $105,000 c. $135,000 d. $165,000

Pensions and Other Employee Future Benefits

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MULTIPLE CHOICE ANSWERS—CPA Adapted Item

58. 59.

Ans.

b d

Item

60. 61.

Ans.

c b

Item

62. 63.

Ans.

a a

Item

64. 65.

Ans.

Item

Ans.

c a

*66. *67.

d c

DERIVATIONS—CPA Adapted No. Answer 58. b 59. d 60. c 61. b 62. a 63. a 64. c 65. a *66. d *67. c

Derivation Conceptual $96,000 + $24,000 + ($96,000 × 10%) – $20,000 = $109,600 $120,000 + $9,000 + $110,000 - $95,000 = $144,000 $1,200,000 + $60,000 + $360,000 - $325,000 = $1,295,000 $6,200,000 – $5,000,000 = $1,200,000 liability $240,000 + $24,000 – $82,500 + $60,000 = $241,500 $300,000 + 30,000 + [($1,270,000 + $30,000) x 8%] – $60,000 = $374,000 Conceptual $360,000 – $300,000 + $45,000 = $105,000 $1,335,000 – $1,200,000 = $135,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 19-68 Pension accounting terminology Briefly explain the following terms: a. Service cost b. Interest cost c. Past service costs d. Vested benefits Solution 19-68 a. The (current) service cost component of pension expense is the cost of the benefits to be provided in future in exchange for services provided in the current period. b. The interest cost component of pension expense is the interest for the period on the defined (accrued) benefit obligation outstanding during the period. To simplify the calculation, the amount of interest is calculated by applying a single rate to the beginning balance of the obligation. c. When a defined benefit plan is initiated or amended, credit that is given to employees for services provided before the date of initiation or amendment results in past service costs. If there is a reduction in the benefit plan, there is a decrease in in the defined (accrued) benefit obligation. The amount of the past service costs is calculated by an actuary, and is added/deducted to the beginning balance of the obligation for calculating the interest cost for the year. d. Vested benefits are those the employee is entitled to receive even if s/he provides no additional services under the plan, e.g. if his/her employment is terminated.

Ex. 19-69 Pension asset terminology Discuss the following ideas related to pension assets: a. Actual return on plan assets. b. Expected return on plan assets. c. Unexpected gains and losses on plan assets. Solution 19-69 a. The actual return earned on plan assets is the income generated on the assets being held by the trustee, less the cost of administering the fund. This can vary considerably from year to year. b. The expected return on plan assets is the long-term rate of return (calculated by the actuary) multiplied by the fair value of the assets at the beginning of the period. A long-term rate is used to smooth out short-term fluctuations in interest rates, and is usually the rate for high-quality corporate bonds. Under IFRS, the same rate is used for interest on the defined benefit obligation and the plan assets. c. An unexpected asset gain occurs when the actual return on plan assets is greater than the expected return on plan assets and an unexpected loss occurs when the actual return is less than the expected return.

Pensions and Other Employee Future Benefits

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Ex. 19-70 Pension plan calculations The following information relates to the defined benefit pension plan for Strawberry Dale Ltd.: Dec 31/13 Dec 31/14 Defined benefit obligation $2,250,000 $3,000,000 Fair value of plan assets 2,300,000 2,640,000 Interest rate 8% 8% Expected rate of return 7% 6% In 2014, the corporation contributed $390,000 to the plan, and the trustee paid $210,000 in benefits to retirees. Strawberry Dale uses the immediate recognition approach under IFRS. Instructions For the year ended December 31, 2014: a. Calculate the interest on the obligation. b. Calculate the actual return on plan assets. c. Calculate the unexpected gain or loss (if any). Solution 19-70 a. $2,250,000 × 8% = $180,000 b.

Fair value of plan assets Dec 31/14 ........................... $2,640,000 Fair value of plan assets Dec 31/13 ........................... (2,300,000) 340,000 Contributions .............................................................. (390,000) Benefits paid .............................................................. 210,000 Actual return on plan assets ....................................... $ 160,000

Actual return (see b.) .................................................. $ 160,000 Expected return ($2,300,000 × 6%) ............................ (138,000) Unexpected gain ........................................................ $ 22,000

Ex. 19-71 Pension plan calculations and journal entries On January 1, 2014, Prune Ltd. reported the following balances relating to their defined benefit pension plan: Defined benefit obligation ........................................... $3,200,000 Fair value of plan assets ............................................ 3,200,000 Other data related to the pension plan for 2014 are: Current service cost ................................................... 140,000 Contributions to the plan ............................................ 204,000 Benefits paid .............................................................. 200,000 Actual return on plan assets ....................................... 192,000 Interest (discount) rate .............................................. 9% Prune uses the immediate recognition approach under ASPE. Instructions a. Calculate the defined benefit obligation at December 31, 2014. b. Calculate the fair value of plan assets at December 31, 2014. c. Calculate pension expense for 2014.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Prepare the journal entries to record the pension expense and the contributions for 2014.

Solution 19-71 a. Defined benefit obligation, Jan 1 ................................ $3,200,000 Current service cost ................................................... 140,000 Interest cost (9% × $3,200,000) ................................. 288,000 Benefits paid .............................................................. (200,000) Defined benefit obligation, Dec 31 .............................. $3,428,000 b. Fair value of plan assets, Jan 1 ..................................... $3,200,000 Actual return............................................................... 192,000 Contributions .............................................................. 204,000 Benefits paid .............................................................. (200,000) Fair value of plan assets, Dec 31 ............................... $3,396,000 c.

Current service cost ................................................... Interest cost (9% × $3,200,000) ................................. Actual return on plan assets ....................................... Pension expense........................................................

$140,000 288,000 (192,000) $236,000

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

236,000

Net Defined Liability/Asset ............................................................ Cash.......................................................................................

204,000

236,000

204,000

Ex. 19-72 Approaches to accounting for pension expense Discuss the difference between the immediate recognition approach and the deferral and amortization approach when accounting for annual pension expense. Solution 19-72 Under the immediate recognition approach, pension expense includes current service costs, past service costs, and interest cost on the opening DBO, less expected return on assets (less the actual return, if different). This may cause the annual pension expense to fluctuate significantly. However, an advantage of this approach is that the actual funded status is disclosed on the statement of financial position via the net defined benefit liability/asset account. Note that under IFRS, any actuarial gains or losses or remeasurement gains/losses on plan assets are not part of pension expense (i.e. net income), but flow through OCI. Under the deferral and amortization approach, the recognition of past service costs and actuarial gains/losses can be deferred and amortized over current and future periods. This tends to smooth out the pension expense, but misstates the funded status on the statement of financial position, as the unrecognized past service costs and actuarial gains/losses are “off balance sheet.” However, all such amounts must be fully disclosed in the notes. IFRS now requires the use of the immediate recognition approach only. ASPE currently permits either approach; however the new Section 3462 of the Handbook will eliminate the use of the deferral and amortization approach.

Pensions and Other Employee Future Benefits

19- 31

Ex. 19-73 Measuring and recording pension expense Pumpkin Ltd. received the following information from its pension plan trustee concerning their defined benefit pension plan for the year ended December 31, 2014: January 1, 2014 December 31, 2014 Defined benefit obligation $3,500,000 $3,990,000 Fair value of plan assets 1,750,000 2,240,000 For 2014, the service cost is $210,000 and past service cost (effective Jan 1) is $100,000. During 2014, Pumpkin contributed $595,000 to the plan. The actual and expected return on plan assets is 8%. Pumpkin uses the immediate recognition approach under IFRS. Instructions a. Calculate the pension expense to be reported in 2014. b. Prepare the journal entries to record the pension expense and the employer’s contribution for 2014. Solution 19-73 a. Current service cost ...................................................................... $210,000 Interest on DBO ($3,500,000 + $100,000) × 8%) .......................... 288,000 Actual/Expected return on plan assets ($1,750,000 × 8%) ............ (140,000) Past service costs ......................................................................... 100,000 $458,000 b.

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

458,000

Net Defined Benefit Liability/Asset ................................................ Cash.......................................................................................

595,000

458,000

595,000

Ex. 19-74 Measuring and recording pension expense The following information relates to the defined benefit pension plan for Huckleberry Ltd. for 2014. The corporation uses the immediate recognition approach under IFRS. Current service cost ................................................... $260,000 Contributions .............................................................. 250,000 Interest rate for obligation........................................... 10% Expected & actual return on plan assets .................... 9% Defined benefit obligation, Jan 1 ................................ 240,000 Fair value of plan assets, Jan 1 .................................. 180,000 Actuarial gain ............................................................. 24,000 Instructions a. Calculate the pension expense to be reported for 2014. b. Prepare the journal entries to record pension expense and the employer's contributions for 2014. Solution 19-74 a. Current service cost ................................................... $260,000 Interest on defined benefit obligation ($240,000 × 10%) 24,000 Expected return on plan assets ($180,000 × 9%) ....... (16,200) Pension expense—2014 ............................................ $267,800

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Note the actuarial gain is not part of pension expense, but would be booked through OCI. b.

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

267,800

Net Defined Benefit Liability/Asset ................................................ Cash.......................................................................................

250,000

267,800

250,000

*Ex. 19-75 Corridor amortization Explain corridor amortization. Solution 19-75 The corridor approach for amortizing pension plan gains and losses is used when they get too large. The unrecognized net gain or loss gets too large when it exceeds the arbitrarily selected criterion of 10% of the larger of the beginning balances of the accrued benefit obligation or the fair value of the plan assets. Any systematic method of amortizing the excess unrecognized gain or loss may be used but it cannot be less than the amount calculated using the straight-line method over the average remaining service life of all active employees. Note this is only used with the deferral and amortization approach, which is now only acceptable for ASPE. IFRS requires the use of the immediate recognition approach, which does not use the corridor approach.

*Ex. 19-76 Pension plan calculations and journal entries Information about the defined benefit pension plan of Olive Corp. is as follows: Dec 31/13 Dec 31/14 Accrued benefit obligation ............................. $6,400,000 $6,690,000 Unrecognized past service cost ..................... 245,000 185,000 Fair value of plan assets ............................... 6,530,000 6,640,000 Pension expense........................................... 1,330,000 1,870,000 Contribution for year ...................................... 1,310,000 1,800,000 Interest rate for ABO ..................................... 9% 8% The accrued pension liability was $15,000 at January 1, 2013 and $35,000 at January 1, 2014. Olive uses the deferral and amortization approach. Instructions a. Calculate the corridor for 2014. b. Calculate the accrued pension liability at December 31, 2014. c. Prepare the entries for 2014 to record the pension expense and employer’s contribution. Solution 19-76 a. 10% × $6,400,000 = $640,000; 10% × $6,530,000 = $653,000 The corridor is the larger, $653,000. b.

Accrued pension liability, Jan 1, 2013 ........................ Addition for 2013 ($1,330,000 – $1,310,000) ............. Addition for 2014 ($1,870,000 – $1,800,000) ............. Accrued pension liability, Dec 31, 2014 ......................

$ 15,000 20,000 70,000 $105,000

Pensions and Other Employee Future Benefits

19- 33

Pension Expense .......................................................................... 1,870,000 Accrued Benefit Liability/Asset ............................................... 1,870,000 Accrued Benefit Liability/Asset ...................................................... 1,800,000 Cash....................................................................................... 1,800,000

*Ex. 19-77 Corridor approach for amortization of actuarial gains and losses Pineapple Corp. has 200 employees who are expected to receive benefits under the company's defined benefit pension plan, which is accounted for using the deferral and amortization approach. The total number of service-years of these employees is 2,000. The actuary for the pension plan calculated the following net gains and losses: For the Year Ended December 31 (Gain) Or Loss 2013 $330,000 2014 (297,000) 2015 495,000 Prior to 2013 there were no unrecognized actuarial gains or losses. Information about the company's accrued benefit obligation and plan asset values follows: As of January 1 2013 2014 2015 Accrued benefit obligation $1,050,000 $1,170,000 $1,470,000 Fair value of plan assets 840,000 1,230,000 1,275,000 Instructions Based on the above information, prepare a schedule which reflects the amount of unrecognized net actuarial gain or loss to be amortized as a component of pension expense for the years 2013, 2014, and 2015. Pineapple amortizes such unrecognized net gains or losses using the straight-line method over the expected average remaining service life (EARSL) of participating employees. Solution 19-77 Corridor Test and Gain/Loss Amortization Schedule Beginning of Year ABO Plan Assets Corridor 2013 $1,050,000 $ 840,000 $105,000 2014 1,170,000 1,230,000 123,000 2015 1,470,000 1,275,000 147,000

Cumulative (Gain) Or Loss $ -0330,000 12,300**

Amortization $ -020,700* -0-

Average Service Years = 2,000 ÷ 200 = 10 years *$330,000 – $123,000 = $207,000 ÷ 10 = $20,700 **$330,000 – $297,000 – $20,700 = $12,300

*Ex. 19-78 Pension reconciliation schedule Boysenberry Inc. provides the following information about its defined benefit pension plan for the year ended December 31, 2014: Service cost for 2014 ................................................. $ 30,000 Unrecognized past service costs ................................ 360,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Fair value of plan assets ............................................ 870,000 Accrued benefit obligation .......................................... 1,040,000 Unrecognized actuarial gain ....................................... 95,000 Interest on accrued benefit obligation ......................... 75,000 The corporation uses the deferral and amortization approach. Instructions Prepare a schedule to reconcile the funded status of the pension plan with the amounts that would be reported on Boysenberry Inc.'s statement of financial position at December 31, 2014. Solution 19-78 BOYSENBERRY INC. Pension Reconciliation Schedule Year Ended December 31, 2014 Accrued benefit obligation ............................................................. $(1,040,000) Fair value of plan assets ............................................................... 870,000 Accrued benefit obligation in excess of plan assets ....................... (170,000) Unrecognized past service cost ..................................................... 360,000 Unrecognized actuarial gain .......................................................... (95,000) Accrued pension liability ................................................................ $ 95,000

*Ex. 19-79 Calculating and recording pension expense The following information is related to the Papaya Corp. defined benefit pension plan for 2014: Accrued benefit obligation, Jan 1 ............................... $480,000 Service cost ............................................................... 126,000 Interest rate on ABO .................................................. 10% Amortization of past service cost ................................ 24,600 Actual return on plan assets ....................................... 16,800 Expected return on plan assets .................................. 21,800 Contributions .............................................................. 168,000 The corporation uses the deferral and amortization approach. Instructions a. Calculate the pension expense for 2014. b. Prepare the journal entries to record pension expense and the employer’s contributions for 2014. Solution 19-79 a. Service cost ............................................................... Interest cost (10% × $480,000) .................................. Amortization of past service cost ................................ Expected return on plan assets .................................. Pension expense........................................................ b.

$126,000 48,000 24,600 (21,800) $176,800

Pension Expense .......................................................................... Accrued Benefit Liability/Asset ...............................................

176,800 176,800

Pensions and Other Employee Future Benefits

Accrued Benefit Liability/Asset ...................................................... Cash.......................................................................................

19- 35

168,000 168,000

*Ex. 19-80 Calculating accrued pension liability/asset Satsuma Corp. provided the following balances regarding their defined benefit pension plan at December 31, 2014: Accrued benefit obligation .......................................... $4,500,000 Fair value of plan assets ............................................ 4,340,000 Unrecognized past service costs ................................ 120,000 The corporation uses the deferral and amortization approach. Instructions a. Calculate the accrued pension liability or asset. b. Assume the same facts as in a. but that Satsuma had an actuarial gain of $20,000 in 2014. Recalculate the accrued pension asset or liability. Solution 19-80 a. Accrued benefit obligation .......................................... $4,500,000 Fair value of plan assets ............................................ 4,340,000 ABO in excess of plan assets ..................................... 160,000 Less unrecognized past service cost .......................... (120,000) Accrued pension liability ............................................. $ 40,000

Accrued benefit obligation .......................................... $4,500,000 Fair value of plan assets ............................................ 4,340,000 ABO in excess of plan assets ..................................... 160,000 Less unrecognized past service cost .......................... (120,000) Plus actuarial gain ...................................................... 20,000 Accrued pension liability ............................................. $ 60,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 19-81 Measuring and recording pension expense Presented below is information related to the defined benefit pension plan of Swiss Chard Ltd. for the year 2014. The corporation uses the immediate recognition approach under IFRS. Defined benefit obligation, Jan 1 ................................ $375,000 Fair value of plan assets, Jan 1 .................................. 350,000 Current service cost ................................................... 300,000 Interest (discount) rate ............................................... 10% Expected & actual return on plan assets .................... 9% Past service cost (as of Jan 1) ................................... 25,000 Actuarial loss.............................................................. 14,900 Contributions to plan .................................................. 290,000 Remeasurement loss on plan assets.......................... 11,500 Payments to retirees .................................................. 250,000 Instructions a. Calculate the pension expense to be reported on the income statement for 2014. b. Calculate the amount to be shown as OCI for 2014. c. Calculate the fair value of the plan assets at December 31, 2014. d. Prepare the journal entries to reflect the accounting for the company's pension plan for the year ending December 31, 2014. Solution 19-81 a. Current service cost ............................................................. $300,000 Interest on DBO [(10% × ($375,000 + $25,000)] .................. 40,000 Expected & actual return on plan assets (9% × $350,000) ... (31,500) Past service cost .................................................................. 25,000 Pension expense.................................................................. $333,500

Actuarial loss........................................................................ Remeasurement loss on plan assets.................................... Amount to be shown as OCI (Dr) .........................................

$14,900 11,500 $26,400

Fair value of plan assets, Jan 1 ............................................ $350,000 Expected & actual return on plan assets ............................. 31,500 Remeasurement loss on plan assets.................................... (11,500) Contributions to plan ............................................................ 290,000 Payments to retirees ............................................................ (250,000) Fair value of plan assets, Dec 31 ......................................... $410,000

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

333,500

Remeasurement Loss (OCI) ......................................................... Net Defined Benefit Liability/Asset ..........................................

26,400

Net Defined Benefit Liability/Asset ................................................

290,000

333,500

26,400

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Pensions and Other Employee Future Benefits

Cash.......................................................................................

290,000

Pr. 19-82 Calculating pension expense and pension plan funded status Fernando’s Furniture Inc. sponsors a defined benefit pension plan for its employees. The plan’s trustee reports the following information for calendar 2014: Defined benefit obligation, Jan 1 ................................ $240,000 Fair value of plan assets, Jan 1 .................................. 180,000 Current service cost ................................................... 80,000 Actual & expected return on plan assets .................... 21,000 Contributions .............................................................. 70,000 Benefits paid to retirees.............................................. 120,000 Interest (discount) rate ............................................... 10% Past service costs (as of Jan 1).................................. 10,000 The corporation uses the immediate recognition approach under ASPE. Instructions a. Calculate the amount of pension expense for 2014, and prepare the required adjusting journal entries. b. Calculate the funded status of the plan on December 31, 2014. Solution 19-82 a. Pension expense for 2014 Current service cost .......................................................... Interest on ABO [(10% x ($240,000 + $10,000)] ................ Actual & expected return on plan assets ........................... Past service cost ............................................................... Pension expense ..............................................................

$ 80,000 25,000 (21,000) 10,000 $ 94,000

Pension Expense....................................... ........................................... Net Defined Benefit Liability/Asset……....................................

94,000

Net Defined Benefit Liability/Asset.................................... ............. Cash ......................................................................... ..............

70,000

94,000

70,000

b. Funded Status at December 31, 2014: Defined Benefit Obligation (1) .................................... $ (235,000) Plan assets (2) ........................................................... 151,000 Underfunded .............................................................. $ (84,000) (1) Defined Benefit Obligation Beginning balance...................................................... Service costs.............................................................. Interest costs.............................................................. Past service cost ........................................................ Payments to retirees ..................................................

$240,000 80,000 25,000 10,000 (120,000)

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Ending balance ..........................................................

$235,000

(2) Plan assets Beginning balance...................................................... Actual return............................................................... Contributions .............................................................. Payments to retirees .................................................. Ending balance ..........................................................

$180,000 21,000 70,000 (120,000) $151,000

Pr. 19-83 Preparation of a pension worksheet and pension entries The accountant for Camberwell Ltd. has developed the following information regarding the company's defined benefit pension plan for calendar 2014: Service cost ............................................................... $ 600,000 Actual return on plan assets ....................................... 315,000 Contributions .............................................................. 1,080,000 Benefits paid to retirees.............................................. 72,000 Interest (discount) rate ............................................... 10% The corporation uses the immediate recognition approach under ASPE. Instructions a. Using the above information, complete the pension work sheet below for 2014. Indicate credit entries by parentheses, e.g. (72,000). b. Prepare the journal entries to reflect the accounting for the company's pension plan for the year ended December 31, 2014. CAMBERWELL LTD. Pension Work Sheet for the year ended December 31, 2014 General Journal Entries Memo Entries —————————————————————————————————————————— Annual Net Defined Defined Pension Benefit Benefit Plan Expense Cash Asset/Liab Obligation Assets —————————————————————————————————————————— Bal., Dec. 31, 2013 (1,200,000) (4,500,000) 3,300,000 Service cost Interest cost Actual return Contributions Benefits paid Journal entry for 2014 ______ ______ ______ ______ ______ Bal., Dec. 31, 2014 ______ ______ ______ ______ ______ Solution 19-83 a.

CAMBERWELL LTD. Pension Work Sheet

Pensions and Other Employee Future Benefits

19- 39

for the year ended December 31, 2014 (immediate recognition approach) General Journal Entries Memo Entries —————————————————————————————————————————— Annual Net Defined Defined Pension Benefit Benefit Plan Expense Cash Asset/Liab Obligation Assets —————————————————————————————————————————— Bal., Dec. 31, 2013 (1,200,000) (4,500,000) 3,300,000 Service cost 600,000 (600,000) Interest cost (1) 450,000 (450,000) Actual return (315,000) 315,000 Contributions (1,080,000) 1,080,000 Benefits paid ________ 72,000 (72,000) Expense entry 735,000 (735,000) Contribution entry (1,080,000) 1,080,000 Bal., Dec. 31, 2014 (855,000) (5,478,000 4,623,000 (1) $4,500,000 × 10% = $450,000 b.

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

735,000 735,000

Net Defined Benefit Liability/Asset ................................................ 1,080,000 Cash....................................................................................... 1,080,000

*Pr. 19-84 Amortization of past service costs using EARSL (Expected Average Remaining Service Life) On January 1, 2014, Fudge Inc. amended its defined benefit pension plan, which caused an increase of $3,600,000 in its accrued benefit obligation. The company has 400 employees who are expected to receive benefits under the plan. The personnel department provided the following information regarding expected employee retirements: Expected Retirements Number of Employees on Dec 31 each year 40 2014 120 2015 60 2016 160 2017 20 2018 400 Fudge plans to use the expected average remaining service life (EARSL) to calculate the amortization of unrecognized past service costs. The corporation uses the deferral and amortization approach. Instructions Prepare a schedule showing the annual amortization of past service costs that Fudge will recognize as a component of pension expense from 2014 through 2018.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 19-84 Calculation of Service Years Year 2014 2015 2016 2017 2018

120 120

60 60 60

160 160 160 160

240

180

640

20 20 20 20 20 100

Total 400 360 240 180 20 1,200

Cost per Service Year: $3,600,000 ÷ 1,200 = $3,000. Fudge Inc. Calculation of Annual Past Service Costs Amortization Total Cost Per Annual Year Service-Years Service-Year Amortization 2014 400 $3,000 $1,200,000 2015 360 3,000 1,080,000 2016 240 3,000 720,000 2017 180 3,000 540,000 2018 20 3,000 60,000 1,200 $3,600,000

*Pr. 19-85 Preparation of a pension worksheet and pension entries The accountant for Camberwell Ltd. has developed the following information regarding the company's defined benefit pension plan for 2014: Service cost ............................................................... $ 600,000 Actual return on plan assets ....................................... 315,000 Contributions .............................................................. 1,080,000 Amortization of unrecognized past service costs ........ 126,000 Benefits paid to retirees.............................................. 72,000 Interest rate on ABO .................................................. 10% Expected rate of return on plan assets ....................... 8% Instructions a. Using the above information, complete the pension work sheet below for 2014. Indicate credit entries by parentheses, e.g. (72,000). Camberwell uses the deferral and amortization approach. b. Prepare the journal entries to reflect the accounting for the company's pension plan for the year ending December 31, 2014. Camberwell Ltd. Pension Work Sheet for the year ended December 31, 2014 (deferral and amortization approach) —————————————————————————————————————————— General Journal Entries Memo Entries ——————————————————————————————————————————

Pensions and Other Employee Future Benefits

19- 41

Unrecog Unrecog Annual Accrued Accrued Past Net Pension Pension Benefit Plan Service (Gain) Expense Cash Asset/Liab Obligation Assets Cost or Loss —————————————————————————————————————————— Bal., Dec. 31, 2011 (450,000) (4,500,000) 3,300,000 750,000 Service cost Interest cost Expected return Amortization of PSC Contributions Benefits paid Unrecognized gain/loss Journal entry for 2014 ______ ______ ______ ______ ______ ______ ______ Bal., Dec. 31, 2014 ______ ______ ______ ______ ______ ______ ______ Solution 19-85

Camberwell Ltd. Pension Work Sheet for the year ended December 31, 2014 (deferral and amortization approach)

—————————————————————————————————————————— General Journal Entries Memo Entries —————————————————————————————————————————— Unrecog Unrecog Annual Accrued Accrued Past Net Pension Pension Benefit Plan Service (Gain) Expense Cash Asset/Liab Obligation Assets Cost or Loss —————————————————————————————————————————— Bal., Dec. 31, 2011 (450,000) (4,500,000) 3,300,000 750,000 Service cost 600,000 (600,000) Interest cost (1) 450,000 (450,000) Expected return (264,000) 264,000 Amortization of PSC 126,000 (126,000) Contributions (1,080,000) 1,080,000 Benefits paid 72,000 (72,000) Unrecog gain/loss (2) 51,000 (51,000) Journal entry for 2014 912,000 (1,080,000) 168,000 ______ ______ ______ ______ Bal., Dec. 31, 2014 (282,000) (5,478,000) 4,623,000 624.000 (51,000) (1) $4,500,000 × 10% = $450,000 (2) $315,000 – ($3,300,000 × 8%) = $51,000 b.

Pension Expense .......................................................................... Accrued Pension Asset/Liability ..............................................

912,000 912,000

Accrued Pension Asset/Liability .................................................... 1,080,000 Cash....................................................................................... 1,080,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 20 LEASES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

1. 2. 3. 4. 5.

2 2 2 2 3

M M M E M

6. 7. 8. 9. 10.

21. 22. 23. 24. 25. 26. 27.

3 3 4 4 5 5 5

E M E E M M M

28. 29. 30. 31. 32. 33. 34.

46. 47. 48.

3 5 5

E E M

49. 50. 51.

55. 56. 57.

2 3 3

E M M

*58. 59. 60.

66.

3,5

67.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 3 M 11. 7 E 3 M 12. 8 M 5 M 13. 9 M 5 M 14. 10 E 5 M 15. 10 E Multiple Choice–Computational 5 M 35. 9 M 7 M 36. 10 M 7 M 37. 10 M 7 E 38. 10 M 7 E 39. 12 M 7,12 M 40. 12 M 9 E *41. 14 E Multiple Choice–CPA Adapted 5 M 52. 10 E 5,8 M *53. 14 E 5,8 H *54. 14 E Exercises 3,16 M 61. 5 M 4,9,10 H 62. 7,12 M 5 M 63. 10 H Problems 5,6 H 68. 9,10 M

M = Medium

Item

LOD

16. 17. *18. *19. *20.

11 12 14 15 16

H M M E M

*42. *43. *44. *45.

15 15 15 15

E M E M

*64. *65.

14 14,15

M H

*69.

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

5. 6.

MC MC

7. 21.

MC MC

23.

24.

8. 9. 10.

MC MC MC

25. 26. 27.

MC MC MC

67.

11. 29.

MC MC

30. 31.

MC MC

12.

50.

13.

34.

14. 15.

MC MC

36. 37.

MC MC

16.

17.

33.

*18.

*41.

*19.

*42.

*20.

*58.

MC = Multiple Choice

Item Type Item Type Learning Objective 2 3. MC 4. MC Learning Objective 3 22. MC 56. Ex 46. MC 57. Ex Learning Objective 4 59. Ex Learning Objective 5 28. MC 49. MC 47. MC 50. MC 48. MC 51. MC Learning Objective 6 Learning Objective 7 32. MC 62. Ex 33. MC Learning Objective 8 51. MC Learning Objective 9 35. MC 59. Ex Learning Objective 10 38. MC 59. Ex 52. MC 63. Ex Learning Objective 11 Learning Objective 12 39. MC 40. MC Learning Objective 14 *53. MC *54. MC Learning Objective 15 *43. MC *44. MC Learning Objective 16

Ex = Exercise

Item

Type

Item

Type

55.

*58. 66.

Ex Pr

60. 61. 66.

Ex Ex Pr

67.

68.

62.

*64.

*65.

*45.

*65.

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Leases

20- 3

CHAPTER STUDY OBJECTIVES 1. Understand the importance of leases from a business perspective. Leases represent a significant source of off–balance sheet financing for companies. One of the issues identified by the IASB in existing accounting standards is the lack of transparency in financial reporting of leases, leaving users like financial analysts having to guess the extent of debt and leverage of many companies.

2. Explain the conceptual nature, economic substance, and advantages of lease transactions. A lease is a contract between two parties that gives the lessee the right to use property that is owned by the lessor. In situations where the lessee obtains the use of the majority of the economic benefits inherent in a leased asset, the transaction is similar in substance to acquiring an asset. Therefore, the lessee recognizes the asset and associated liability and the lessor transfers the asset under one of the approaches to lease accounting. The major advantages of leasing for the lessee relate to the cost and flexibility of the financing, and protection against obsolescence. For the lessor, the finance income is attractive.

3. Identify and apply the criteria that are used to determine the type of lease for accounting purposes for a lessee under the classification approach. A lease is classified as a capital or finance lease where the risks and benefits of owning the leased asset are transferred to the lessee, which is evidenced by one or more of the following: (1) the transfer of title, (2) the use of the majority of the asset services inherent in the leased asset, (3) the recovery by the lessor of substantially all of its investment in the leased asset plus a return on that investment, or (4) under IFRS, in some cases the degree of specialization of the specific asset. If none of these criteria is met, the lease is classified as an operating lease.

4. Calculate the lease payment that is required for a lessor to earn a specific return. The lessor determines the investment that it wants to recover from a leased asset. If the lessor has acquired an asset for the purpose of leasing it, the lessor usually wants to recover the asset’s cost. If the lessor participates in leases as a way of selling its product, it usually wants to recover the sales price. The lessor’s investment in the cost or selling price can be recovered in part through a residual value if the asset will be returned to the lessor, or through a bargain purchase price that it expects the lessee to pay, if a bargain purchase is part of the lease agreement. In addition to these sources, the lessor recovers its investment through the lease payments. The periodic lease payment, therefore, is the annuity amount whose present value exactly equals the amount to be recovered through lease payments. 5. Account for a lessee’s basic capital (finance) lease. As a capital lease, called a finance lease under IFRS, the asset is capitalized on the lessee’s SFP and a liability is recognized for the obligation owing to the lessor. The amount capitalized is the present value of the minimum lease payments (in effect the payments, excluding executory costs) that the lessee has agreed to take responsibility for. The asset is then depreciated in the same way as other capital assets owned by the lessee. Payments to the lessor are divided into an interest portion and a principal payment, using the effective interest method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

6. Determine the effect of, and account for, residual values and bargain purchase options in a lessee’s capital (finance) lease. When a lessee guarantees a residual value, it is obligated to return either the leased asset or cash, or a combination of both, in an amount that is equal to the guaranteed value. The lessee includes the guaranteed residual in the lease obligation and leased asset value. The asset is depreciated to this value by the end of the lease term. If the residual is unguaranteed, the lessee takes no responsibility for the residual and it is excluded from the lessee’s calculations.

7. Account for an operating lease by a lessee and compare the operating and capitalization methods of accounting for leases. A lessee recognizes the lease payments that are made as rent expense in the period that is covered by the lease, usually based on the proportion of time. Over the term of a lease, the total amount that is charged to expense is the same whether the lease has been treated as a capital/finance lease or as an operating lease. The difference relates to (1) the timing of recognition for the expense (more is charged in the early years for a finance lease), (2) the type of expense that is charged (depreciation and interest expense for a finance lease versus rent expense for an operating lease), and (3) the recognition of an asset and liability on the SFP for a finance lease versus non-recognition for an operating lease. Aside from any income tax differences, the cash flows for a lease are the same whether it is classified as an operating or finance lease.

8. Determine the statement of financial position presentation of a capital (finance) lease and identify other disclosures required. The current portion of the obligation is the principal that will be repaid within 12 months from the SFP date. The current portion also includes the amount of interest that has accrued up to the SFP date. The long-term portion of the obligation or net investment is the principal balance that will not be paid within 12 months of the SFP date. Lessees disclose the same information as is required for capital assets and long-term debt in general. In addition, details are required of the future minimum lease payments for each of the next five years, and under IFRS, information about its leasing arrangements is required.

9. Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach. If a lease, in substance, transfers the risks and benefits of ownership of the leased asset to the lessee (decided in the same way as for the lessee) and revenue recognition criteria related to collectibility and ability to estimate any remaining unreimbursable costs are met, the lessor accounts for the lease as either a direct financing or a sales-type lease. Under IFRS, it is classified either as a financing, or a manufacturer or dealer lease. The existence of a manufacturer’s or dealer’s profit on the amount to be recovered from the lessee is the difference between a manufacturer/dealer or sales-type lease and a direct financing lease, as the objective is only to generate finance income in the latter. If any one of the capitalization or revenue recognition criteria is not met, the lessor accounts for the lease as an operating lease. While the revenue recognition criteria are not set out in IAS 17, they would be applied in general before any revenue is recognized by the lessor.

10. Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor. In a finance lease, the lessor removes the cost of the leased asset from its books and replaces it with its net investment in the lease. This is made up of two accounts: (1) the gross investment or lease receivable, offset by (2) the portion of these amounts that represents

Leases

20- 5

unearned interest. The net investment represents the present value of the lease payments and the residual value or bargain purchase option amounts. As the lease payments are received, the receivable is reduced. As time passes, the unearned interest is taken into income based on the implicit rate of return that applies to the net investment. Under a manufacturer/dealer or sales-type lease, the accounting is similar except that the net investment represents the sale amount the lessor wants to recover. The lessor also transfers the inventory “sold” to cost of goods sold.

11. Account for and report financing and manufacturer/dealer or sales-type leases with guaranteed residual values or a bargain purchase option by a lessor. For both types of lease, the net investment in the lease includes the estimated residual value whether it is guaranteed or not, or the bargain purchase option amount. Under a manufacturer/dealer or sales-type lease, both the sale and cost of goods sold amounts are reduced by any unguaranteed residual values.

12. Account for and report an operating lease by a lessor. The lessor records the lease payments received from the lessee as rental income in the period covered by the lease payment. Because the leased asset remains on the lessor’s books, the lessor records depreciation expense. Separate disclosure is required of the cost and accumulated amortization of property held for leasing purposes, and the amount of rental income earned.

13. Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future. Under the classification approach, ASPE is substantially the same as the IFRS requirements. Different terminology is used and the classification requirements that differentiate between a capital/finance lease and an operating lease under IFRS are based more on principles and judgement than ASPE. A new lease standard was expected to be issued by the IASB and FASB after a 2013 exposure draft, and it was expected to significantly change the approach to lease accounting. Under the revisions planned, a contract-based or right-of-use approach is used by both lessee and lessor. 14. Describe and apply the lessee’s accounting for sale-leaseback transactions. A sale and leaseback is accounted for by the lessee as if the two transactions were related. In general, any gain or loss, with the exception of a real (economic) loss, is deferred by the lessee and recognized in income over the lease term. For an operating lease under ASPE, the seller-lessee takes the deferred gain or loss into income in proportion to the rental payments made. Under IFRS, if the transaction is done at fair value, the gain or loss may be taken to income immediately. For a finance lease, the deferred gain or loss is taken into income over the same period and basis as the depreciation of the leased asset (ASPE) or over the term of the lease (IFRS).

15. Explain the classification and accounting treatment for leases that involve real estate. Because the capitalization of land by the lessee in a capital or finance lease that does not transfer title results in an unwanted and unintended effect on the lessee’s financial statements, the portion of such leases that relates to land is accounted for as an operating lease. If the relative value of the land is minor, however, the minimum lease payments are fully capitalized as building.

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16. Explain and apply the contract-based approach to a basic lease for a lessee and lessor. The contract-based approach to lease accounting assumes that the asset transferred by the lease contract from the lessor to the lessee is the right to use the leased property. The lessee recognizes this right-of-use as an asset and recognizes the obligation to make rental payments as an obligation. The lessor recognizes the contractual right to receive lease payments as an asset—a receivable—and recognizes its performance obligation to permit the lessee to use the asset as a liability. As performance takes place, the lessor recognizes revenue.

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MULTIPLE CHOICE—Conceptual Answer b c a b c d d c c a b c c d a c d c a d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. *18. *19. *20.

Description Essential element of a lease agreement Identification of executory costs Advantages of leasing Current standards in lease accounting ASPE capitalization criteria Components of minimum lease payments Interest/discount rate used by lessee Identify incorrect statement Lessee accounting for a capital (finance) lease Depreciation of a leased asset by lessee Effect on accounting of finance lease vs. operating lease Disclosing obligations under leases Objective of accounting for direct financing leases by lessor Components of gross investment in lease Recognition of unearned interest income Accounting for a sales-type lease (manufacturer or dealer lease) Accounting for initial direct costs Gain/loss recognition in a sale-leaseback Classification of lease of land Contract-based approach

MULTIPLE CHOICE—Computational Answer c b c d c c a c b d d b c a a b c d a d b b

No. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. *41. *42.

Description Identification of lease type for lessee Identification of lease type for lessee Calculate minimum annual lease payment. Calculate total annual lease payment. Calculate interest expense and depreciation expense for lessee. Calculate depreciation expense for lessee. Calculate depreciation and interest expense for lessee. Calculate reduction of lease obligation for lessee. Calculate rent expense. Calculate rent expense with inducement. Calculate operating lease expense. Expense recorded by lessee/operating lease Calculate operating lease income/expense. Identification of lease type for lessor Identification of lease type for lessor Calculate gross profit and interest income for lessor. Calculate gross profit and interest income for lessor. Calculate Lease Receivable. Calculate income before taxes from operating lease. Revenues and expenses recorded by lessor/operating lease Rent expense with sale-leaseback Determine interest rate implicit in lease payments.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*43. *44. *45.

Calculate lease-related expenses recognized by lessee. Determine long-term lease obligation for lessee. Lease-related income in sale-leaseback

MULTIPLE CHOICE—CPA Adapted Answer c d a a a d a d b

No. 46. 47. 48. 49. 50. 51. 52. *53. *54.

Description Identification of lease type for lessee Calculate interest expense for lessee. Calculate depreciation expense for lessee. Determine reduction of lease obligation for lessee. Calculate the lease liability of a lessee. Calculate the lease liability of a lessee. Calculate income realized by lessor. Reporting gain on a sale-leaseback Accounting for deferred profit in a sale-leaseback

EXERCISES Item E20-55 E20-56 E20-57 *E20-58 E20-59 E20-60 E20-61 E20-62 E20-63 *E20-64 *E20-65

Description Types of lessors Lease criteria under IFRS Lease criteria for classification by lessor under ASPE Classification approach vs. contract-based approach Lessor accounting—sales-type lease Accounting for a capital lease by the lessee Capital lease amortization and journal entries Operating lease calculations Accounting for a direct financing lease by lessor Lessee and lessor accounting (sale-leaseback) Lessee and lessor accounting (sale-leaseback)

PROBLEMS Item P20-66 P20-67 P20-68 *P20-69

Description Lessee accounting—capital lease Lessee accounting—capital lease Lessor accounting—lease with IFRS criteria Sale and leaseback

*This topic is dealt with in an Appendix to the chapter.

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MULTIPLE CHOICE—Conceptual 1. An essential element in a lease agreement is that the a. lessee transfers less than the total interest in the property. b. lessor transfers less than the total interest in the property. c. lease must contain a bargain purchase option. d. rental (lease) payments must be constant for the duration of the lease.

2. Executory costs include a. maintenance, interest and property taxes. b. interest, property taxes and depreciation. c. insurance, maintenance and property taxes. d. maintenance, insurance and income taxes.

3. Which of the following is NOT a potential advantage of leasing? a. no tax advantages for the lessor b. cheaper financing c. 100% financing at fixed rates d. protection against obsolescence

4. Which of the following best describes current standards in accounting for leases? a. Leases are not capitalized. b. Leases similar to instalment purchases are capitalized. c. Only long-term leases are capitalized. d. All leases are capitalized.

5. Which of the following is a correct statement regarding one of the ASPE capitalization criteria? a. The lease transfers ownership of the property to the lessor. b. The lease must contain a bargain purchase option. c. The lease term is 75% or more of the leased property’s estimated economic life. d. The fair value of the minimum lease payments is equal to 90% or more of the present value of the leased asset.

6. For a lessee, the minimum lease payments may include a. the minimum rental payments and a guaranteed residual value only. b. the minimum rental payments and a bargain purchase option only. c. a bargain purchase option and a guaranteed residual value. d. the minimum rental payments, a bargain purchase option, and a guaranteed residual value.

7. In calculating the present value of the minimum lease payments, IFRS requires the lessee should a. use its incremental borrowing rate in all cases.

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b. use either its incremental borrowing rate or the interest rate implicit in the lease, whichever is higher. c. use either its incremental borrowing rate or the interest rate implicit in the lease, whichever is lower. d. use the interest rate implicit in the lease whenever this is reasonably determinable, otherwise use the lessee’s incremental borrowing rate.

8. Regarding a basic capital (finance) lease for a lessee, which of the following statements is INCORRECT? a. The lessee records the leased asset at the lower of the minimum lease payments and the fair value of the asset at the lease’s inception. b. The lessee accounts for the lease as if an asset is purchased and a long-term obligation is entered into. c. The lessor uses the lease as a source of funding. d. The lessee uses the lease as a source of funding.

9. When a lessee is accounting for a capital (finance) lease a. a guaranteed residual value is excluded from the “minimum lease payments.” b. an unguaranteed residual value is excluded from the “minimum lease payments.” c. a guaranteed residual value is basically an additional lease payment due at the end of the lease. d. the present value of any guaranteed residual is deducted from the leased asset cost in determining the depreciable amount.

10. In calculating depreciation of a leased asset, the lessee should subtract a(n) a. guaranteed residual value and depreciate over the term of the lease. b. unguaranteed residual value and depreciate over the term of the lease. c. guaranteed residual value and depreciate over the economic life of the asset. d. unguaranteed residual value and depreciate over the economic life of the asset.

11. In the earlier years of a lease, from the lessee's perspective, accounting for a leased asset as a. a finance lease will enable the lessee to report higher income in the earlier years, compared to accounting for it as an operating lease. b. a finance lease will cause debt to increase, compared to accounting for it as an operating lease. c. an operating lease will cause income to decrease in the earlier years, compared to accounting for it as a finance lease. d. an operating lease will cause debt to increase, compared to accounting for it as a finance lease.

12. Obligations under leases should be disclosed as a. all current liabilities. b. all noncurrent liabilities. c. the current portion in current liabilities and the remainder in noncurrent liabilities. d. deferred credits.

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13. For companies engaged in direct financing leases (ASPE) or finance leases (IFRS) a. they are generally manufacturers or retail stores. b. their profits are derived from leasing their inventory at a profit. c. their objective is to earn interest income on the financing arrangement with the lessee. d. such leases are frequently operating leases.

14. For a lessor, which of the following would NOT be included in the Gross Investment in Lease (Lease Receivable)? a. guaranteed residual value b. unguaranteed residual value c. bargain purchase option d. executory costs

15. In a lease that is appropriately recorded as a direct financing lease (ASPE) or finance lease (IFRS) by the lessor, the unearned interest income is a. amortized and taken into income over the lease term using the effective interest method. b. amortized and taken into income over the lease term using the straight-line method. c. taken into income at the inception of the lease. d. taken into income at the end of the lease.

16. For a sales-type lease (ASPE) or manufacturer or dealer lease (IFRS), a. the sales price includes the present value of the unguaranteed residual value. b. the present value of the guaranteed residual value is deducted to determine the cost of goods sold. c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed. d. cost of goods sold is not recognized.

17. Initial direct costs are a. costs incurred by a lessee that are directly associated with negotiating and arranging a lease. b. expensed in the year of incurrence by the lessor in a financing-type lease. c. spread over the term of a sales-type lease by the lessee. d. deferred and allocated over the term of an operating lease in proportion to the amount of rental (lease) income that is recognized.

*18. If a corporation adhering to IFRS sells machinery at fair value and then leases it back (sale-leaseback) as a finance lease, any gain on the sale should be a. recognized in the year of “sale.” b. recorded as other comprehensive income. c. deferred and amortized to income over the term of the lease. d. deferred and recognized as income at the end of the lease.

*19. If land is the sole property being leased, and title does NOT transfer at the end of the lease, it

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should be accounted for as a(n) a. operating lease. b. capital lease. c. sales-type lease. d. direct-financing lease.

*20. Which statement is correct regarding the contract-based approach advocated by the IASB and FASB? a. The lessee recognizes a lease as the leased property itself when there is a transfer of the risk and benefits of ownership. b. It includes contracts that actually transfer control of the underlying assets itself or almost all of the risks and benefits of ownership. c. It will apply to all types of assets, including property, plant and equipment, and intangible assets. d. The asset taken on by the lessee is viewed as the contractual right to the use the asset, not the transfer of the asset itself.

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MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3.

Ans.

b c a

Item

4. 5. 6.

Ans.

b c d

Item

7. 8. 9.

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

d c c

10. 11. 12.

a b c

13. 14. 15.

c d a

16. 17. *18.

c d c

*19. *20.

a d

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MULTIPLE CHOICE—Computational 21. On January 1, 2014, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectibility of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement: 1. The agreement requires equal payments at the end of each year. 2. At January 1, 2014, the fair value of the building is $900,000 and Seline’s book value is $750,000. 3. The building has an estimated economic life of 10 years, with no residual value. Dionne uses straight-line depreciation for all its depreciable assets. 4. At the termination of the lease, title to the building will transfer to the lessee. 5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne. 6. The yearly lease payment includes $3,000 executory costs related to taxes on the property. From the lessee's viewpoint, what type of lease is this? a. sales-type lease b. sale-leaseback c. capital lease d. operating lease

22. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year. 2. The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful. From Marlene’s viewpoint, what type of lease is this? a. operating lease b. finance lease c. manufacturer or dealer lease d. other finance lease

Use the following information for questions 23–24. On January 1, 2014, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectibility of the lease payments is reasonably assured and no additional costs are to be incurred by the

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lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement: 1. The agreement requires equal payments at the end of each year. 2. At January 1, 2014, the fair value of the building is $900,000 and Seline’s book value is $750,000. 3. The building has an estimated economic life of 10 years, with no residual value. Dionne uses straight-line depreciation for all its depreciable assets. 4. At the termination of the lease, title to the building will transfer to the lessee. 5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne. 6. The yearly lease payment includes $3,000 executory costs related to taxes on the property.

23. Rounded to the nearest dollar, the amount of the minimum annual lease payment is a. $ 56,471. b. $143,471. c. $146,471. d. $149,471.

24. Rounded to the nearest dollar, the amount of the total annual lease payment is a. $ 56,471. b. $143,471. c. $146,471. d. $149,471.

25. On January 1, 2014, X-Man Corp. signed a ten-year non-cancellable lease for new machinery. The terms of the lease called for X-Man to make annual payments of $100,000 at the end of each year for ten years, with title to pass to X-Man at the end of the lease period. X-Man accordingly accounted for this lease transaction as a finance lease. The machinery has an estimated useful life of 15 years and no residual value. X-Man uses straight-line depreciation for all of its property, plant and equipment. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. It was also determined that the fair value of the machinery on January 1, 2014 was $674,000. With respect to this lease, for the year ending December 31, 2014, X-Man should report (rounded to the nearest dollar) a. lease expense of $100,000, and depreciation expense of $44,734. b. interest expense of $53,681 and depreciation expense of $67,101. c. interest expense of $53,681 and depreciation expense of $44,734. d. interest expense of $53,920 and depreciation expense of $44,933.

26. On January 1, 2014, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectibility of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement: 1. The agreement requires equal payments at the end of each year. 2. At January 1, 2014, the fair value of the building is $900,000 and Seline’s book value is

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$750,000. 3. The building has an estimated economic life of 10 years, with no residual value. Dionne uses straight-line depreciation for all its depreciable assets. 4. At the termination of the lease, title to the building will transfer to the lessee. 5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne. 6. The yearly lease payment includes $3,000 executory costs related to taxes on the property. Rounded to the nearest dollar, how much depreciation expense would Dionne record on this asset for calendar 2014? a. $ 0 b. $ 75,000 c. $ 90,000 d. $146,471

27. On July 1, 2014, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2014. Justin had purchased the equipment for $390,000 on January 1, 2014, and established a selling price of $500,000 (which was fair value at July 1, 2014). Assume that, at July 1, 2014, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years. For the year ended December 31, 2014, and assuming that Trudeau uses straight-line depreciation, how much depreciation and interest expense should Trudeau record? a. $18,750 and $15,516 b. $18,750 and $24,840 c. $22,500 and $15,516 d. $22,500 and $24,840

28. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year. 2. The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful. Assume the present value of the lease payments is $700,000 at January 1, 2014. If Marlene accounts for this lease as a finance lease, what is the amount of the reduction in the lease obligation in calendar 2015? (Round to the nearest dollar.) a. $201,622 b. $215,622 c. $221,784

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d. $232,873

29. On December 1, 2014, Quincannon Corp. leased office space for 10 years at a monthly rental of $25,000, under an operating lease. On that date Quincannon paid the landlord the following amounts: Rent deposit ............................................. $25,000 First month's rent ..................................... 25,000 Last month's rent ...................................... 25,000 Installation of new walls and offices.......... 135,000 $210,000 Quincannon debited the entire $210,000 payment to Prepaid Rent. How much should Quincannon recognize as rent expense for the year ended December 31, 2014? a. $25,000 b. $26,125 c. $51,125 d. $137,500

30. Laurel Ltd. leased an office building to Hardy Inc. for a three year, non-renewable term. This was properly classified as an operating lease by both parties. The monthly rental is set at $12,000 per month. However, as an added inducement, Laurel agreed to grant Hardy a four-month rent-free period at the beginning of the lease, and a further two-month rent-free period at the end of the lease. How much rent expense should Hardy record each month during the three year period? a. $12,000 b. $11,250 c. $10,667 d. $10,000

31. On May 1, 2014, Charles Corp. leased equipment to Darwin Inc. for one year under an operating lease. Instead of leasing it, Darwin could have bought the equipment from Charles for $800,000 cash. At this time, Charles's accounting records showed a book value for the equipment of $700,000. Depreciation on the equipment in 2014 was $90,000. During 2014, Darwin paid $22,500 per month rent to Charles for the 8-month period, and Charles incurred maintenance and other related costs under the terms of the lease of $16,000. The pre-tax expense reported by Darwin from this lease for the year ended December 31, 2014, should be a. $74,000. b. $90,000. c. $164,000. d. $180,000.

32. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

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The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful. If Marlene accounts for the lease as an operating lease, what expense(s) will be reported in calendar 2014 in relation to this lease? a. Depreciation Expense b. Rent Expense c. Interest Expense d. Depreciation Expense and Interest Expense

33. On July 1, 2013, Huey Corp. leased heavy equipment to Duey Inc. for one year, at $60,000 a month. Duey returned the equipment on June 30, 2014, and the next day, Huey Corp. leased this equipment to Luey Ltd. for three years, at $75,000 a month. The original cost of the equipment was $3,200,000. The equipment, which has been continually on lease since July 1, 2011, is being depreciated on a straight-line basis over ten years with no residual value. Assuming that both the lease to Duey and the lease to Luey are appropriately recorded as operating leases for accounting purposes, how much net income (loss) before income taxes that each company would record as a result of the above facts for the year ended December 31, 2014? Huey Duey Luey a. $810,000 $(360,000) $(450,000) b. $450,000 $(450,000) $(360,000) c. $490,000 $(360,000) $(450,000) d. $490,000 $(360,000) $(900,000)

34. On January 1, 2014, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectibility of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement: 1. The agreement requires equal payments at the end of each year. 2. At January 1, 2014, the fair value of the building is $900,000 and Seline’s book value is $750,000. 3. The building has an estimated economic life of 10 years, with no residual value. Dionne uses straight-line depreciation for all its depreciable assets. 4. At the termination of the lease, title to the building will transfer to the lessee. 5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne. 6. The yearly lease payment includes $3,000 executory costs related to taxes on the property. From the lessor's viewpoint, what type of lease is this? a. sales-type lease b. sale-leaseback

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c. direct financing lease d. operating lease

35. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year. 2. The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful. From Dietrich’s viewpoint, what type of lease is this? a. operating lease b. finance lease c. manufacturer or dealer lease d. other finance lease

36. On July 1, 2014, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2014. Justin had purchased the equipment for $390,000 on January 1, 2014, and established a selling price of $500,000 (which was fair value at July 1, 2014). Assume that, at July 1, 2014, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years. For the year ended December 31, 2014, what is the amount of gross profit and interest income that Justin should record regarding this lease? a. $ 0 and $15,516 b. $ 60,000 and $15,516 c. $110,000 and $15,516 d. $231,000 and $24,840

37. On July 1, 2014, Nickel Ltd. leases equipment from Dime Corp., under an eight year capital (finance) lease. Equal annual payments of $100,000 are required, payable on July 1 of each year. The first payment is made on July 1, 2014. The appropriate rate of interest for this lease is 9%, and title will transfer to Nickel at the end of the lease contract. The fair value of the equipment is $620,000 and the cost in Dime's accounting records is $550,000. The present value of the lease payments is $620,637. What is the amount of gross profit and interest income that Dime would record for the year ended December 31, 2014? a. $0 and $23,400 b. $0 and $36,000 c. $70,000 and $23,400 d. $70,637 and $23,400

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38. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year. 2. The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful. If Dietrich records this lease as a finance lease, what amount would be recorded as Lease Receivable at the inception of the lease? a. $271,622 b. $675,483 c. $700,000 d. $814,866

39. On May 1, 2014, Charles Corp. leased equipment to Darwin Inc. for one year under an operating lease. Instead of leasing it, Darwin could have bought the equipment from Charles for $800,000 cash. At this time, Charles's accounting records showed a book value for the equipment of $700,000. Depreciation on the equipment in 2014 was $90,000. During 2014, Darwin paid $22,500 per month rent to Charles for the 8-month period, and Charles incurred maintenance and other related costs under the terms of the lease of $16,000. The net income before income taxes reported by Charles from this lease for the year ended December 31, 2014, should be a. $74,000. b. $90,000. c. $164,000. d. $180,000.

40. On January 1, 2014, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement: 1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year. 2. The fair value of the machine on January 1, 2014, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease. 3. Marlene depreciates all its machinery on a straight-line basis. 4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich. 5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful.

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If Dietrich accounts for the lease as an operating lease, what revenue(s) and/or expense(s) will be reported in calendar 2014 in relation to this lease? a. Rental Revenue b. Interest Income c. Interest Expense and Depreciation Expense d. Rental Revenue and Depreciation Expense

*41. On June 30, 2014, Sharma Corp. sold equipment for $300,000. The equipment had a book value of $500,000 and a remaining useful life of 10 years. The same day, Sharma leased back the equipment at $6,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Sharma's equipment rent expense for this equipment for the year ended December 31, 2014, should be a. $72,000. b. $36,000. c. $30,000. d. $24,000.

Use the following information for questions *42–*45. Ball Ltd. purchased land and constructed a service station, at a total cost of $450,000. On January 2, 2013, when construction was completed, Ball sold the service station and land to a major oil company for $500,000, and immediately leased it back from the oil company. Fair value of the land at the time of the sale was $50,000. The lease is a 10-year, non-cancellable lease. Ball uses straight-line amortization for its other assets. The economic life of the station is 15 years with zero residual value. Title to the property will revert back to Ball at the end of the lease. A partial amortization schedule for this lease follows: Payments Interest_ Amortization Balance__ Jan 02, 2013 $500,000.00 Dec 31, 2013 $81,372.66 $50,000.00 $31,372.66 468,627.34 Dec 31, 2014 81,372.66 46,862.74 34,509.92 434,117.42 Dec 31, 2015 81,372.66 43,411.74 37,960.92 396,156.50

*42. What is the interest rate implicit in the amortization schedule presented above? a. 12% b. 10% c. 8% d. 6%

*43. The total lease-related expenses recognized by the lessee during 2014 are (rounded to the nearest dollar) a. $76,863. b. $80,000. c. $81,373. d. $91,863.

*44. What is the amount of the lessee's obligation to the lessor after the December 31, 2015

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

payment? (Round to the nearest dollar.) a. $500,000 b. $468,627 c. $434,117 d. $396,157

*45. The total lease-related income recognized by the lessee during 2014 is a. $ -0-. b. $3,333. c. $5,000. d. $50,000.

Leases

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MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

21. 22. 23. 24.

c b c d

25. 26. 27. 28.

c c a c

29. 30. 31. 32.

b d d b

33. 34. 35. 36.

c a a b

37. 38. 39. 40.

c d a d

*41. *42. *43. *44.

b b a d

*45.

Period 1 2 3 4 5 6 7 8 9 10

5%__ 1.00000 2.05000 3.15250 4.31013 5.52563 6.80191 8.14201 9.54911 11.02656 12.57789

Future Value of Ordinary Annuity of 1 6%__ 8%_ 10%__ 1.00000 1.00000 1.00000 2.06000 2.08000 2.10000 3.18360 3.24640 3.31000 4.37462 4.50611 4.64100 5.63709 5.86660 6.10510 6.97532 7.33592 7.71561 8.39384 8.92280 9.48717 9.89747 10.63663 11.43589 11.49132 12.48756 13.57948 13.18079 14.48656 15.93743

12%_ 1.00000 2.12000 3.37440 4.77933 6.35285 8.11519 10.08901 12.29969 14.77566 17.54874

Period 1 2 3 4 5 6 7 8 9 10

5% .95238 1.85941 2.72325 3.54595 4.32948 5.07569 5.78637 6.46321 7.10782 7.72173

Present Value of an Ordinary Annuity of 1 6%_ 8%_ 10%_ .94340 .92593 .90909 1.83339 1.78326 1.73554 2.67301 2.57710 2.48685 3.46511 3.31213 3.16986 4.21236 3.99271 3.79079 4.91732 4.62288 4.35526 5.58238 5.20637 4.86842 6.20979 5.74664 5.33493 6.80169 6.24689 5.75902 7.36009 6.71008 6.14457

12%_ .89286 1.69005 2.40183 3.03735 3.60478 4.11141 4.56376 4.96764 5.32825 5.65022

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

DERIVATIONS—Computational No. Answer 21. c 22. b

Derivation Conceptual $271,622 × 2.48685 = $675,483; $675,483 = 96% > 90% $700,000

23. 24. 25. 26. 27.

c d c c a

28.

29. 30. 31. 32. 33.

b d d b c

34. 35. 36.

a a b

37.

38. 39. 40. *41. *42. *43. *44. *45.

d a d b b a d b

$900,000 ÷ 6.14457 = $146,471 (PV of Ordinary Annuity Table) $146,471 + $3,000 = $149,471 $671,008 × .08 = $53,681; $671,008 ÷ 15 = $44,734 $900,000 ÷ 10 = $90,000 $450,000/12 x 50% = $18,750 $450,000 – $62,100) × .08 X 6/12 = $15,516 $700,000 – [$271,622 – ($700,000 × .1)] = $498,378 $271,622 – ($498,378 × .1) = $221,784 $25,000 +[($135,000/10) x 1 ÷ 12] = $26,125 ($12,000 x 30) ÷ 36 = $10,000 $22,500 x 8 = $180,000 Conceptual Huey: ($60,000 × 6) + ($75,000 × 6) – ($3,200,000 ÷ 10) = $490,000 Duey: ($60,000) × 6 = $(360,000) Luey: ($75,000) × 6 = $(450,000) Conceptual, FV exceeds cost (profit element) Fails to meet all requirements for lessor $450,000 – $390,000 = $60,000 ($450,000 – $62,100) × .08 X 6/12 = $15,516 $620,000 – $550,000 = $70,000 ($620,000 – $100,000) × .09 X 6/12= $23,400 $271,622 × 3 = $814,866 ($22,500 x 8) – $16,000 – $90,000 = $74,000 Conceptual $6,000 × 6 = $36,000 $50,000 ÷ $500,000 = 10% [($500,000 – $50,000) ÷ 15] + $46,863 = $76,863 $396,157 (See amortization table.) ($500,000 – $450,000) ÷ 15 = $3,333

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MULTIPLE CHOICE—CPA Adapted 46. Lease A does not contain a bargain purchase option, but the lease term is equal to 90% of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 85% of the estimated economic life of the leased property. Using ASPE criteria, how should the lessee classify these leases? Lease A Lease B a. Operating lease Capital lease b. Operating lease Operating lease c. Capital lease Capital lease d. Capital lease Operating lease

Use the following information for questions 47–48. On January 2, 2014, Cambridge Ltd. signed a ten-year non-cancellable lease for a heavy-duty drill press. The lease required annual payments of $35,000, starting December 31, 2014, with title passing to Cambridge at the end of the lease. Cambridge is accounting for this lease as a capital (finance) lease. The drill press has an estimated useful life of 20 years, with no residual value. Cambridge uses straight-line depreciation for all its plant assets. The lease payments were determined to have a present value of $215,000, based on an implicit interest rate of 10%.

47. On their 2014 income statement, how much interest expense should Cambridge report in connection with this lease? a. $0 b. $13,125 c. $17,500 d. $21,500

48. On their 2014 income statement, how much depreciation expense should Cambridge report in connection with this lease? a. $10,750 b. $17,500 c. $21,500 d. $35,000

49. A lessee reported a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal a. the current liability shown for the lease at the end of year 1. b. the current liability shown for the lease at the end of year 2. c. the reduction of the lease obligation in year 1. d. one-tenth of the original lease liability.

50. On December 31, 2014, Eastern Inc. leased machinery with a fair value of $420,000 from

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Northern Rentals. The agreement is a six-year non-cancellable lease requiring annual payments of $80,000 beginning December 31, 2014. The lease is appropriately accounted for by Eastern as a finance lease. Eastern’s incremental borrowing rate is 11%; however, they also know that the interest rate implicit in the lease payments is 10%. Eastern adheres to IFRS. The present value of an annuity due for 6 years at 10% is 4.7908. The present value of an annuity due for 6 years at 11% is 4.6959. On its December 31, 2014 statement of financial position, Eastern should report a lease liability of (rounded to the nearest dollar) a. $303,264. b. $340,000. c. $375,672. d. $383,264.

51. On December 31, 2013, Northern Skies Corp. leased a machine from Eastern Star Ltd. for a five-year period. Annual lease payments are $315,000 (including $15,000 annual executory costs), due on December 31 each year. The first payment was made on December 31, 2013, and the second payment on December 31, 2014. The appropriate interest rate for this type of lease is 10%. The present value of the minimum lease payments at the inception of the lease (before the first payment) was $1,251,000. The lease is being accounted for as a finance lease by Northern Skies. On its December 31, 2014 statement of financial position, Northern Skies should report a lease liability of a. $951,000. b. $936,000. c. $855,900. d. $746,100.

52. Sukwinder Corp. manufactures equipment for sale or lease. On December 31, 2014, Sukwinder leased equipment to Pattar Sales Inc. for five years, with ownership of the equipment being transferred to Pattar at the end of the lease. Annual lease payments are $126,000 (including $6,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2014. Collectibility of the remaining lease payments is reasonably assured, and there are no additional costs (other than executory costs) to be incurred by Sukwinder. The normal sales price of the equipment (fair value) is $462,000, and Sukwinder’s cost is $360,000. For the year ended December 31, 2014, what amount of income should Sukwinder report from this lease? a. $102,000 b. $132,000 c. $138,000 d. $198,000

*53. Madrigal Corp. sold its headquarters building at a gain, and simultaneously leased back the building from the buyer. The lease was reported as a capital (finance) lease. At the time of the sale, the gain should be reported as a. operating income. b. other comprehensive income. c. a separate component of shareholders' equity. d. a deferred gain.

Leases

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*54. On December 31, 2014, Lewis Ltd. sold a machine to Martin Inc. and simultaneously leased it back for one year. Pertinent information at this date follows: Sales price ............................................... $180,000 Book value of machine ............................. 165,000 Present value of reasonable lease rentals ($1,500 for 12 months @ 12%) ............ 16,883 Machine’s estimated remaining useful life 12 years On Lewis’s December 31, 2014 statement of financial position, the deferred profit from the sale of this machine should be reported as a. $17,000. b. $15,000. c. $ 2,000. d. $ 0.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

46. 47.

c d

Item

48. 49.

Ans.

a a

Item

50. 51.

Ans.

a d

Item

52. *53.

Ans.

Item

Ans.

a d

*54

DERIVATIONS—CPA Adapted No. Answer 46. c 47. d 48. a 49. a 50. a 51. d 52. *53. *54

a d b

Derivation Conceptual $215,000 × .10 = $21,500 $215,000 ÷ 20 = $10,750 Conceptual ($80,000 × 4.7908) – $80,000 = $303,264 $1,251,000 – $300,000 = $951,000 (2013) $951,000 – [$300,000 – ($951,000 × .10)] = $746,100 (2014) $462,000 – $360,000 = $102,000 Conceptual $180,000 – $165,000 = $15,000

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20- 29

EXERCISES Ex. 20-55 Types of lessors Explain the difference between a manufacturer finance company and an independent finance company. Solution 20-55 A manufacturer finance company, also called a captive leasing company, is a subsidiary whose main business is to provide leasing services for a parent company. Examples are General Motors Acceptance Company of Canada (GMAC), which provides lease financing for General Motors dealers, and Chrysler Finance Service Canada, which provides lease financing for Chrysler dealers. An independent finance company, on the other hand, acts as financial intermediary by providing lease financing for a wide range of manufacturers, distributors and other dealers. The dealer will sell the customer the product(s) and then outsource the financing to an independent finance company. This is commonly seen in the construction industry.

Ex. 20-56 Lease criteria under IFRS Discuss the criteria cited by IFRS to support classifying a lease as a finance lease. Solution 20-56 1. There is reasonable assurance that the lessee will obtain ownership of the leased asset by the end of the lease term. 2. The lease term is long enough that the lessee will receive substantially all of the economic benefits expected to be derived from using the leased property over its economic life. 3. The lease allows the lessor to recover substantially all of its investment in the leased property and to earn a return on the investment. 4. The leased asset is so specialized that, without major modification, it would be of use only to the lessee. Note that the IFRS criteria do not cite any specific numbers, as the ASPE criteria do. They are intended to be principles based and require professional judgment.

Ex. 20-57 Lease criteria for classification by lessor under ASPE What are the criteria that must be satisfied for a lessor under ASPE to classify a lease as a direct financing or sales-type lease? Solution 20-57 In order for a lessor to classify a lease as a direct financing or a sales-type lease, the lease at the date of inception must satisfy one or more of the following Group I criteria (a, b, and c) and both of the following Group II criteria (a and b): Group I

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a. b. c.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

There is reasonable assurance that the lessee will obtain ownership of the property at the end of the lease term. The lease term is equal to 75% or more of the estimated economic life of the leased property. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property.

Group II a. Collectibility of the payments required from the lessee is reasonably assured. b. Any unreimbursable costs under the lease that are likely to be incurred by the lessor can be reasonably estimated.

*Ex. 20-58 Classification approach vs. contract-based approach Explain the difference between classification approach vs contract-based approach for capitalizing leases. Which does the IASB favour? Why? *Solution 20-58 The classification approach says that transactions should be classified and accounted for according to their economic substance. This would justify capitalizing leases that have similar characteristics to instalment purchases. On the other hand, the contract-based approach (also called a right-of-use approach) views the lease as conveying a contractual right to use the property (not the physical property itself). This approach would justify capitalizing the fair value of the rights and obligations of just about all leases, even those currently accounted for as operating leases. Exceptions would be leases that actually transfer control of the asset or almost all of the risks and benefits associated with ownership, such as leases where title will transfer at the end of the contract, or where there is a bargain purchase option. The IASB favours the contract-based approach, since it will capture almost all leases, including those that are currently “off balance-sheet” (operating leases) and make accounting for leases more transparent.

Ex. 20-59 Lessor accounting—sales-type lease Albert Corp., a private corporation that adheres to ASPE, is a manufacturer of truck trailers. On January 1, 2014, Albert leases ten trailers to Einstein Inc. under a six-year non-cancellable lease agreement. The following information about the lease and the trailers is provided: 1. Equal annual payments (due on December 31 each year) will be payable, to provide Albert with an 8% return on their investment . 2. Title to the trailers will pass to Einstein at the end of the lease. 3. At January 1, 2014, the fair value of each trailer is $50,000. The cost of each trailer to Albert Corp. is $45,000. Each trailer has an expected useful life of nine years. 4. Collectibility of the lease payments is reasonably assured, and any unreimbursable costs under the lease that are likely to be incurred by Albert can be reasonably estimated. Instructions a. What type of lease is this for the lessor? Discuss. b. Calculate the annual lease payment. Present value factor for 6 periods at 8% is 4.62288. Round to the nearest dollar.

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Leases

c. d.

Prepare a lease amortization schedule for Albert Corp. for the first three years. Prepare the journal entries for the lessor for 2014 and 2015 to record the lease agreement, the receipt of the lease rentals, and the recognition of income. Assume the use of a perpetual inventory system and round all amounts to the nearest dollar.

Solution 20-59 a. This is a sales-type lease to the lessor, Albert Corp. Albert's gross profit on this sale is $50,000, which is recognized in the year of sale (2014). It is not an operating lease because title to the assets passes to the lessee, the present value ($500,000) of the minimum lease payments equals or exceeds 90% ($450,000) of the fair value of the leased trailers, collectibility is reasonably assured, and any unreimbursable costs under the lease that are likely to be incurred can be reasonably estimated. b.

($50,000 × 10) ÷ 4.62288 = $108,158 or 6 N 8 i 500000 PV CPT PMT => $108,158

Date 1/1/14 12/31/14 12/31/15 12/31/16

Lease Amortization Schedule (ALBERT CORP.) Net Annual Interest on Investment Lease Rental Net Investment Recovery_ $108,158 108,158 108,158

$40,000 34,547 28,658

$68,158 73,611 79,500

d. Jan 1, 2014 Lease Receivable ($108,158 x 6) .................................................. Cost of Goods Sold ....................................................................... Sales Revenue ....................................................................... Inventory ................................................................................ Unearned Interest Income ...................................................... Dec 31, 2014 Cash ............................................................................................. Lease Receivable ................................................................... Unearned Interest Income ............................................................. Interest Income ...................................................................... Dec 31, 2015 Cash ............................................................................................. Lease Receivable ................................................................... Unearned Interest Income ............................................................. Interest Income ......................................................................

Net Investment $500,000 431,842 358,231 278,731

648,948 450,000 500,000 450,000 148,948

108,158 108,158 40,000 40,000

108,158 108,158 34,547 34,547

Ex. 20-60 Accounting for a capital lease by the lessee Explain the procedures used by the lessee to account for a capital or finance lease.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Solution 20-60 When the capital lease method is used, the lessee treats the lease transactions as if the asset were being purchased. The asset and obligation are recorded at the lower of (1) the present value of the minimum lease payments (excluding executory costs) or (2) the fair value of the asset at the inception of the lease. Under ASPE, the present value of the lease payments is calculated using the lessee's incremental borrowing rate, unless the implicit rate used by the lessor is lower and the lessee has knowledge of it. Under IFRS, the present value is calculated using the interest rate implicit in the lease whenever this is reasonably determinable, otherwise by using the lessee’s incremental borrowing rate. The effective interest method is used to allocate each lease payment between interest expense and a reduction of the lease obligation. If the lease transfers ownership or contains a bargain purchase option, the asset is depreciated in a manner consistent with the lessee's normal depreciation policy over the economic life of the asset and allowing for residual value. If the lease does not transfer ownership, the leased asset is depreciated over the lease term.

Ex. 20-61 Capital lease amortization and journal entries Erica Corp. leases machinery on January 1, 2014, and records this as a finance lease. Seven annual lease payments of $140,000 are required the end of each year, starting December 31, 2014. The present value of the lease payments at 10% is $681,600. Erica uses the effective interest method of amortization for the lease. For all machinery, the company uses straight-line depreciation over eight years, with no residual value. Instructions (Round values to the nearest dollar.) a. Prepare a lease amortization table for 2014 and 2015. b. Prepare the general journal entries relating to this lease for 2014. Solution 20-61 a. Date__ Jan 1/14 Dec 31/14 Dec 31/15

Payments

10% Interest_

Reduction Obligation

$140,000 140,000

$68,160 60,976

$71,840 79,024

Lease Obligation $681,600 609,760 530,736

b. Jan 1, 2014 Equipment under Lease ................................................................ Obligations under Lease......................................................... Dec 31, 2014 Interest Expense ........................................................................... Obligations under Lease ...............................................................

681,600 681,600

68,160 71,840

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Leases

Cash....................................................................................... Depreciation Expense ($681,600/8) .............................................. Accumulated Depreciation--Machinery ..................................

140,000 85,200 85,200

Ex. 20-62 Operating lease calculations On January 1, 2014, Lewis Corp. purchased a building for $900,000, with the intention of leasing it. The building is expected to have a 20 year life, no residual value, and will be depreciated on a straight-line basis. On April 1, 2014, under a cancellable lease, Lewis leased the building to Clark Company for $300,000 a year ($25,000 a month) for a four-year period ending March 31, 2018. Clark paid $300,000 to Lewis on April 1, 2014. During calendar 2014, Lewis incurred $30,000 in maintenance and other executory costs under the provisions of the lease. This lease is properly classified as an operating lease by both parties. Instructions a. How much income before income taxes will Lewis report from this lease for calendar 2014? b. How much rent expense will Clark report in connection with this lease for calendar 2014? Solution 20-62 a. Revenue Apr 1-Dec 31, 2014 ($25,000 × 9) .................................. Expenses: Depreciation ($900,000 ÷ 20) × 9 ÷ 12) .................................. Maintenance, etc.. .................................................................. Income before taxes...................................................................... b.

Rent expense, Apr 1-Dec 31, 2014 ($25,000 × 9) .........................

$225,000 $33,750 30,000

63,750 $161,250 $225,000

Ex. 20-63 Accounting for a direct financing lease by the lessor Explain the procedures used to account for a direct financing lease (ASPE) or finance lease (IFRS) by the lessor. Solution 20-63 The lessor records the gross amounts of the minimum lease payments (excluding executory costs) and the unguaranteed residual value (a guaranteed residual value is included in the minimum lease payments) as Lease Receivable and removes the asset from the books. The difference between the gross investment in lease (Lease Receivable) and the asset's cost (or carrying amount), also called the net investment in lease, is recorded as Unearned Interest Income. This is a contra-account to Lease Receivable. The lessor records payments received as a reduction in the receivable. Unearned income is recognized periodically as interest income, using the effective interest method and the implicit interest rate used to calculate the lease payments.

*Ex. 20-64 Lessee and lessor accounting (sale-leaseback) On January 1, 2014, Baritone Inc. sells machinery to Contralto Corp. at its fair value of $1,200,000 and immediately leases it back. The machinery’s original cost was $2,000,000, and its book value at January 1, 2014 was $1,050,000. The lease is for 10 years and the implicit interest rate is 10%.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

The lease payments of $177,500 start on January 1, 2014. Baritone uses straight-line depreciation and assumes there will be no residual value at the end of the 10 years. Assume this lease will be accounted for as a capital (finance) lease by both parties. Instructions a. Prepare all of Baritone's 2014 entries to reflect the above sale and lease transactions. b. Prepare all of Contralto's 2014 entries to reflect the above sale and lease transactions. *Solution 20-64 a.

BARITONE INC. (Lessee)

Jan 1, 2014 Cash ............................................................................................. 1,200,000 Accumulated Depreciation, Machinery .......................................... 950,000 Machinery............................................................................... 2,000,000 Deferred Profit on Sale-Leaseback ......................................... 150,000 Machinery under Lease ................................................................. 1,200,000 Obligations under Lease......................................................... 1,200,000 Obligations under Lease ............................................................... Cash....................................................................................... Dec 31, 2014 Depreciation Expense ................................................................... Accumulated Depreciation—Leased Machinery .....................

177,500 177,500

120,000 120,000

Deferred Profit on Sale-Leaseback................................................ Depreciation Expense—Leased Machinery ............................

15,000

Interest Expense [$10% × ($1,200,000 – $177,500)]..................... Interest Payable .....................................................................

102,250

15,000

102,250

CONTRALTO CORP. (Lessor)

Jan 1, 2014 Machinery Acquired for Lessee ..................................................... 1,200,000 Cash....................................................................................... 1,200,000 Lease Receivable ($177,500 x 10) ................................................ 1,775,000 Machinery Acquired for Lessee .............................................. 1,200,000 Unearned Interest Income ...................................................... 575,000 Cash ............................................................................................. Lease Receivable ................................................................... Dec 31, 2014 Unearned Interest Income ............................................................. Interest Income ......................................................................

177,500 177,500

102,250 102,250

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Leases

*Ex. 20-65 Lessee and lessor accounting (sale-leaseback) On January 1, 2014, Kirk Corp. sells land to Spock Inc. for $2,000,000, and immediately leases the land back. Both companies follow ASPE. The following information relates to this transaction: 1. The term of the non-cancellable lease is 20 years and the title transfers to Kirk at the end of the lease term. 2. The land has a cost basis of $1,600,000 to Kirk. 3. The lease agreement calls for equal rental payments of $203,704 at the end of each year. 4. The land has a fair value of $2,000,000 on January 1, 2014. 5. The incremental borrowing rate of Kirk Corp. is 10%. Kirk is aware that Spock set the annual rentals to ensure a rate of return of 8%. 6. Kirk pays all executory costs, which total $170,000 in 2014. 7. Collectibility of the rentals is reasonably assured, and any unreimbursable costs under the lease that are likely to be incurred can be reasonably estimated by the lessor. Instructions a. Prepare all the 2014 journal entries on the books of Kirk Corp. to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.) b. Prepare all the 2014 journal entries on the books of Spock Inc. to reflect the above purchase and lease transactions. *Solution 20-65 a. KIRK CORP. (Lessee) Jan 1, 2014 Cash ............................................................................................. 2,000,000 Land ....................................................................................... 1,600,000 Deferred Profit on Sale-Leaseback ......................................... 400,000 Land under Lease ......................................................................... 2,000,000 Obligations under Lease......................................................... 2,000,000 Throughout 2014 Executory Costs (Insurance and Taxes) ........................................ Accounts Payable or Cash .....................................................

170,000 170,000

Dec 31, 2014 Deferred Profit on Sale-Leaseback ($400,000 ÷ 20) ..................... 20,000 Gain from Sale-Leaseback* .................................................... * a revenue account is used since there is no Depreciation Expense here Interest Expense ........................................................................... Obligations under Lease ............................................................... Cash.......................................................................................

Date

Partial Lease Amortization Schedule Annual Interest Reduction of Lease Payment 8% Lease Obligation

20,000

160,000 43,704 203,704

Balance_

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Jan 1, 2014 Dec 31, 2014

$203,704

$160,000

$43,704

$2,000,000 1,956,296

b. SPOCK INC. (Lessor) Jan 1, 2014 Land………………………………………………………….. .............. 2,000,000 Cash………………………………………………….. .................. 2,000,000 Lease Receivable ($203,704 × 20)………………........................... 4,074,080 Unearned Interest Income…………………………. .................. 2,074,080 Land………………………………………………… .................... 2,000,000 Dec 31, 2014 Cash ............................................................................................. Lease Receivable ................................................................... Unearned Interest Income ............................................................. Interest Income ......................................................................

203,704 203,704 160,000 160,000

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Leases

PROBLEMS Pr. 20-66 Lessee accounting—capital lease Long Ltd., a private corporation adhering to ASPE, enters into a non-cancellable lease agreement on July 1, 2014, to lease equipment from Fong Ltd. The following data are relevant to the lease agreement: 1. The term of the lease is 4 years, with no renewal option. Payments of $126,807 are due on June 30 of each year, with the first payment due June 30, 2015. 2. The fair value of the equipment on July 1, 2014 is $420,000. The equipment has an economic life of 6 years with no residual value. 3. Long depreciates similar equipment it owns on the double declining-balance basis. 4. Long's incremental borrowing rate is 10%. The lessee is aware that the lessor used an implicit rate of 8% in calculating the lease payments. 5. Present value factor for 4 periods at 8% is 3.31213; at 10%, 3.16986. Instructions a. What type of lease this is for Long? What is your rationale? b. Prepare the journal entries on Long's books that relate to the lease agreement for the following dates. Round all amounts to the nearest dollar. Include a partial amortization schedule. i. July 1, 2014 ii. December 31, 2014 iii. June 30, 2015 iv. December 31, 2015 Solution 20-66 a. Present value of minimum lease payments: $126,807 × PV of an ordinary annuity for 4 periods at 8% (use the lessor’s implicit rate, since it is known) $126,807 × 3.31213 = $420,000 Because the present value of the lease payments ($420,000) equals the fair value of the leased property, it is a capital lease. b. July 1, 2014 Equipment under Lease ................................................................ Obligations under Lease......................................................... Dec 31, 2014 Depreciation Expense [($420,000 × 2 ÷ 4) × 6 ÷ 12] ...................... Accumulated Depreciation—Leased Equipment .....................

420,000 420,000

105,000

Interest Expense ($33,600 × 6 ÷ 12).............................................. Interest Payable .....................................................................

Date__

Annual Lease Payment

Lease Amortization Schedule Interest on Reduction of Unpaid Obligation Lease Obligation

105,000 16,800 16,800

Balance of Lease Obligation

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Jul 1/14 Jun 30/15 Jun 30/16

$126,807 126,807

$33,600 26,143

$420,000 326,793 226,129

$ 93,207 100,664

Jun 30, 2015 Interest Expense ........................................................................... 33,600 Obligations under Capital Leases .................................................. 93,207 Cash....................................................................................... (Interest payable entry assumed to have been reversed Jan 1/13) Dec 31, 2015 Depreciation Expense ................................................................... 157,500 Accumulated Depreciation—Leased Equipment .................... {($420,000 × 2 ÷ 4) + [($420,000 – $210,000) × 2 ÷ 4] × 6 ÷ 12} Interest Expense ($26,143 × 6 ÷ 12) ............................................. Interest Payable.....................................................................

126,807

157,500

13,072 13,072

Pr. 20-67 Lessee accounting—capital lease On January 1, 2014, Fargo Corp. enters into a ten-year non-cancellable lease with Wells Ltd. for equipment having an estimated useful life of 11 years and a fair value of $6,000,000. Fargo's incremental borrowing rate is 8%, but they do not know Wells’ implicit rate. Fargo uses the straight-line method to depreciate assets. The lease contains the following provisions: 1. Semi-annual lease payments of $438,000 (including $38,000 for property taxes), payable on January 1 and July 1 of each year. 2. A guarantee by Fargo Corp. that Wells Ltd. will realize $200,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $120,000. Both companies adhere to ASPE. Instructions a. Calculate the undiscounted minimum lease payments over the life of the lease. b. Calculate the present value of the minimum lease payments. PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for $1 due in 20 interest periods at 8% annual rate, .45639. Round to nearest dollar. c. What kind of lease is this to Fargo Corp.? Why? d. Present the journal entries that Fargo would record during the first year of the lease. Include an amortization schedule through January 1, 2015 and round values to the nearest dollar. Solution 20-67 a. The undiscounted minimum lease payments are: Semi-annual rental payments ................................................................... $ 438,000 Less executory costs ................................................................................ (38,000) ....................................................................................................... 400,000 Number of payments over lease term ....................................................... 20 ....................................................................................................... 8,000,000 Residual guarantee .................................................................................. 200,000 Minimum lease payments................................................................................ $8,200,000 b.

The present value of the minimum lease payments is:

Leases

20- 39

Factor for present value of an annuity due, 20 periods, 4% ........... 14.13394 Semi-annual payments, less executory costs ................................ $ 400,000 (OR 20 N 4 i 400000 PMT CPT PV => 5,653,576) ...................... $5,653,576 Factor for present value of $1 due in 20 semi-annual interest periods at 4% ............................................................................. . 0.45639 Guaranteed residual ..................................................................... $200,000 91,278 (OR 20 N 4 i 200000 FV CPT PV => 91,277) Present value of lease payments .................................................. $5,744,854 c.

This lease is a capital lease to Fargo Corp. because its 10 year term exceeds 75% of the equipment's estimated useful life. In addition, the present value of the minimum lease payments exceeds 90% of the current fair value of the equipment ($6,000,000).

Date Initial PV Jan 1/14 Jul 1/14 Jan 1/15

Semi-Annual Lease Payment $400,000 400,000 400,000

Lease Amortization Schedule Interest Reduction of 4%__ Lease Obligation — $213,794 206,346

$400,000 186,206 193,654

Balance $5,744,854 5,344,854 5,158,648 4,964,994

Jan 1, 2014 Equipment under Lease ................................................................ 5,744,854 Obligations under Lease......................................................... 5,744,854 AND Obligations under Lease ............................................................... 400,000 Property Taxes .............................................................................. 38,000 Cash....................................................................................... 438,000 (These two entries can be combined) Jul 1, 2014 Obligations under Lease… ............................................................ Property Taxes .............................................................................. Interest Expense ........................................................................... Cash.......................................................................................

186,206 38,000 213,794

Dec 31, 2014 Depreciation Expense ................................................................... Accumulated Depreciation—Leased Equipment .....................

511,350*

438,000

511,350 206,346 206,346

Pr. 20-68 Lessor accounting—lease with IFRS criteria On January 1, 2014, Regal Air Inc. enters into an eight year, non-cancellable lease agreement to lease an airplane to Atlantic Airlines, with payments required at the end of each year. The following information relates to this agreement:

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1. 2. 3. 4.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

Atlantic Airlines has the option to purchase the airplane for $7,000,000 at the end of the lease, at which time the airplane’s fair value is expected to be $12,000,000. The airplane cost Regal Air $30,000,000. It has an estimated useful life of fifteen years, and a residual value of zero at the end of that time (due to technological obsolescence). Atlantic will pay all executory costs related to the leased airplane. Annual year-end lease payments of $4,562,337 will allow Regal Air to earn an 8% return on its investment.

Instructions a. What type of lease is this for the lessor? Justify your answer. Assume Regal Air adheres to IFRS. b. Prepare a lease amortization schedule for Regal Air for the first two years (2014 and 2015). Round all amounts to the nearest dollar. c. Prepare the journal entries on Regal Air’s books to record the lease agreement, to reflect payments received under the lease, and to recognize income, for the years 2014 and 2015. Solution 20-68 a. Under IFRS, the presence of any one or a combination of the following situations will normally support classification as a finance lease: 1. There is reasonable assurance that the lessee will obtain ownership of the leased asset by the end of the lease term. 2. The lease term is long enough that the lessee will receive substantially all of the economic benefits expected to be derived from using the leased property over its economic life. 3. The lease allows the lessor to recover substantially all of its investment in the leased property and to earn a return on the investment. 4. The leased asset is so specialized that, without major modification, it would be of use only to the lessee. Both #1 and #3 apply here, and since only one criterion has to be satisfied, this is a finance lease, and would be classified as an “other financing lease” for Regal Air (called a “direct financing lease” under ASPE). #1. The option to buy the airplane for $7,000,000 at the termination of the lease when the asset is expected to have a fair value of $12,000,000 constitutes a bargain purchase option. Since the bargain purchase option exists, it is assumed Atlantic will exercise the option and acquire the airplane. #3. Since the undiscounted total of the eight lease payments plus the bargain purchase option is $43,498,696 and the present value of the eight payments plus the BPO is approx $30,000,000 (8 N 8 i 4562337 PMT 7000000 FV CPT PV = > $29,999,986) this criterion is satisfied. #2 and #4 do not apply. Note that the IFRS criteria do not cite any specific numbers, as the ASPE criteria do. They are intended to be principles based and require professional judgment. b. Date__ Jan 1/14 Dec 31/14 Dec 31/15

Regal Air's Lease Amortization Schedule Annual Interest on Net Investment Lease Rental Net Investment Recovery $4,562,337 4,562,337

$2,400,000 2,227,013

$2,162,337 2,335,324

Net Investment $30,000,000 27,837,663 25,502,339

Leases

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c. Jan 1, 2014 Lease Receivable ($4,562,337 × 8) + $7,000,000 ......................... 43,498,696 Airplane .................................................................................. 30,000,000 Unearned Interest Income ...................................................... 13,498,696 Dec 31, 2014 Cash ............................................................................................. 4,562,337 Lease Receivable ................................................................... 4,562,337 Unearned Interest Income ............................................................. 2,400,000 Interest Income ...................................................................... 2,400,000 Dec 31, 2015 Cash ............................................................................................. 4,562,337 Lease Receivable ................................................................... 4,562,337 Unearned Interest Income ............................................................. 2,227,013 Interest Income ...................................................................... 2,227,013

*Pr. 20-69 Sale and Leaseback Simian Valley Corp. owns both the land and building that it uses for a banana plantation. The original cost of the building was $412,500 and had a book value of $225,000 at January 1, 2014. On this date the building was sold to Bonobo Leasing Inc. for $250,000 and simultaneously leased back to Simian Valley. The lease had a guaranteed 10-year term and required annual payments of $47,250 on December 31 each year. The lease allows the property to revert to the lessee at the end of the lease. Simian Valley’s incremental borrowing rate is 12%, but they do not know Bonobo’s implicit rate. Bonobo will pay property taxes on the building of $6,000 per year; however, this cost is included in the lease payment. Simian Valley will pay maintenance and other operating costs. The building will be depreciated straight line over its remaining 10-year life. The lease qualifies as a capital (finance) lease since the lease term is equal to the economic life of the building. Instructions a. Prepare entries on Simian Valley’s books to record the sale and leaseback of the building. b. Prepare year-end adjusting entries for Simian Valley for 2014. *Solution 20-69 a. Cash ............................................................................................. Accumulated Depreciation, Building .............................................. Building .................................................................................. Deferred Profit on Sale-leaseback .......................................... *($412,500 – $225,000) Building under Lease .................................................................... Obligations under Lease ........................................................

250,000 187,500* 412,500 25,000

250,000 250,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b. Interest Expense ($250,000 x 12%) .............................................. Interest payable ......................................................................

30,000

Obligations under Lease ............................................................... Property tax expense .................................................................... Cash.......................................................................................

41,250 6,000

Depreciation Expense ($250,000 ÷ 10) ......................................... Accumulated Amortization—Leased Building .........................

25,000

Deferred Profit on Sale-Leaseback ($25,000 ÷ 10)........................ Depreciation Expense ............................................................

2,500

30,000

47,250

25,000

2,500

Leases

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CHAPTER 21 ACCOUNTING CHANGES AND ERROR ANALYSIS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

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

1 1 1 1 1 1

E M M M M M

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

24. 25. 26. 27.

4 5 5 6

H M M M

28. 29. 30. 31.

39. 40.

4 4

M M

41. 42.

47. 48. 49.

Overview

1 1

M M M

50. 51. 52.

58.

59.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 1,3 M 13. 4 M 2 M 14. 4 M 3 M 15. 4 M 3 M 16. 4 M 3 E 17. 5 E 3 E 18. 6 M Multiple Choice–Computational 6 M *32. 9 H 6 M *33. 9 H 6 M *34. 9 H 6 M *35. 9 H Multiple Choice–CPA Adapted 4,6 M 43. 6 H 6 H *44. 9 H Exercises 1 M 53. 4–6 M 1,4–6 H 54. 5 H 4,5 M 55. 5 M Problems 5 H *60. 9 H

M = Medium

Item

LOD

19. 20. *21. *22. *23.

6 6 9 9 9

H M M M H

*36. *37. *38.

9 9 9

H H H

*45. *46.

9 9

H M

56. *57.

7 9

H M

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Type

3. 4.

MC MC

47.

1. 2.

MC MC

13. 14.

MC MC

15. 16.

MC MC

17. 25.

MC MC

26. 51.

MC Ex

18. 19. 20.

MC MC MC

27. 28. 29.

MC MC MC

56.

*21. *22. *23. Note:

Item

MC MC MC

*32. *33. *34.

MC MC MC

MC = Multiple Choice

Item

Type Item Overview

Type

Item

Type

Item

Type

Learning Objective 1 5. MC 7. MC 6. MC 48. Ex Learning Objective 2

49. 50.

Ex Ex

51.

12.

51. 52.

Ex Ex

53.

58. 59.

Pr Pr

53.

*46. *57. *60.

MC Ex Pr

Learning Objective 3 10. MC 11. MC Learning Objective 4 24. MC 40. MC 39. MC 41. MC Learning Objective 5 52. Ex 54. Ex 53. Ex 55. Ex Learning Objective 6 30. MC 42. MC 31. MC 43. MC 41. MC 51. Ex Learning Objective 7 Learning Objective 9 *35. MC *38. MC *36. MC *44. MC *37. MC *45. MC Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Accounting Changes and Error Analysis

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CHAPTER STUDY OBJECTIVES 1. Identify and differentiate among the types of accounting changes. There are three types of accounting changes. (1) Change in accounting policy: a change in the specific principles, bases, rules, or practices that an entity applies in the preparation of its financial statements. (2) Change in an accounting estimate: a change in the carrying amount of an asset or liability or the amount of an asset’s periodic consumption from reassessing the current status of the asset or liability or the expected future benefits or obligations associated with it. (3) Correction of a prior period error: a change caused by an omission from or misstatement in prior years’ financial statements from the misuse of or failure to use reliable information that existed at the time the statements were completed and that could have been used in their preparation and presentation.

2. Identify and explain alternative methods of accounting for accounting changes. Accounting changes could be accounted for retrospectively, currently, or prospectively. The retrospective method requires restatement of prior periods as if the accounting change had been used from the beginning, or the error had never been made. The current method calculates a catch-up adjustment related to the effect on all prior years, and reports it in the current period. Prospective treatment requires making no adjustment for past effects, but instead, beginning to use the new method in the current and future periods.

3. Identify the accounting standards for each type of accounting change under ASPE and IFRS. A change in accounting policy due to the initial application of a new primary source of GAAP is accounted for according to the transitional provisions of that standard. If none is provided, or if it is a voluntary change, retrospective application is used. A change in an accounting estimate is accounted for prospectively. Errors are corrected through full retrospective restatement.

4. Apply the retrospective application method of accounting for a change in accounting policy and identify the disclosure requirements. Comparative periods are presented as if the new accounting policy had always been applied. The opening balance of each affected component of equity is adjusted for the earliest prior period presented, and all other affected comparative amounts for each prior period provided are restated. When the effects on particular prior periods are impracticable to determine, the cumulative effect of the change is shown as an adjustment to the beginning retained earnings of the earliest prior period possible. Required disclosures therefore include identifying the nature of the change, the effect on each financial statement item affected, the amounts relating to periods prior to those that are presented, and why full retrospective application was not applied, if applicable. If the change resulted from applying transitional provisions, information about the standards and the provisions is provided, including, if under IFRS, the effects on future periods. If it is a voluntary change, excluding specific ASPE accounting changes, the reasons why the new policy results in more relevant information are disclosed. Information about the future effect of changes in primary sources of GAAP that are issued but not yet effective is also required under IFRS.

5. Apply retrospective restatement for the correction of an accounting error and identify the disclosure requirements. Comparative amounts for prior periods affected are restated, unless under IFRS it is not practicable to identify the effect on specific past periods. If the error is Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

in a period before the earliest comparative statements included, the opening balances of the earliest comparative period are restated. An opening SFP is required under IFRS for the earliest comparative period presented as is information about the nature of any impracticality. The nature of the error and the amount of the adjustment to each comparative financial statement line item and to EPS are all required disclosures.

6. Apply the prospective application method for an accounting change and identify the disclosure requirements for a change in an accounting estimate. Under prospective treatment, only the current and future fiscal periods are affected. There is no adjustment of current-year opening balances and no attempt is made to “catch up” for prior periods. The nature and amount of a change in an accounting estimate that affects the current period or, under IFRS, is expected to affect future periods, is required to be disclosed.

7. Identify economic motives for changing accounting methods and interpret financial statements where there have been retrospective changes to previously reported results. Some of the aspects that affect decisions about the choice of accounting methods are (1) political costs, (2) the capital structure, (3) bonus payments, and (4) the desire to smooth earnings. Financial statement users should analyze the information presented about accounting changes and adjust any trend information affected.

8. Identify the differences between ASPE and IFRS related to accounting changes. The accounting standards under ASPE are very similar to those under IFRS. Minor differences exist, such as IAS 8’s permitting partial retrospective treatment for the correction of an accounting error, ASPE allowing specific voluntary changes without justification on a “reliable and more relevant” basis, and IFRS requiring additional disclosures.

9. Correct the effects of errors and prepare restated financial statements. Three types of errors can occur: (1) errors that affect only the SFP, (2) errors that affect only the income statement, and (3) errors that affect both the SFP and the income statement. This last type of error is classified either as (a) a counterbalancing error, where the effects are offset or corrected over two periods; or (b) a non-counterbalancing error, where the effects take longer than two periods to correct themselves.

Accounting Changes and Error Analysis

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MULTIPLE CHOICE—Conceptual Answer b d c c a c c b a a a b d b c b c d b b b c d

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. *21. *22. *23.

Description Identify accounting changes. Voluntary change in accounting policy Identify changes in accounting policy. Identify accounting errors. Identify changes in accounting policy. Identify a correction of an error. Identify correct statement. Accounting policy changes and errors Alternative accounting methods allowed for accounting changes Retrospective application Change accounted for prospectively Change in accounting estimate Accounting for retrospective change Underlying principle of retrospective application Change in inventory costing method Adjustments required when transitioning to IFRS Disclosures required under IFRS Change in depreciation method Identify a change in accounting estimate. Change in asset service life Counterbalancing errors Impact of failure to record purchase and count in ending inventory Impact of incorrectly recording depreciation

MULTIPLE CHOICE—Computational Answer b c a c d c a d d c c a a b c

No. 24. 25. 26. 27. 28. 29. 30. 31. *32. *33. *34. *35. *36. *37. *38.

Description Calculate net income with change in inventory costing method. Calculate effect on retained earnings of error in recording asset. Calculate cumulative effect of error on income statement. Calculate revised depreciation expense. Calculate revised depreciation expense. Calculate net income with change in depreciation method. Calculate effect on net income with change in an accounting estimate. Calculate depreciation expense after a change in estimated life. Effect of errors on net income Effect of errors on working capital Effect of errors on retained earnings Effect of errors on net income and retained earnings Effect of errors on net income Effect of errors on retained earnings Effect of errors on working capital

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Answer c a b c b c a b

No. 39. 40. 41. 42. 43. *44. *45. *46.

Description Cumulative effect of inventory costing change Cumulative effect of inventory costing change Use of retrospective treatment Balance of accumulated depreciation after a change in estimate Calculate carrying value of a patent with a change in estimate Impact of failure to accrue insurance costs Retained earnings balance with multiple errors Depreciation expense to be recorded following an error

Item E21-47 E21-48 E21-49 E21-50 E21-51 E21-52 E21-53 E21-54 E21-55 E21-56 *E21-57

Description Overall objectives of accounting and disclosure standards for accounting changes Conditions for a change in accounting policy under IFRS and ASPE Matching accounting changes to situations Matching disclosures to situations Change in estimate, voluntary change in accounting policy, correction of errors Retrospective application for accounting changes Recognition of accounting changes or corrections Effects of errors on financial statements Effects of errors on net income Economic reasons for changing accounting policies Non-counterbalancing error correction

EXERCISES

PROBLEMS Item P21-58 P21-59 *P21-60

Description Corrections of errors in prior years. Accounting for accounting changes and error corrections. Error corrections and adjustments.

*This topic is dealt with in an Appendix to the chapter.

Accounting Changes and Error Analysis

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MULTIPLE CHOICE—Conceptual 1. Which of the following is NOT considered to be an accounting change? a. change in accounting estimate b. change in the composition of the board of directors c. change in accounting policy d. correction of a prior period error

2. One condition required by IFRS is that a voluntary change in accounting policy must result in information that is a. more reliable than before. b. more reliable, but equally as relevant as before. c. both more reliable and more relevant. d. more relevant, but equally as reliable as before.

3. Which of the following is NOT considered to be a change in accounting policy? a. changing from weighted average to FIFO for valuing inventories b. initial adoption of a new accounting standard c. reclassifying items on the financial statements of prior periods to make the statements more comparable d. changing from the cost basis to the fair value model for measuring investments

4. Which of the following is NOT considered to be an accounting error? a. changing from the cash basis to the accrual basis b. expensing the cost of a new machine c. changing depreciation methods from declining-balance to straight line d. failing to accrue wages payable at year end

5. Which of the following is NOT considered a change in accounting policy? a. change in depreciation method b. change from FIFO to weighted average cost c. initial adoption of a new accounting standard d. change in accounting for a defined benefit pension plan from deferral and amortization to immediate recognition

6. An example of a correction of an error in previously issued financial statements is a change a. from the FIFO method of inventory valuation to the average cost method. b. in the service life of plant assets, based on changes in the economic environment. c. from the cash basis of accounting to the accrual basis of accounting. d. in the tax assessment related to a prior period.

7. Which of the following statements is correct? a. Changes in accounting policy are always handled in the current or prospective period. b. Prior year statements should always be restated for changes in accounting estimates. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. A change from the deferral and amortization method to the immediate recognition method of accounting for defined benefit pension plans should be treated as a change in accounting policy. d. Correction of prior period error should be presented as an adjustment on the current income statement.

8. For accounting changes, which of the following is NOT allowed? a. To use retrospective application for an accounting policy change without restatement, if restatement is impractical. b. To net accounting errors for disclosure purposes. c. To use prospective application for an accounting policy change, if allowed in the transition policy. d. To use prospective application for a change in estimate.

9. Which of the following alternative accounting methods is(are) allowed by ASPE and IFRS for reporting accounting changes? a. prospective and retrospective b. current and retrospective c. current and prospective d. retrospective only

10. Retrospective application is required for all a. errors and non-mandated policy changes. b. changes in estimates and non-mandated policy changes. c. errors and changes in estimates. d. changes in estimates.

11. Which type of accounting change may be accounted for in current and future periods only? a. change in accounting estimate b. change in inventory costing method c. change in accounting policy d. correction of an error

12. Which of the following is (are) the proper time period(s) to record the effects of a change in accounting estimate? a. retrospectively only b. current period and prospectively c. current period and retrospectively d. current period only

13. Accounting for a retrospective change requires a. reissuing all prior financial statements affected by the change. b. adjusting the ending balance of retained earnings for the current year. c. reporting the “catch-up” adjustment on the current income statement. d. adjusting the opening balance of each affected component of equity for the current year.

Accounting Changes and Error Analysis

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14. The underlying principle of the retrospective application method is to a. apply changes currently and in the future. b. present all comparative periods as if the new accounting policy had always been used. c. make assumptions about what management’s intent was in prior years. d. disclose all mistakes made in the past.

15. Stockton Ltd. changed its inventory system from FIFO to average cost. What type of accounting change does this represent? a. A change in accounting estimate for which the financial statements for the prior periods included for comparative purposes do not need to be restated. b. A change in accounting policy for which the financial statements for prior periods included for comparative purposes do not need to be restated. c. A change in accounting policy for which the financial statements for prior periods included for comparative purposes should be restated. d. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be restated.

16. When an entity is first transitioning to IFRS, any adjustments required to bring GAAP measures in line with IFRS a. are recognized directing in other comprehensive income. b. are recognized directly in retained earnings. c. must be accounted for by prospective application. d. are ignored.

17. Under IFRS, which of the following disclosures is NOT required for the correction of an accounting error? a. the amount of the correction made to each affected financial statement item for each prior period presented b. the nature of the error c. who was responsible for the error d. the effect of the correction on both basic and diluted earnings per share for each prior period presented

18. A publicly accountable enterprise changes from straight-line depreciation to double declining balance. Management feels that this will result in equally reliable and more relevant information; thus it will be treated as a change in accounting policy. The entry to record this change should include a a. debit to Accumulated Depreciation. b. credit to Other Comprehensive Income. c. credit to Deferred Tax Asset. d. debit to Deferred Tax Liability.

19. When a company decides to switch from deferring development costs to expensing them immediately, this change should probably be treated as a a. change in accounting policy. b. change in accounting estimate. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. prior period adjustment. d. correction of an error.

20. The service life of a building that has been depreciated for 30 years of an originally estimated 50-year life (no residual value) has been revised to an estimated remaining life of 10 years. Based on this information, the accountant should a. continue to depreciate the building over the original 50-year life. b. depreciate the remaining book value over the remaining life of the asset. c. adjust accumulated depreciation to its appropriate balance through net income, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years. d. adjust accumulated depreciation to its appropriate balance through retained earnings, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years.

*21. Counterbalancing errors do NOT include a. errors that correct themselves in two years. b. errors that correct themselves in three or more years. c. an understatement of ending inventory. d. an overstatement of unearned revenue.

*22. A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. This merchandise was also omitted from the year-end physical count. How will these errors affect assets, liabilities, and shareholders' equity at year end and net income for the year? Assets Liabilities Shareholders' Equity Net Income a. No effect Understate Overstate Overstate. b. No effect Overstate Understate Understate. c. Understate Understate No effect No effect. d. Understate No effect Understate Understate.

*23. MissTake Corp. is a small private corporation that does not prepare comparative statements. At the end of their 2014 fiscal year, it was discovered that the 2013 depreciation expense on their computer equipment had been incorrectly debited to maintenance expense. How should MissTake deal with this situation? a. Prepare an adjusting entry to debit depreciation expense and credit maintenance expense. b. Prepare an adjusting entry to debit retained earnings and credit maintenance expense. c. Restate their 2013 financial statements. d. Ignore it.

Accounting Changes and Error Analysis

21- 11

MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4.

b d c c

5. 6. 7. 8.

a c c b

9. 10. 11. 12.

a a a b

13. 14. 15. 16.

d b c b

17. 18. 19. 20.

c d b b

*21. *22. *23.

b c d

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 24. Caspar Corp. began operations on January 1, 2013, and uses FIFO to cost its inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on pre-tax income. Accordingly, the following information has been developed: Ending Inventory 2013 2014 FIFO $240,000 $270,000 Average cost 200,000 250,000 Pre-tax Income (calculated using FIFO) 375,000 450,000 Based upon the above information, a change to the average cost method in 2014 would result in pre-tax income for 2014 of a. $395,000. b. $430,000. c. $470,000. d. $490,000.

Use the following information for questions 25–26. On January 2, 2012, Beaver Corp. purchased machinery for $135,000. The entire cost was incorrectly recorded as an expense. The machinery has a nine-year life and a $9,000 residual value. Beaver uses straight line depreciation for all its plant assets. The error was not discovered until May 1, 2014, and the appropriate corrections were made. Ignore income tax considerations.

25. Before the corrections were made, retained earnings was understated by a. $135,000. b. $121,000. c. $107,000. d. $ 93,000.

26. Beaver's income statement for the year ended December 31, 2014 should show the cumulative effect of this error of a. $ 0. b. $93,000. c. $107,000. d. $121,000.

27. On January 1, 2011, Detroit Ltd. bought machinery for $500,000. They used straight-line depreciation for this machinery, over an estimated useful life of ten years, with no residual value. At the beginning of 2014, Detroit decided the estimated useful life of this machinery was only eight years (from the date of acquisition), still with no residual value. For calendar 2014, the depreciation expense for this machinery is a. $50,000. b. $62,500. c. $70,000. d. $100,000. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Accounting Changes and Error Analysis

21- 13

28. On January 1, 2012, Missoula Corporation bought machinery for $800,000. They used double declining balance depreciation for this asset, with an estimated life of eight years, and an estimated $200,000 residual value. At the beginning of 2015, Missoula decided to change to the straight-line method of depreciation for this equipment, and treated the change as a change in estimate. For calendar 2015, the depreciation expense for this machinery is a. $100,000. b. $ 92,500. c. $ 75,050. d. $ 27,500.

29. On January 1, 2012, Reno Inc. purchased a machine for $150,000. The machine has an estimated five year life, and no residual value. Double declining balance depreciation has been used for financial statement reporting and CCA for income tax reporting. Effective January 1, 2015, Reno decided to change to straight-line depreciation for this machine, and treated the change as a change in accounting policy. For calendar 2015, Reno’s pre-tax income before depreciation on this asset is $125,000. Their income tax rate has been 30% for many years. What net income should Reno report for calendar 2015? a. $95,000 b. $85,820 c. $66,500 d. $45,500

Use the following information for questions 30–31. Minor Corp. purchased a machine on January 1, 2011, for $600,000. The machine is being depreciated on a straight-line basis, using an estimated useful life of six years and no residual value. On January 1, 2014, Minor determined, as a result of additional information, that the machine had an estimated useful life of eight years from the date of acquisition with no residual value. An accounting change was made in 2014 to reflect this additional information.

30. Assuming that the direct effects of this change are limited to the effect on depreciation and the related tax provision, and that the income tax rate for all years since the machine was purchased was 30%, what should be reported in the income statement for calendar 2014 as the cumulative effect on prior years of changing the estimated useful life of the machine? a. $0 b. $40,000 c. $60,000 d. $210,000

31. What is the amount of depreciation expense on this machine that should be reported in Minor's income statement for calendar 2014? a. $150,000 b. $120,000 c. $75,000 d. $60,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Use the following information for questions *32–*34. Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors: Dec. 31, 2013 Dec. 31, 2014 Ending inventory $1,500 understated $2,200 overstated Depreciation expense $400 understated An insurance premium of $3,600 was prepaid in 2013 covering the calendar years 2013, 2014, and 2015. This had been debited to insurance expense. In addition, on December 31, 2014, fully depreciated machinery was sold for $1,900 cash, but the sale was not recorded until 2015. There were no other errors during 2014 or 2015 and no corrections have been made for any of the errors. Ignore income tax considerations. *32. What is the total net effect of the errors on Cheyenne’s 2014 net income? a. Net income understated by $2,900 b. Net income overstated by $1,500 c. Net income overstated by $2,600 d. Net income overstated by $3,000

*33. What is the total net effect of the errors on the amount of Cheyenne's working capital at December 31, 2014? a. Working capital overstated by $1,000 b. Working capital overstated by $300 c. Working capital understated by $900 d. Working capital understated by $2,400

*34. What is the total effect of the errors on the balance of Cheyenne's retained earnings at December 31, 2014? a. Retained earnings understated by $2,000 b. Retained earnings understated by $900 c. Retained earnings understated by $500 d. Retained earnings overstated by $700 *35. At December 31, 2014, Grant Corp.’s auditor discovered the following errors: 1. Accrued salaries payable of $11,000 were NOT recorded at December 31, 2013. 2. Office supplies on hand of $5,000 at December 31, 2014 had been treated as expense instead of supplies inventory. Neither of these errors was discovered nor corrected. The effect of these two errors would cause a. 2014 net income to be understated $16,000 and December 31, 2014 retained earnings to be understated $5,000. b. 2013 net income and December 31, 2013 retained earnings to be understated $11,000 each. c. 2013 net income to be overstated $6,000 and 2014 net income to be understated $5,000. d. 2014 net income and December 31, 2014 retained earnings to be understated $5,000 each.

Accounting Changes and Error Analysis

21- 15

Fairfax Inc. began operations on January 1, 2013. Financial statements for 2013 and 2014 contained the following errors: Dec. 31, 2013 Dec. 31, 2014 Ending inventory $33,000 too high $39,000 too low Depreciation expense 21,000 too high — Insurance expense 15,000 too low 15,000 too high Prepaid insurance 15,000 too high — In addition, on December 31, 2014 fully depreciated equipment was sold for $7,200, but the sale was NOT recorded until 2015. No corrections have been made for any of the errors. Ignore income tax considerations.

*36. The total effect of the errors on Fairfax's 2014 net income is a. understated by $94,200. b. understated by $61,200. c. overstated by $28,800. d. overstated by $49,800.

*37. The total effect of the errors on Fairfax's retained earnings at December 31, 2014 is that the balance is understated by a. $82,200. b. $67,200. c. $46,200. d. $34,200.

*38. The total effect of the errors on Fairfax's working capital at December 31, 2014 is that working capital is understated by a. $100,200. b. $79,200. c. $46,200. d. $31,200.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

24. 25. 26.

b c a

27. 28. 29.

c d c

30. 31. *32.

a d d

*33. *34. *35.

c c a

*36. *37. *38.

a b c

DERIVATIONS—Computational No. Answer 24. b 25. c 26. a 27. c 28.

29.

30. 31.

a d

*32. *33. *34. *35.

d c c a

*36. *37.

a b

*38.

Derivation $450,000 – ($270,000 – $250,000) = $430,000 $135,000 – [($135,000 – $9,000) ÷ 9 x 2] = $107,000 Not booked through I/S, booked through R/E Acc deprec to Dec 31/13 $500,000 ÷ 10 x 3 = $150,000 new annual expense $500,000 – $150,000 = $350,000 ÷ 8 – 3 = $70,000 Acc deprec to Dec 31/14 (DDB) ($800,000 × .25) + ($600,000 × .25) + ($450,000 × .25) = $462,500 new depreciable amount $800,000 – $200,000 – $462,500 = $137,500 new annual expense $137,500 ÷ 5 = $27,500 $150,000 ÷ 5 = $30,000 (ann deprec.using S/L) ($125,000 – $30,000) × (1 – .3) = $66,500 $0, use prospective application since this is a change in estimate ($600,000 ÷ 6) × 3 = $300,000 $300,000 ÷ 5 = $60,000 $1,500 (o) + $2,200 (o) + $1,200 (o) – $1,900 (u) = $3,000 (o) $2,200 (o) – $1,200 (u) – $1,900 (u) = $900 (u) $400 (o) + $2,200 (o) – $1,200 (u) – $1,900 (u) = $500 (u) 2014 NI = $11,000 (u) + $5,000 (u) = $16,000 (u) 2014 RE = $5,000 (u) The $11,000(o) from 2013 is offset by the $11,000(u) in 2014 $33,000 (u) + $39,000 (u) + $15,000 (u) + $7,200 (u) = $94,200 (u) $39,000 (u) + $21,000 (u) – $15,000 (o) + $15,000 (u) + $7,200 (u) = $67,200 (u) $39,000 (u) + $7,200 (u) = $46,200 (u)

Accounting Changes and Error Analysis

21- 17

MULTIPLE CHOICE—CPA Adapted 39. On January 1, 2014, Robin Ltd. changed its inventory valuation method to FIFO from weighted-average cost for financial statement and income tax purposes, to make their reporting as reliable and more relevant. The change resulted in a $600,000 increase in the beginning inventory at January 1, 2014. Assume a 25% income tax rate. The cumulative effect of this accounting change reported for the year ended December 31, 2014 is a. $ 0. b. $150,000. c. $450,000. d. $600,000.

40. On January 1, 2014, Chickadee Corp. changed its inventory costing to average cost from FIFO for financial statement and income tax purposes, to make their reporting as reliable and more relevant. The change resulted in a $400,000 increase in the beginning inventory at January 1, 2014. Assume a 30% income tax rate. The cumulative effect of this accounting change should be reported by Chickadee in its 2014 a. Retained earnings statement as a $280,000 addition to the beginning balance. b. Income statement as $280,000 other comprehensive income. c. Retained earnings statement as a $400,000 addition to the beginning balance. d. Income statement as a $400,000 cumulative effect of accounting change.

41. Which of the following should be given retrospective treatment? Change in Change from Estimated Lives Unacceptable Policy of Depreciable Assets to Acceptable Policy a. Yes Yes b. No Yes c. Yes No d. No No

42. On January 1, 2010, Plover Ltd. purchased a machine for $330,000 and depreciated it using the straight-line method with an estimated useful life of eight years with no residual value. On January 1, 2013, Plover determined that the machine had a useful life of only six years from the date of acquisition, but will have a residual value of $30,000. An accounting change was made in 2013 to reflect these additional facts. At December 31, 2014, the accumulated depreciation for this machine should have a balance of a. $182,500. b. $187,500. c. $241,250. d. $250,000.

43. On January 1, 2011, Wren Corp. purchased a patent for $238,000. The patent is being amortized straight-line with no residual value over its remaining legal life of 15 years. At the beginning of 2014, however, Wren determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition. What amount should be reported in the Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

statement of financial position for the patent, net of accumulated amortization, at December 31, 2014? a. $142,800 b. $163,200 c. $168,000 d. $174,550

*44. On December 31, 2014, the bookkeeper at Thrush Corp. did not record special insurance costs that had been incurred (but not yet paid), related to a building that Thrush Corp. is constructing. What is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2014 statement of financial position? Accrued Liabilities Retained Earnings a. No effect No effect b. No effect Overstated c. Understated No effect d. Understated Overstated

*45. Eagle Corp. is a calendar-year corporation whose financial statements for 2013 and 2014 included errors as follows: Year Ending Inventory Depreciation Expense 2013 $36,000 overstated $30,000 overstated 2014 12,000 understated 10,000 understated Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2013 or December 31, 2014. Ignoring income taxes, by how much should Eagle's retained earnings be retrospectively adjusted at January 1, 2015? a. $32,000 increase b. $8,000 increase c. $4,000 decrease d. $2,000 increase

*46. On January 1, 2013, Condor Corp. acquired a machine for $200,000. It is to be depreciated straight line over five years, with no residual value. Because of a bookkeeping error, no depreciation was recognized in Condor's 2013 financial statements. The oversight was discovered during the preparation of Condor's 2014 financial statements. Depreciation expense on this machine for 2014 should be a. $0. b. $40,000. c. $50,000. d. $80,000.

Accounting Changes and Error Analysis

21- 19

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

39. 40.

c a

41. 42.

b c

43. *44.

b c

*45. *46.

a b

DERIVATIONS—CPA Adapted No. Answer 39. c 40. a 41. b 42. c

43.

*44. *45. *46.

c a b

Derivation $600,000 × (1 – .25) = $450,000 $400,000 × (1 – .3) = $280,000 Conceptual Acc deprec to Dec 31/12 $330,000 × 3 ÷ 8 = $123,750 new annual rate ($330,000 – $123,750 – $30,000) ÷ 3 = $58,750 Acc deprec at Dec 31/14 = $123,750 + ($58,750 x 2) = $241,250 Acc amort to Dec 31/13 $238,000 × 3 ÷ 15 = $47,600 new annual rate [($238,000 – $47,600) ÷ 7] = $27,200 patent at Dec 31/14 = $238,000 – $47,600 – $27,200 = $163,200 Conceptual $12,000 (u) + $30,000 (u) – $10,000 (o) = $32,000 (u) $200,000 ÷ 5 = $40,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex 21-47 Overall objectives of accounting and disclosure standards for accounting changes What are the three main objectives of accounting and disclosure standards for accounting changes? Solution 21-47 1. To limit the types of changes permitted. 2.

To standardize the reporting for each type of change.

To ensure that readers of accounting reports have the necessary information to understand the effects of such changes on the financial statements.

Ex. 21-48 Conditions for a change in accounting policy under IFRS and ASPE What conditions are allowed for a change in accounting policy to be acceptable? Solution 21-48 Under IFRS, there are only two situations where a change in accounting policy is acceptable: 1. The change is required by a primary source of GAAP. 2. A voluntary change results in the information in the financial statements being as reliable and more relevant. However, some voluntary changes are allowed under ASPE without having to meet the “reliable and more relevant” criterion. These include: i. reporting for investments in subsidiaries ii. reporting where the investor has significant influence or joint control iii. accounting for defined benefit plans iv. accounting for income taxes v. measuring a hybrid financial instrument that has both a liability and equity component (the equity component may be measured at zero). vi. for expenditures during the development phase on internally generated intangible assets. Ex. 21-49 Matching accounting changes to situations The three types of accounting changes are: Code a. Change in accounting policy b. Change in accounting estimate c. Error correction Instructions Following are a series of situations. You are to enter a code letter to the left to indicate the type of change. ____ 1. Change due to debiting a new asset to an expense account. ____ 2. Change from FIFO to weighted average costing. ____ 3. Change due to failure to recognize unearned portion of revenue. Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Accounting Changes and Error Analysis

____ 4. ____ 5 ____ 6. ____ 7. ____ 8. ____ 9. ____ 10. ____ 11. ____ 12. ____ 13. ____ 14. ____ 15.

21- 21

Change in amortization period for an intangible asset. Change in the calculation of warranty liabilities. Change due to failure to recognize and accrue income. Change in residual value of a depreciable plant asset. Change from an unacceptable accounting policy to an acceptable accounting policy. Adoption of a new accounting standard. Change due to expensing prepaid assets. Change from straight-line to double declining-balance method of depreciation. Change in estimated service life of a depreciable plant asset. Change from one acceptable policy to another acceptable policy. Change due to understatement of inventory. Change in estimated net realizable value of accounts receivable.

Solution 21-49 1. c 2.

10. c 11. b 12. b 13. a 14. c 15. b

Ex. 21-50 Matching disclosures to situations In the blank to the left of each statement, fill in the letter from the following list which best describes the treatment of the item on the financial statements of Sora Inc. for the current year ending December 31, 2014: a. Change in accounting policy requiring retrospective application Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

b. c. d.

Change in estimate Correction of error None of the above

____

____ ____

8. 9.

____ 10.

In 2014, the company changed its method of recognizing income from the completed-contract method to the percentage-of-completion method. At the end of 2014, an audit revealed that the corporation's allowance for doubtful accounts was too large and should be reduced to 2%. When the audit was performed in 2013, the allowance seemed appropriate. Depreciation on a truck, acquired in 2010, was understated because the service life had been overestimated. The understatement had been made in order to show higher net income in 2011 and 2012. The company switched from average cost to FIFO inventory costing during the current year. In 2014, Sora decided to change from the deferral and amortization approach for their defined benefit pension plan to the immediate recognition approach. During 2014, a long-term bond with a carrying value of $3,600,000 was retired at a cost of $4,100,000. After negotiations with Canada Revenue Agency, income taxes owing for 2013 were established at $42,900. They were originally estimated to be $28,600. In 2014, the company incurred interest expense of $29,000 on a 20-year bond issue. In calculating the depreciation in 2012 for buildings, an error was made which overstated income in that year by $75,000. The error was discovered in 2014. In 2014, the company changed its method of depreciating plant assets from the double declining-balance method to the straight-line method.

Solution 21-50 1. a 2.

10. b

Ex. 21-51 Change in estimate, voluntary change in accounting policy, correction of errors Give examples and discuss the accounting procedures and disclosure required for the following: Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Accounting Changes and Error Analysis

1. 2. 3.

21- 23

Change in estimate Voluntary change in accounting policy Correction of an error

Solution 21-51 1. Examples: collectability of receivables change in depreciation methods estimated lives or residual values warranty costs Accounting estimates will change as new events occur, as more experience is acquired, or new information is obtained. Changes in estimates are handled prospectively; that is in current and future periods. No restatement of previous financial statements is made. Financial statement disclosure includes the nature and amount of the change. Immaterial changes in estimates do not need to be disclosed. 2.

Examples:

change in the basis of inventory pricing change in the method of accounting for construction contracts change in the method of accounting for instalment sales change in the method of accounting for defined pension plans

The financial statements need to be adjusted to reflect the change in all of the prior years presented, the current year, and the cumulative effect of the change on prior periods, net of tax, should be shown as an adjustment to beginning retained earnings in the current year. Disclosure should include the amount of the adjustment for the current period and each prior period presented including the effect on each financial statement line item and the per share amounts, the amount of the adjustment related to periods prior to those presented, either that the change has been applied retrospectively, or without restatement and an explanation why this was impractical, and justification of the change. 3.

Examples:

a change from an accounting policy that is not generally accepted to an accounting policy that is accepted mathematical mistakes changes in estimates that occur because the estimates are not made in good faith an oversight a misuse of facts misclassification of an asset as an expense or vice versa

Corrections of errors are recorded in the year discovered, are corrected retrospectively with restatement of all prior years presented, and the beginning balance of retained earnings is adjusted. The nature of the error, the amount of the correction for each prior period presented, and the amount related to periods prior to those presented, and that the comparative information has been restated, must all be disclosed.

Ex. 21-52 Retrospective application for accounting changes Discuss how retrospective application for accounting changes would be applied. Solution 21-52 The general requirement for changes in accounting policy and the required method for error Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

correction is that the change’s cumulative effect be shown as an adjustment to the beginning retained earnings. Income statements of the affected prior periods presented for comparison purposes are restated to show, on a retrospective basis, the effects of the new accounting policy. When historical summaries are reported, the adjustments are reported in each prior year affected. When the effects on particular prior periods of a change in accounting policy is impractical to determine, the cumulative effect of the change (net of tax) is shown as an adjustment to the beginning retained earnings. Comparative financial statements of prior periods presented for comparison are not restated.

Ex. 21-53 Recognition of accounting changes or corrections For each of the following items, indicate the type of accounting change and how each is recognized in the accounting records in the current year. 1. Change from straight-line method of depreciation to double declining-balance 2. Change from the cash basis to the accrual basis of accounting 3. Change from FIFO to weighted average cost method for inventory valuation purposes 4. Change due to failure to record depreciation in a previous period 5. Change in the net realizable value of certain receivables

Solution 21-53 1. Change in accounting estimate; prospective application for current and future periods only. 2.

Correction of an error; retrospective treatment; restatement of financial statements of all prior periods presented; adjustment of beginning retained earnings of the current period. If restatement is not practical, restatement may be omitted.

Change in accounting policy; retrospective treatment; adjustment of beginning retained earnings, restatement of financial statements of all prior periods presented. If restatement is not practical, restatement may be omitted.

Correction of an error; restatement of financial statements of the period affected; adjustment of beginning retained earnings of the first period after the error.

Change in accounting estimate; prospective application for current and future periods only.

Ex. 21-54 Effects of errors on financial statements Show how the following independent errors will affect net income on the income statement and the shareholders' equity section of the statement of financial position (SFP) using the symbol + (plus) for overstated, – (minus) for understated, and 0 (zero) for no effect. 2013 2014 Income SFP Income SFP Statement Statement 1. Ending 2013 inventory overstated 2. Failure to accrue 2013 interest revenue 3. A capital expenditure for factory equipment (useful life, 5 years) was charged to expense in error in 2013 4. Failure to accrue 2013 wages Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Accounting Changes and Error Analysis

5. Ending inventory in 2013 understated 6. Overstated 2013 depreciation expense; 2014 expense correct Solution 21-54 2013 Income Statement SFP

2014 Income Statement SFP

1. Ending 2013 inventory overstated.

–

2. Failure to accrue 2013 interest revenue.

–

3. A capital expenditure for factory equipment (useful life, 5 years) was charged to expense in 2013. 4. Failure to accrue 2013 wages. 5. Ending inventory in 2013 understated. 6. Overstated 2013 depreciation expense; 2014 expense correct.

Ex. 21-55 Effects of errors on net income Hummingbird Corp. began operations on January 1, 2013. Financial statements for 2013 and 2014 contained the following errors: Dec. 31, 2013 Dec. 31, 2014 Ending inventory $20,000 too high $35,000 too high Depreciation expense 16,000 too low — Accumulated depreciation 16,000 too low 16,000 too low Insurance expense 14,000 too high 10,000 too low Prepaid insurance 14,000 too low In addition, on December 26, 2014, fully depreciated equipment was sold for $19,000, but the sale was not recorded until 2015. No corrections have been made for any of the errors. Instructions Ignoring income tax, show your calculation of the total effect of the errors on 2014 net income. Solution 21-55 2013 ending inventory ................................................ 2014 ending inventory ................................................ Insurance expense ..................................................... Unrecorded gain......................................................... Overstatement of 2014 income ..................................

$(20,000) 35,000 10,000 (19,000) $ 6,000

Note: The error in depreciation expense has no effect on 2014 income. The error in prepaid insurance is related to the error in insurance expense.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Ex. 21-56 Economic reasons for changing accounting policies Discuss possible economic reasons why companies may choose to change accounting policies. Solution 21-56 Research has shown that choice of accounting policies often have economic consequences for business organizations. As a result, management may choose accounting policies based on the expected economic impact of the policy. Some of these reasons are political costs, capital structure, bonus payments, and smoothing of earnings. Political costs: The management of large firms may seek policies that reduce their net income and therefore the likelihood that politicians and regulators will seek to increase taxes or restrictive regulations on them, or that unions will seek higher wage settlements. Capital structure: Companies that have restrictive covenants included in their debt contracts may seek policies that make it less likely that they violate the terms of these agreements. Examples would be covenants that specify maximum debt to equity ratios or minimum working capital ratios. Bonus payments: Many companies have compensation plans that include bonuses for management linked to income measures or stock option agreements. Management as a result may favour policies that increase net income and share prices. Smoothing of earnings: Stock markets react negatively to volatility in earnings. As well, high earnings may attract the attention of politicians and regulators, and may be hard for management to repeat in subsequent years. For these reasons, management may choose policies that smooth earnings and reduce volatility.

*Ex. 21-57 Non-counterbalancing error correction Turkey Corp. bought a machine on January 3, 2012 for $275,000. It had a $15,000 estimated residual value and a ten-year life. The corporation uses straight-line depreciation. An expense account was debited in error on the purchase date, but this was not discovered until late 2014. Instructions Prepare the correcting entry or entries related to the machine for 2014. Ignore income tax effects. Solution 21-57 Annual depreciation is ($275,000 – $15,000) ÷ 10 = $26,000 Machine........................................................................................ Retained Earnings ................................................................... Accumulated Depreciation (2 × $26,000) .................................

275,000

Depreciation Expense .................................................................. Accumulated Depreciation .......................................................

26,000

223,000 52,000

26,000

Accounting Changes and Error Analysis

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PROBLEMS Pr. 21-58 Correction of errors in prior years Goldfinch Inc. reported net incomes for the last three years as follows: 2012, $62,000;

2013, $63,000;

2014, $60,000

In reviewing the accounts in 2015 (after the books for the prior year had been closed), you find that the following errors have been made: 2012 2013 2014 Overstatement of ending inventory .................................. $7,000 $8,500 $4,000 Understatement of accrued advertising expense ............. 1,100 2,000 1,200 Instructions a. Calculate corrected net incomes for 2012, 2013, and 2014. b. Prepare the entry required in 2015 to correct the books. Ignore income taxes. Show any calculations. Solution 21-58 a. Net income (unadjusted) Overstatement of ending inventory—2012 Overstatement of ending inventory—2013 Overstatement of ending inventory—2014 Understatement of accrued advertising expense—2012 Understatement of accrued advertising expense—2013 Understatement of accrued advertising expense—2014 Net income (corrected) b.

2012 $62,000 (7,000)

(1,100) _______ $53,900

Retained Earnings......................................................................... Advertising Expense............................................................... Inventory ................................................................................

2013 $63,000 7,000 (8,500) 1,100 (2,000) _______ $60,600

2014 $60,000 8,500 (4,000) 2,000 _(1,200) $65,300

5,200 1,200 4,000

Pr. 21-59 Accounting for accounting changes and error corrections Parrot Corp. reported net incomes for the last three years as follows: 2014 2013 2012 $240,000 $225,000 $180,000 During the 2014 year-end audit, the following items come to your attention: 1. Parrot bought a truck on January 1, 2011 for $98,000 cash, with an $8,000 estimated residual value and a six-year life. The company debited an expense account for the entire cost of the asset. Parrot uses straight-line depreciation for all trucks. 2. During 2014, Parrot changed from straight-line depreciation for its cement plant to double declining balance. The following calculations present depreciation on both bases: 2014 2013 2012 Straight-line $18,000 $18,000 $18,000 Double declining balance 23,100 30,000 36,000 The net income for 2014 was calculated using the double declining balance method. 3. In reviewing its provision for uncollectible accounts during 2014, the corporation has Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2013 and 2012 when the expense had been $9,000 and $6,000, respectively. Parrot recorded bad debt expense using the new rate for 2014. If they had used the old rate, they would have recorded $3,000 less bad debt expense on December 31, 2014. Instructions (Ignore all income tax effects) a. Prepare the general journal entry required to correct the books for the item 1 situation (only) of this problem, assuming that the books have not been closed for 2014. b. Present comparative income statement data for the years 2012 to 2014, starting with income before the cumulative effect of any accounting changes. c. Assume that the beginning retained earnings balance (unadjusted) for 2012 was $630,000. At what adjusted amount should the beginning retained earnings balance for 2012 be shown, assuming that comparative financial statements were prepared? d. Assume that the beginning retained earnings balance (unadjusted) for 2014 is $900,000 and that comparative financial statements are not prepared. At what adjusted amount should this beginning retained earnings balance be shown? Solution 21-59 Annual depreciation would be ($98,000 – $8,000) ÷ 6 = $15,000 a.

Truck ............................................................................................ Depreciation Expense (2014 only) ................................................ Accumulated Depreciation (4 years, 2011–2014) .................. Retained Earnings .................................................................

b. Income before cumulative effect of of error correction Depreciation of truck

98,000 15,000 60,000 53,000

2014

2013

2012

$240,000 (15,000) $225,000

$225,000 (15,000) $210,000

$180,000 (15,000) $165,000

Note items 2 and 3 are considered changes in estimates, and are accounted for prospectively. c.

Retained earnings (unadjusted) ................................................ Correction of 2011 error ($98,000 – $15,000) ........................... Retained earnings (adjusted) ....................................................

$630,000 83,000 $713,000

Retained earnings (unadjusted) ................................................ Correction of error ($98,000 – $45,000).................................... Retained earnings (adjusted) ....................................................

$900,000 53,000 $953,000

*Pr. 21-60 Error corrections and adjustments The controller for Stork Corp. is concerned about certain business transactions that the company experienced during 2014. The controller, after discussing these matters with various individuals, has come to you for advice. The transactions at issue are presented below: 1. The company has decided to switch from the direct write-off method for accounting for bad debts to the percentage-of-sales approach. Assume that Stork has recognized bad debt expense as the receivables have actually become uncollectible in the following way: 2013 2014 Copyright © 2013 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Accounting Changes and Error Analysis

21- 29

From 2011 sales 10,600 4,000 From 2012 sales 15,000 The controller estimates that an additional $21,800 in bad debts will be written off in 2015: $3,800 applicable to 2013 sales and $18,000 to 2014 sales. Inventory has been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such (on account). At December 31, 2014, inventory billed and in the hands of consignees amounted to $160,000. The percentage markup on selling price is 20%. Assume that the consigned inventory is sold the following year. The company uses the perpetual inventory system. During 2014, Stork sold $300,000 worth of goods on the instalment basis. The cost of sales associated with these instalment sales is $225,000. The company inadvertently handled these sales and related costs as part of their regular sales transactions. Cash of $86,000, including a down payment of $30,000, was collected on these instalment sales during 2014. Due to questionable collectability, the instalment method was considered appropriate.

Instructions a. Assume that Stork Corp. reported pre-tax income of $500,000 for 2014. Present a schedule showing the corrected pre-tax income after the above transactions are taken into account. Ignore income tax effects. b. Prepare the correcting journal entries required at December 31, 2014, assuming that the books have been closed. Solution 21-60 a. Reported net income ..................................................................... 1. Additional charge for bad debts 2011 debts written off in 2014 (add back) ............................... 2014 debts to be written off in 2015 (deduct) .......................... 2.

$ 4,000 (18,000)

Consignment—(20% × $160,000) ..........................................

$500,000

(32,000)

Gross profit—Recognized ...................................................... Should be 25% × $86,000................................................ Corrected income ..........................................................................

75,000 (21,500)

Retained Earnings .................................................................. Allowance for Doubtful Accounts .....................................

21,800

Consignment Inventory........................................................... Retained Earnings .................................................................. Accounts Receivable .......................................................

128,000 32,000

Retained Earnings .................................................................. Deferred Gross Profit .......................................................

53,500

(14,000)

(53,500) $400,500

21,800

160,000

53,500

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 22 STATEMENT OF CASH FLOWS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

1. 2. 3. 4. 5.

2 2 2 3 4

E E E M M

6. 7. 8. 9. 10.

21. 22. 23. 24. 25. 26. 27. 28.

4 4 4 4 4 4 4 4

H M M M H M M E

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

52. 53. 54.

4 4 4

E M M

55. 56. 57.

62. 63. 64.

4 4 4,7

M M M

*65. *66. *67.

74.

4,6

*75.

Note:

E = Easy

LO LOD Item LO LOD Multiple Choice–Conceptual 4 E 11. 5 E 4 M 12. 5 M 4 M 13. 5 M 4 M 14. 6 M 5 E 15. 6 M Multiple Choice–Computational 4 M 37. 4,7 H 4 M 38. 4,7 M 4 M 39. 4,7 M 4 M 40. 4,7 M 4,6 H 41. 4,7 H 4,6 M *42. 11 M 4,6 M *43. 11 M 4,7 M *44. 11 M Multiple Choice–CPA Adapted 4 M 58. 4 M 4 M 59. 4 M 4 M 60. 6 H Exercises 4,7,11 M *68. 4,7,11 H 4,7,11 H 69. 5 E 4,7,11 M 70. 5–7 M Problems 4,7,11 H *76. 4,7,11 H

M = Medium

Item

LOD

16. 17. 18. 19. 20.

6,7 6,7 7 8 9

M M M M M

*45. *46. *47. *48. *49. *50. *51.

11 11 11 11 11 11 11

H M M M E H E

61.

71. *72. *73.

7 7,11 7,11

M H H

77.

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type 1.

Item

Type

5. 6. 7. 8. 9. 21. 22. 23.

MC MC MC MC MC MC MC MC

24. 25. 26. 27. 28. 29. 30. 31.

MC MC MC MC MC MC MC MC

10. 11.

MC MC

12. 13.

MC MC

14. 15.

MC MC

16. 17.

MC MC

16. 17. 18. 36.

MC MC MC MC

37. 38. 39. 40.

MC MC MC MC

19.

Item Type Item Type Learning Objective 2 3. MC Learning Objective 3 Learning Objective 4 32. MC 40. MC 33. MC 41. MC 34. MC 52. MC 35. MC 53. MC 36. MC 54. MC 37. MC 55. MC 38. MC 56. MC 39. MC 57. MC Learning Objective 5 69. Ex 77. Pr 70. Ex Learning Objective 6 33. MC 35. MC 34. MC 60. MC Learning Objective 7 41. MC 66. Ex 61. MC 67. Ex 64. Ex 68. Ex 65. Ex 70. Ex Learning Objective 8

Item

Type

Item

Type

58. 59. 62. 63. 64. 65. 66. 67.

MC MC Ex Ex Ex Ex Ex Ex

68. 74. 75. 76.

Ex Pr Pr Pr

70. 74.

Ex Pr

71. 72. 73. 75.

Ex Ex Ex Pr

76.

*67. *68. *72.

Ex Ex Ex

*73. *75. *76.

Ex Pr Pr

Learning Objective 9 20. *42. *43. *44. Note:

MC MC MC MC

*45. *46. *47.

MC MC MC

MC = Multiple Choice

Learning Objective 11 *48. MC *51. MC *49. MC *65. Ex *50. MC *66. Ex Ex = Exercise

Pr = Problem

*This topic is dealt with in an Appendix to the chapter.

Statement of Cash Flows

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CHAPTER STUDY OBJECTIVES 1. Understand the importance of cash flows from a business perspective. One sign of a healthy company is positive cash flow from operations. Companies can use these funds to finance expansion, to issue dividends, or to ensure that they remain solvent during economic downturns. Given the importance of cash flows for business, it is not surprising that the statement of cash flows has grown in importance for companies and standard setters over the past 25 years. Many also consider it to be less susceptible to earnings management than the statement of comprehensive income.

2. Describe the purpose and uses of the statement of cash flows. The primary purpose of this statement is to provide information about an entity’s cash receipts and cash payments during a period. A secondary objective is to report the entity’s operating, investing, and financing activities during the period. The statement’s objective is to provide information about historical changes in an enterprise’s cash so that investors and creditors can assess the amount, timing, and degree of certainty associated with an entity’s future cash flows, as well as the organization’s needs for cash and how cash will be used. 3. Define cash and cash equivalents. The definition of cash is related to an organization’s cash management activities. Cash and cash equivalents include cash on hand, demand deposits, and short-term, highly liquid non-equity investments that are convertible to known amounts of cash with insignificant risk of changes in value. These amounts are reduced by bank overdrafts that fluctuate from positive to negative balances and that are repayable on demand. IFRS allows preferred shares acquired within a short period of their maturity to be included as a cash equivalent.

4. Identify the major classifications of cash flows and explain the significance of each classification. Cash flows are classified into those resulting from operating, investing, and financing activities. A company’s ability to generate operating cash flows affects its capacity to pay dividends to shareholders, to take advantage of investment opportunities, to provide internal financing for growth, and to meet obligations when they fall due. The amount of cash spent on investing activities affects an organization’s potential for future cash flows. Cash invested in increased levels of productive assets forms the basis for increased future operating cash inflows. Financing cash activities affect the firm’s capital structure and, therefore, the requirements for future cash outflows.

5. Prepare the operating activities section of a statement of cash flows using the direct versus the indirect method. The direct method presents operating cash flows in a manner similar to a condensed cash basis income statement. The accrual amounts are listed and adjusted whenever the cash received or paid out differs from the revenues, gains, expenses, and losses reported in net income, and for non-operating gains and losses.

6. Prepare a statement of cash flows using the direct method. The direct method involves determining the change in cash and cash equivalents during the period, inserting line items from

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

the income statement as the starting point within the statement’s Operating Activities section, and analyzing the changes in all accounts on the statement of financial position to identify all transactions that have an impact on cash. Those with a cash impact are recorded on the statement of cash flows. To ensure that all cash flows have been identified, the results recorded on the statement are compared with the change in cash during the period. The statement is then prepared with required disclosures.

7. Prepare a statement of cash flows using the indirect method. The steps using the indirect method are the same as in Objective 6 above, with one exception. Rather than starting with line items from the income statement in the Operating Activities section, the net income amount is the beginning point. All the same adjustments are then made to adjust net income to a cash basis, but the style and format of the Operating Activities sections differ.

8. Identify the financial presentation and disclosure requirements for the statement of cash flows. Under IFRS, disclosure is required of cash flows associated with interest and dividends received and paid, the definition and components of cash and cash equivalents reconciled to the amounts reported on the statement of financial position, and the amount of and explanation for cash and cash equivalents not available for use. All income tax cash flows are reported as operating flows unless they can be linked directly to investing or financing flows. Choices are available under IFRS for the reporting of interest and dividends received (operating or investing) and interest and dividends paid (operating or financing). Gross amounts should be reported except in specifically permitted circumstances, and non-cash investing and financing transactions are excluded from the statement of cash flows, but details about these are reported elsewhere on the financial statements. ASPE presentation requirements are very similar, but required disclosures are limited to interest and dividends paid and charged to retained earnings and the amount of any restricted cash. In addition, interest and dividends received are both operating flows, and interest and dividends paid are operating flows unless they were charged directly to retained earnings.

9. Read and interpret a statement of cash flows. The first step in reading and interpreting a statement of cash flows is to look at the subtotals for the three classifications of activities and the overall change in cash. This provides a high-level summary of the period’s cash flows. Next, analyze the items within each section for additional insights, keeping alert for accounting policies that affect the type of cash flow reported. Familiarity with the company’s business and strategic direction is very useful in interpreting the statement.

10. Identify differences in ASPE and IFRS, and explain what changes are expected to standards for the statement of cash flows. There are no significant differences between ASPE and IFRS related to the statement of cash flows except for the definition of cash equivalents and the presentation and disclosure requirements identified above.

11. Use a work sheet to prepare a statement of cash flows. A work sheet can be used to organize the analysis and cash flow information needed to prepare a statement of cash flows. This method accounts for all changes in the balances of non-cash statement of financial position accounts from the period’s beginning to the end, identifying all operating, investing, and financing cash flows in the process. The statement of cash flows is prepared from the cash flow information

Statement of Cash Flows

22- 5

accumulated at the bottom of the work sheet.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c b c d d a d c c b b d c c d a a d d b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Description Primary purpose of the statement of cash flows Assessment of information in the statement of cash flows IFRS and ASPE requirements Cash equivalent elements Significant non-cash transactions Major source of cash for a successful company Cash flow effects of a stock dividend Item(s) to include in investing activities Additional cash invested by a sole proprietor Reporting of inventory increase on the statement of cash flows Adjustments to reconcile net income to cash from operating activities Adjustment to net income for inventory increase Adjustments under the direct method and indirect method Effect of decrease in accounts payable Net loss under direct method Adjustment for an increase in accounts payable Adjustment for a decrease in prepaid insurance Adjustment for equity method investment income Disclosures under IFRS and ASPE Free cash flow

MULTIPLE CHOICE—Computational Answer a c a b c b c a d b b c a d a c c b c d a b

No. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. *42.

Description Adjust net income for bad debt expense. Cash flow effects of selling plant assets at a gain Cash flow effects of selling equipment at a loss Cash flow effects of depreciation expense and purchase of assets Calculate depreciation expense for year. Calculate cash provided by (used in) investing activities. Calculate cash provided by financing activities. Calculate cash provided by investing activities. Calculate cash provided by (used in) financing activities. Calculate cash provided by operating activities. Calculate cash provided by (used in) investing activities. Calculate cash provided by (used in) financing activities. Calculate cash provided by operating activities using direct method. Calculate cash received from customers. Calculate cash paid for income taxes. Reporting insurance proceeds Calculate cash provided by operating activities. Calculate cash provided by (used in) investing activities. Calculate cash provided by (used in) financing activities. Calculate cash provided by operating activities. Calculate cash provided by operating activities. Calculate net income for year.

Statement of Cash Flows

b a c a b c d b d

*43. *44. *45. *46. *47. *48. *49. *50. *51.

22- 7

Calculate depreciation expense for year. Calculate equipment purchased during year. Calculate cost of equipment sold. Calculate book value of assets at end of year. Calculate ending balance of accounts payable. Calculate ending balance of retained earnings. Calculate ending balance of common shares account. Calculate amount of a cash dividend. Reporting a stock dividend

MULTIPLE CHOICE—CPA Adapted Answer a c c b b b a d b c

No. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61.

Description Calculate cash provided by investing activities. Calculate cash provided by financing activities. Calculate cash used in investing activities. Calculate cash provided by (used in) financing activities. Calculate cash provided by investing activities. Calculate cash provided by financing activities. Calculate cash used in investing activities. Calculate cash provided by financing activities. Calculate cash paid for insurance (direct method). Calculate depreciation expense for year.

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Item E22-62 E22-63 E22-64 *E22-65 *E22-66 *E22-67 *E22-68 E22-69 E22-70 E22-71 *E22-72 *E22-73

Description Choices of statement of cash flow categories under IFRS Classification of cash flows and transactions Effects of transactions on statement of cash flows (indirect method) Effects of transactions on statement of cash flows (indirect method) Effects of transactions on statement of cash flows (indirect method) Preparation of statement of cash flows (indirect method) Preparation of statement of cash flows (format provided) Direct and indirect methods Cash flows from operating activities (indirect and direct methods) Classification of cash flows (indirect method) Calculations for statement of cash flows (indirect method) Calculations for statement of cash flows (indirect method)

PROBLEMS Item P22-74 *P22-75 *P22-76 P22-77

Description Preparation of statement of cash flows (direct method) Preparation of statement of cash flows (indirect method) Complex statement of cash flows (indirect method) Advantages and disadvantages of direct and indirect methods

*This topic is dealt with in an Appendix to the chapter.

Statement of Cash Flows

22- 9

MULTIPLE CHOICE—Conceptual 1. The primary purpose of the statement of cash flows is to provide information a. about an entity’s operating, investing, and financing activities during a period. b. that is useful in assessing cash flow prospects. c. about an entity’s cash receipts and cash payments during a period. d. about an entity's ability to meet its obligations, its ability to pay dividends, and its needs for external financing.

2. The information in a statement of cash flows enables stakeholders to assess the a. amounts, timing and certainty of future cash flows. b. liquidity and solvency of an entity. c. change in working capital during the period. d. reason(s) for the difference between net income and cash flows from financing activities.

3. The statement of cash flows is required to be included a. only for financial statements prepared under IFRS. b. only for financial statements prepared under ASPE. c. for both financial statements prepared under IFRS and under ASPE. d. for financial statements prepared under IFRS, but is optional under ASPE.

4. Cash equivalents include a. treasury bills, equity investments and long term bonds. b. non-equity investments with short maturities and bank overdrafts repayable on demand. c. treasury bills, commercial paper and all equity investments. d. treasury bills, commercial paper, and money market funds purchased with excess cash.

5. Which of the following is NOT a significant non-cash transaction? a. capital (finance) lease obligations b. conversion of preferred shares to common shares c. exchange of non-monetary assets d. purchasing a building with a 10% cash down payment and mortgaging the balance 6. A successful company’s major source of cash should be a. operating activities. b. investing activities. c. financing activities. d. both operating activities and investing activities.

7. A statement of cash flows generally would NOT include the effects of a. common shares issued at an amount greater than par value. b. the purchase of treasury shares. c. cash dividends paid.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

d. stock dividends declared and issued.

8. In a statement of cash flows, which of the following would be reported in the cash flows from investing activities section? a. issuance of common shares in exchange for a factory building b. stock dividends received c. development costs incurred (intangible asset) d. declaration of cash dividends

9. On a statement of cash flows, additional cash invested by a sole proprietor would be disclosed in a. operating activities. b. investing activities. c. financing activities. d. both operating and financing activities.

10. Using the indirect method, an increase in inventory would be reported in a statement of cash flows as a(n) a. addition to net income in calculating cash flows from operating activities. b. deduction from net income in calculating cash flows from operating activities. c. cash flow from investing activities. d. cash flow from financing activities.

11. When preparing a statement of cash flows (indirect method), which of the following is NOT an adjustment to reconcile net income to cash flows from operating activities? a. an increase in prepaid expenses b. an increase in bonds payable c. a decrease in income taxes payable d. depreciation expense

12. When preparing a statement of cash flows (indirect method), an increase in ending inventory over beginning inventory will result in an adjustment to net income because a. cash was increased while cost of goods sold was decreased. b. acquisition of inventory is an investment activity. c. inventory purchased during the period was less than inventory sold, resulting in a net cash increase. d. cost of goods sold on an accrual basis is lower than on a cash basis.

13. When preparing a statement of cash flows, a decrease in accounts receivable during a period would cause which one of the following adjustments in calculating cash flows from operating activities? Direct Method Indirect Method a. Increase Decrease b. Decrease Increase c. Increase Increase

Statement of Cash Flows

d. Decrease

22- 11

Decrease

14. In calculating cash flows from operating activities, a decrease in accounts payable during a period a. means that accrual basis income is less than cash basis income. b. requires an addition to net income under the indirect method. c. requires an increase to cost of goods sold under the direct method. d. requires a decrease to cost of goods sold under the direct method.

15. When preparing a statement of cash flows using the direct method, a net loss reported on the income statement will a. automatically result in a cash outflow from operating activities. b. be included in financing activities. c. be disclosed as a note to the statement of cash flows. d. not be included on the statement at all.

16. When preparing a statement of cash flows, an increase in accounts payable during a period would require which of the following adjustments in determining cash flows from operating activities? Indirect Method Direct Method a. Increase Decrease b. Decrease Increase c. Increase Increase d. Decrease Decrease

17. When preparing a statement of cash flows, a decrease in prepaid insurance during a period would require which of the following adjustments in determining cash flows from operating activities? Indirect Method Direct Method a. Increase Decrease b. Decrease Increase c. Increase Increase d. Decrease Decrease

18. Oyster Corp. reports its income from investments by the equity method and recognized income of $25,000 from its investment in Pearl Ltd. during the current year, even though no dividends were declared or paid by Pearl during the year. On Oyster's statement of cash flows (indirect method), the $25,000 should a. not be shown. b. be shown as cash inflow from investing activities. c. be shown as cash outflow from financing activities. d. be shown as a deduction from net income in the cash flows from operating activities section.

19. With regard to disclosures required under IFRS and ASPE, which of the following statements

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

is INCORRECT? a. IFRS requires separate disclosure of taxes on income. b. IFRS requires separate disclosure of interest received and paid and dividends received and paid. c. ASPE does not require reporting and explanation of the amount of cash and cash equivalents that have restrictions on their use. d. ASPE does not require separate disclosure of taxes on income.

20. Free cash flow is a. the cash flows from operating activities reported on the statement of cash flows. b. the discretionary cash that an entity has available for increasing capacity, acquiring new investments, paying dividends, and retiring debt. c. the discretionary cash that an entity has available for increasing capacity, selling off investments, paying dividends, and incurring new debt. d. the cash flows from operating activities reported on the statement of cash flows increased by the capital expenditures that are needed to sustain the current level of operations.

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Statement of Cash Flows

MULTIPLE CHOICE ANSWERS—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3.

c b c

4. 5. 6.

d d a

7. 8. 9.

d c c

10. 11. 12.

b b d

13. 14. 15.

c c d

16. 17. 18.

a a d

19. 20.

d b

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 21. During 2014, Danish Corp., which uses the allowance method of accounting for doubtful accounts, recorded bad debts expense of $10,000. As well, the corporation wrote off uncollectible accounts receivable of $4,000. As a result of these transactions, their cash flows from operating activities would be calculated (indirect method) by adjusting net income with a a. $10,000 increase. b. $4,000 increase. c. $6,000 increase. d. $6,000 decrease.

22. Horatio Corp. sold some of its plant assets during calendar 2014 for $21,000 cash. The original cost of the assets was $150,000, and the accumulated depreciation to the date of sale was $140,000. This transaction should be shown on Horatio's 2014 statement of cash flows (indirect method) as a(n) a. deduction from net income of $11,000 and a $10,000 cash inflow from financing activities. b. addition to net income of $11,000 and a $21,000 cash inflow from investing activities. c. deduction from net income of $11,000 and a $21,000 cash inflow from investing activities. d. addition to net income of $21,000.

23. Claudius Ltd. sold equipment during calendar 2014 for $19,000 cash. The original cost of the equipment was $46,000, and the accumulated depreciation to the date of sale was $24,500. This transaction should be shown on Claudius’s 2014 statement of cash flows (indirect method) as a(n) a. addition to net income of $2,500 and a $19,000 cash inflow from investing activities. b. deduction from net income of $2,500 and a $21,500 cash inflow from investing activities. c. deduction from net income of $2,500 and a $19,000 cash inflow from investing activities. d. addition to net income of $2,500 and a $19,000 cash inflow from financing activities.

24. An analysis of the machinery accounts of Polonius Ltd. during 2014 follows: Accumulated Book Machinery Depreciation Value Balance, Jan 1, 2014 $500,000 $125,000 $375,000 Purchases of new machinery in 2014 for cash 200,000 — 200,000 2014 depreciation — 100,000 (100,000) Balance, Dec 31, 2014 $700,000 $225,000 $475,000 The information concerning Polonius's machinery accounts should be shown in their statement of cash flows (indirect method) for the year ended December 31, 2014, as a(n) a. subtraction from net income of $100,000 and a $200,000 decrease in cash flows from financing activities. b. addition to net income of $100,000 and a $200,000 decrease in cash flows from investing activities. c. $100,000 increase in cash flows from financing activities. d. $200,000 decrease in cash flows from investing activities.

Statement of Cash Flows

22- 15

25. During calendar 2014, Marcellus Inc. sold equipment for $168,000. The equipment had cost $252,000 and had a book value of $144,000 at the time of sale. Accumulated Depreciation—Equipment was $688,000 at Dec 31, 2013 and $736,000 at Dec 31, 2014. Therefore, Depreciation Expense (Equipment) for 2014 was a. $60,000. b. $96,000. c. $156,000. d. $192,000.

Use the following information for questions 26–27. Marcellus Corp. provided the following information for calendar 2014: Marcellus adheres to ASPE. Proceeds from issuing bonds ..................................... $200,000 Purchase of inventories .............................................. 380,000 Purchase of treasury shares....................................... 60,000 Purchase of long term investment .............................. 280,000 Dividends paid to preferred shareholders ................... 40,000 Proceeds from issuing preferred shares ..................... 160,000 Proceeds from sale of equipment ............................... 40,000

26. The cash provided by (used in) investing activities during 2014 is a. $ 40,000. b. $(240,000). c. $(400,000). d. $(440,000).

27. The cash provided by financing activities during 2014 is a. $360,000. b. $320,000. c. $260,000. d. $220,000.

28. Selected information from Regan Ltd.'s 2014 accounting records is as follows: Proceeds from sale of land ......................................... $300,000 Proceeds from long-term borrowings.......................... 400,000 Purchase of plant assets ............................................ 280,000 Purchase of inventories .............................................. 850,000 Proceeds from issuance of common shares ............... 300,000 Based on the above information, the cash provided by investing activities for calendar 2014 is a. $ 20,000 b. $200,000. c. $320,000. d. $400,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

29. Selected information from Cordelia Corp.'s 2014 accounting records is as follows: Cordelia adheres to ASPE. Proceeds from issuance of common shares ............... $ 400,000 Proceeds from issuance of bonds .............................. 1,200,000 Cash dividends paid on common shares .................... 160,000 Cash dividends paid on preferred shares ................... 60,000 Purchase of a FV-NI investment ................................. 120,000 Sale of shares to officers and employees NOT included above............................................ 100,000 Based on the above information, the cash provided by (used in) financing activities for calendar 2014 is a. $ 160,000. b. $ 180,000. c. $(220,000). d. $1,480,000.

30. Edmund Corp. reported net income for calendar 2014 of $300,000. Additional information follows: Depreciation on property, plant and equipment .......... $150,000 Bad debts expense .................................................... 55,000 Purchase of equipment .............................................. 25,000 Interest paid on long-term bonds ................................ 15,000 Loss on sale of equipment ......................................... 85,000 Based on the above information, the cash provided by operating activities (indirect method) for calendar 2014 is a. $565,000. b. $590,000. c. $605,000. d. $630,000.

Use the following information for questions 31–32. Oswald Ltd. has recently decided to go public and has hired you as their independent accountant. They wish to adhere to IFRS and know that they must prepare a statement of cash flows. Their financial statements for 2014 and 2013 are provided below. Statements of Financial Position Dec 31/14 Cash ........................................................... $ 51,000 Accounts receivable .................................... 45,000 Merchandise inventory ................................ 48,000 Property, plant and equipment .................... $76,000 Less accumulated depreciation ............ (40,000) 36,000 $180,000 Accounts payable........................................ Income taxes payable ................................. Bonds payable ............................................ Common shares..........................................

$ 22,000 44,000 45,000 27,000

Dec 31/13 $ 24,000 27,000 60,000 $120,000 (38,000)

82,000 $193,000 $ 12,000 49,000 75,000 27,000

Statement of Cash Flows

Retained earnings .......................................

42,000 $180,000

22- 17

30,000 $193,000

Income Statement Year ended December 31, 2014 Sales ...................................................................................................................... $1,050,000 Cost of sales .......................................................................................................... 894,000 Gross profit ............................................................................................................ 156,000 Selling and administrative expenses ...................................................................... 99,000 Income from operations ......................................................................................... 57,000 Interest expense .................................................................................................... 9,000 Income before taxes .............................................................................................. 48,000 Income taxes ......................................................................................................... 12,000 Net income............................................................................................................. $ 36,000 The following additional data were provided for calendar 2014: 1. Dividends declared and paid were $24,000. 2. Equipment was sold for $30,000. This equipment originally cost $44,000, and had a book value of $36,000 at the time of sale. The loss on sale was included in “selling and administrative expenses,” as was the depreciation expense for the year. 3. Bonds were retired during the year at par. For a statement of cash flows for calendar 2014:

31. The cash provided by (used in) investing activities is a. $ 6,000. b. $ 30,000. c. $(36,000). d. $(44,000).

32. The cash provided by (used in) by financing activities is a. $ 6,000. b. $ 24,000. c. $(54,000). d. $(30,000).

33. Gertrude Inc., a service organization, reports the following for calendar 2014: Service revenue ......................................................... $350,000 Cash received from customers ................................... 300,000 Interest payments (on long term debt) ........................ 8,000 Salaries and wages paid to employees ...................... 105,000 Purchase of new equipment for cash ......................... 160,000 Cash dividends paid ................................................... 20,000 Payments for office rental & general expenses .......... 140,000 Income taxes paid ...................................................... 15,000 Net income ................................................................. 45,000 Gertrude adheres to ASPE. Based on the above information, and using the direct method, the

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

cash provided by (used in) operating activities to be reported on Gertrude’s 2014 statement of cash flows is a. $ 32,000. b. $ 40,000. c. $ 70,000. d $(90,000).

Use the following information for questions 34–35. Oswald Ltd. has recently decided to go public and has hired you as their independent accountant. They wish to adhere to IFRS and know that they must prepare a statement of cash flows. Their financial statements for 2014 and 2013 are provided below. Statements of Financial Position Dec 31/14 Cash ........................................................... $ 51,000 Accounts receivable .................................... 45,000 Merchandise inventory ................................ 48,000 Property, plant and equipment .................... $76,000 Less accumulated depreciation ............ (40,000) 36,000 $180,000 Accounts payable........................................ Income taxes payable ................................. Bonds payable ............................................ Common shares.......................................... Retained earnings .......................................

$ 22,000 44,000 45,000 27,000 42,000 $180,000

Dec 31/13 $ 24,000 27,000 60,000 $120,000 (38,000)

82,000 $193,000 $ 12,000 49,000 75,000 27,000 30,000 $193,000

Statement of Cash Flows

22- 19

34. The cash received from customers is a. $1,068,000. b. $1,055,000. c. $1,050,000. d. $1,032,000.

35. The cash paid for income taxes is a. $17,000. b. $12,000. c. $ 7,000. d. $ 5,000. 36. A fire damaged Francisco Corp.’s office building. The company received $600,000 as a settlement from their insurance company, which was $180,000 less than the book value of the building. Their income tax rate is 25%. On the statement of cash flows (indirect method), the receipt from the insurance company should a. be shown as an addition to net income of $420,000. b. be shown as an inflow from investing activities of $420,000. c. be shown as an inflow from investing activities of $600,000. d. be shown as an inflow from investing activities of $450,000.

Use the following information for questions 37–39. The statement of financial position data of the King Lear Corp. at the ends of 2014 and 2013 follow: 2014 2013 Cash ............................................................................................... $ 75,000 $105,000 Accounts receivable (net) ................................................................ 180,000 135,000 Merchandise inventory .................................................................... 210,000 135,000 Prepaid expenses ........................................................................... 30,000 75,000 Land................................................................................................ 270,000 120,000 Buildings and equipment ................................................................. 270,000 225,000 Accumulated depreciation—buildings and equipment ..................... (54,000) (24,000) Totals ....................................................................................... $981,000 $771,000 Accounts payable............................................................................ Salaries payable ............................................................................. Notes payable—long-term .............................................................. Mortgage payable ........................................................................... Common shares.............................................................................. Retained earnings (deficit) ..............................................................

$204,000 36,000

$165,000 54,000 120,000

90,000 627,000 477,000 24,000 (45,000) $981,000 $771,000 During 2014, land was acquired in exchange for common shares (which had a market value of $150,000 at the time). All equipment purchased was for cash. Equipment costing $15,000 was sold for $6,000 cash; book value of the equipment at the time of sale was $12,000, and the loss was included in net income. Cash dividends of $30,000 were declared and paid during the year. In

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

the statement of cash flows (indirect method) for calendar 2014. King adheres to ASPE.

37. The cash provided by operating activities was a. $72,000. b. $78,000. c. $84,000. d. $99,000.

38. The cash provided by (used in) investing activities was a. $ 39,000. b. $ (54,000). c. $ (60,000). d. $(204,000).

39. The cash provided by (used in) financing activities was a. $ 90,000. b. $(30,000). c. $(60,000). d. $ 0.

40. Edgar Inc. reported net income for calendar 2014 of $3,500,000. Additional information follows: Impairment of goodwill ............................................... $ 30,000 Depreciation on plant assets ...................................... 1,100,000 Long-term debt: Bond premium amortized ........................................... 45,000 Interest expense......................................................... 600,000 Bad debts expense .................................................... 75,000 Based on the above information, the cash provided by operating activities (indirect method) for calendar 2014 is a. $4,750,000. b. $4,730,000. c. $4,715,000. d. $4,660,000.

41. Oswald Ltd. has recently decided to go public and has hired you as their independent accountant. They wish to adhere to IFRS and know that they must prepare a statement of cash flows. Their financial statements for 2014 and 2013 are provided below. Statements of Financial Position Dec 31/14 Cash ........................................................... $ 51,000 Accounts receivable .................................... 45,000 Merchandise inventory ................................ 48,000 Property, plant and equipment .................... $76,000 Less accumulated depreciation ............ (40,000) 36,000

Dec 31/13 $ 24,000 27,000 60,000 $120,000 (38,000)

82,000

Statement of Cash Flows

Accounts payable........................................ Income taxes payable ................................. Bonds payable ............................................ Common shares.......................................... Retained earnings .......................................

22- 21

$180,000

$193,000

$ 22,000 44,000 45,000 27,000 42,000 $180,000

$ 12,000 49,000 75,000 27,000 30,000 $193,000

*42. Hamlet Ltd. adheres to ASPE. On Hamlet Ltd.'s statement of cash flows (indirect method) for calendar 2014, cash flows from operating activities were reported at $154,000. The statement included the following items: depreciation on plant assets of $60,000; impairment of goodwill of $10,000; and cash dividends paid of $72,000. Based only on the information given above, Hamlet’s net income for 2014 was a. $ 12,000. b. $ 84,000. c. $154,000. d. $214,000.

Use the following information for questions *43–*44. During calendar 2014, Laertes Corp. sold equipment for $70,000. The equipment had cost

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

$100,000 and had a book value of $52,000 at the time of sale. Data from their comparative statements of financial position are: Dec 31/14 Dec 31/13 Equipment $720,000 $650,000 Accumulated Depreciation 210,000 190,000

*43. Depreciation expense for 2014 was a. $86,000. b. $68,000. c. $18,000. d. $12,000.

*44. Equipment purchased during 2014 was a. $170,000. b. $100,000. c. $70,000. d. $30,000.

Use the following information for questions *45–*49. Financial statements for Bernardo Corp. are presented below: BERNARDO CORP. Statement of Financial Position January 1, 2014 Assets Liabilities and Equity Cash ................................. $160,000 Accounts payable ....... Accounts receivable ........................ 144,000 Buildings and equipment ................. 600,000 Accumulated depreciation— buildings and equipment ............. (200,000) Common shares ......... Patents ................................. 72,000 Retained earnings ...... $776,000

$ 76,000

460,000 240,000 $776,000

BERNARDO CORP. Statement of Cash Flows (indirect method) Year ended December 31, 2014 Cash provided by operating activities Net income .................................................................................... $200,000 Add back non-cash expenses: Increase in accounts receivable ............................................. $ (64,000) Increase in accounts payable ................................................. 32,000 Depreciation expense ............................................................. 60,000 Gain on sale of equipment...................................................... (24,000) Amortization of patents ........................................................... 8,000 12,000 Cash provided by operating activities ................................................... 212,000

Statement of Cash Flows

22- 23

Cash provided by (used in) investing activities Sale of equipment ......................................................................... 48,000 Purchase of land ........................................................................... (100,000) Purchase of buildings and equipment............................................ (192,000) Cash used by investing activities ......................................................... (244,000) Cash provided by financing activities Payment of cash dividends ........................................................... Issuance of common shares.......................................................... Cash provided by financing activities ................................................... Net increase in cash ............................................................................ Cash, January 1, 2014 ......................................................................... Cash, December 31, 2014 ...................................................................

(60,000) 160,000 100,000 68,000 160,000 $228,000

Total assets on the December 31, 2014 statement of financial position were $1,108,000. Accumulated depreciation on the equipment sold was $56,000.

*45. When the equipment was sold, the Buildings and Equipment account was credited with a. $ 48,000. b. $ 56,000. c. $ 80,000. d. $104,000.

*46. The book value of the buildings and equipment at December 31, 2014 was a. $508,000. b. $520,000. c. $588,000. d. $712,000.

*47. The balance in the Accounts Payable account at December 31, 2014 was a. $148,000. b. $108,000. c. $ 44,000. d. $ 32,000.

*48. The balance in the Retained Earnings account at December 31, 2014 was a. $500,000. b. $440,000. c. $380,000. d. $180,000.

*49. The balance in the Common Shares account at December 31, 2014 was a. $260,000. b. $400,000. c. $460,000. d. $620,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Use the following information for questions *50–*51. Ophelia Ltd. reported retained earnings at December 31, 2013 of $270,000, and at December 31, 2014, $218,000. Net income for calendar 2014 was $187,500. During 2014, a stock dividend was declared and distributed, which increased the common shares account by $116,500. As well, a cash dividend was declared and paid during the year.

*50. The amount of the cash dividend declared and paid was a. $ 93,000. b. $123,000. c. $164,500. d. $239,500.

*51. The stock dividend should be reported on the statement of cash flows as a. an outflow from operating activities of $116,500. b. an outflow from financing activities of $116,500. c. an outflow from investing activities of $116,500. d. Stock dividends are not shown on a statement of cash flows.

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Statement of Cash Flows

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

21. 22. 23. 24. 25.

a c a b c

26. 27. 28. 29. 30.

b c a d b

31. 32. 33. 34. 35.

b c a d a

36. 37. 38. 39. 40.

c c b c d

41. *42. *43. *44. *45.

a b b a c

*46. *47. *48. *49. *50.

a b c d b

*51.

DERIVATIONS—Computational No. Answer 21. a 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37.

c a b c b c a d b b c a d a c c

38. 39. 40. 41.

b c d a

*42. *43. *44.

b b a

Derivation $10,000 (bad debts expense added back). A/R write-offs are not relevant using indirect method. $21,000 – ($150,000 – $140,000) = $11,000 (gain); $21,000 (proceeds) $19,000 – ($46,000 – $24,500) = $2,500 (loss); $19,000 (proceeds) Conceptual $736,000 – $688,000 + ($252,000 – $144,000) = $156,000 $40,000 – $280,000 = $(240,000) $200,000 – $60,000 – $40,000 + $160,000 = $260,000 $300,000 – $280,000 = $20,000 $400,000 + $1,200,000 – $160,000 – $60,000 + $100,000 = $1,480,000 $300,000 + $150,000 + $55,000 + $85,000 = $590,000 $30,000 (sale of equipment; no purchases) ($24,000) – ($30,000) = ($54,000) $300,000 – $8,000 – $105,000 – $140,000 – $15,000 = $32,000 $27,000 + $1,050,000 – $45,000 = $1,032,000 $49,000 + $12,000 – $44,000 = $17,000 Conceptual, $600,000 (actual proceeds) $24,000 + $30,000 + $45,000 = $99,000 (NI) ($15,000 – $3,000) – $6,000 = $6,000 (Loss) $54,000 + $3,000 – $24,000 = $33,000 (Deprec. exp.) $99,000 – $45,000 – $75,000 + $45,000 + $6,000 + $33,000 + $39,000 – $18,000 = $84,000 $6,000 – ($270,000 + $15,000 – $225,000) = ($54,000). ($120,000) + $90,000 – $30,000 = ($60,000) $3,500,000 + $30,000 + $1,100,000 – $45,000 + $75,000 = $4,660,000 $36,000 + $6,000 + ($40,000 + $8,000 – $38,000) – $18,000 + $12,000 + $10,000 – $5,000 = $51,000 $154,000 – $60,000 – $10,000 = $84,000 $210,000 – $190,000 + ($100,000 – $52,000) = $68,000 $720,000 – $650,000 + $100,000 = $170,000

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*45. *46. *47. *48. *49. *50. *51.

Test Bank for Intermediate Accounting, Tenth Canadian Edition

c a b c d b d

$48,000 – $24,000 = $24,000 (BV); $24,000 + $56,000 = $80,000 ($600,000 – $200,000) – $24,000 + $192,000 – $60,000 = $508,000 $76,000 + $32,000 = $108,000 $240,000 + $200,000 – $60,000 = $380,000 $460,000 + $160,000 = $620,000 $270,000 + $187,500 – $116,500 – X = $218,000; X = $123,000 Conceptual

Statement of Cash Flows

22- 27

MULTIPLE CHOICE—CPA Adapted Use the following information for questions 52–53. Duncan Corp. purchased a building, paying part of the purchase price in cash and issuing a mortgage note payable to the seller for the balance.

52. In a statement of cash flows, what amount is included in investing activities for the above transaction? a. the cash payment b. the full purchase price c. zero (but disclosed in the notes) d. the amount mortgaged

53. In a statement of cash flows, what amount is included in financing activities for the above transaction? a. the cash payment b. the full purchase price c. zero (but disclosed in the notes) d. the amount mortgaged

Use the following information for questions 54–55. Banquo adheres to ASPE. Banquo Corp.'s transactions for the year ended December 31, 2014 included the following: 1. Purchased land for $220,000 cash. 2. Borrowed $220,000 from the bank on a long term note. 3. Sold long-term investments for $200,000. 4. Accounts receivable decreased by $40,000. 5. Paid cash dividends of $240,000. 6. Issued 1,000 common shares for $100,000. 7. Purchased machinery and equipment for $50,000 cash. 8. Accounts payable increased by $80,000.

54. The cash used in investing activities for 2014 was a. $(270,000). b. $(150,000). c. $(70,000). d. $(20,000).

55. The cash provided by (used in) financing activities for 2014 was a. $ 10,000. b. $ 80,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

c. $(180,000). d. $(200,000).

Use the following information for questions 56–57. Ross Corp.'s transactions for calendar 2014 included the following: 1. Acquired 50% of Lennox Ltd.'s common shares for $90,000 cash. 2. Issued 5,000 preferred shares in exchange for land with a fair value of $160,000. 3. Issued 11% bonds, par value $200,000, due 2020, for $196,000 cash. 4. Purchased a patent for $110,000 cash. 5. Borrowed $90,000 from Bank A. 6. Paid $60,000 toward a bank loan with Bank B. 7. Sold long-term investments for $398,000.

56. The cash provided by investing activities in 2014 was a. $148,000. b. $198,000. c. $238,000. d. $308,000.

57. The cash provided by financing activities in 2014 was a. $136,000. b. $226,000. c. $286,000. d. $296,000.

Use the following information for questions 58–59. Malcolm Corp.'s statements of financial position at December 31, 2014 and 2013 and information relating to 2014 activities are presented below: December 31,___ 2014 2013 Assets Cash ........................................................................................ $ 110,000 $ 50,000 Temporary investments ............................................................ 150,000 — Accounts receivable (net) ......................................................... 255,000 255,000 Inventory .................................................................................. 345,000 300,000 Long-term investments ............................................................. 100,000 150,000 Property, plant and equipment ................................................. 850,000 500,000 Accumulated depreciation ........................................................ (225,000) (225,000) Goodwill ................................................................................... 45,000 50,000 Total assets ....................................................................... $1,630,000 $1,080,000 Liabilities and Shareholders' Equity Accounts payable ..................................................................... $ 415,000 Long-term note payable ........................................................... 145,000 Common shares ....................................................................... 600,000

$ 360,000 — 475,000

Statement of Cash Flows

Retained earnings .................................................................... 470,000 Total liabilities and shareholders' equity ............................ $1,630,000

22- 29

245,000 $1,080,000

Other information relating to 2014 activities: 1. Net income was $375,000. 2. Cash dividends of $150,000 were declared and paid. 3. Equipment costing $250,000, with a book value of $80,000, was sold for $90,000. 4. A long-term investment was sold for $80,000. There were no other transactions affecting long-term investments. 5. 5,000 common shares were issued for $25 a share. 6. Temporary investments consist of treasury bills maturing on June 30, 2015.

58. The cash used in investing activities in 2014 was a. $580,000. b. $455,000. c. $430,000. d. $420,000.

59. The cash provided by financing activities in 2014 was a. $420,000. b. $270,000. c. $130,000. d. $120,000.

60. Macduff Ltd.'s prepaid insurance balance was $10,000 at December 31, 2014 and $5,000 at December 31, 2013. Insurance expense was $4,000 for 2014 and $3,000 for 2013. How much cash paid for insurance would be reported in Blackfoot's 2014 statement of cash flows prepared using the direct method? a. $11,000 b. $ 9,000 c. $ 6,000 d. $ 4,000

61. Macbeth Corp.'s comparative statements of financial position at December 31, 2014 and 2013 reported accumulated depreciation balances of $960,000 and $720,000, respectively. Equipment with a cost of $60,000 and a book value of $48,000 was the only equipment sold in 2014. Therefore, the depreciation expense for 2014 was a. $228,000. b. $240,000. c. $252,000. d. $264,000.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

52. 53.

a c

54. 55.

c b

56. 57.

b b

58. 59.

a d

60. 61.

b c

DERIVATIONS—CPA Adapted No. Answer 52. a 53. c 54. c 55. b 56. b 57. b 58. a 59. 60. 61.

d b c

Derivation Conceptual Conceptual $200,000 – $220,000 – $50,000 = $(70,000) $220,000 – $240,000 + $100,000 = $80,000 $398,000 – $90,000 – $110,000 = $198,000 $196,000 + $90,000 – $60,000 = $226,000 $80,000 + $90,000 – ($850,000 + $250,000 – $500,000) – $150,000 = $580,000 (5,000 × $25 = $125,000) + $145,000 – $150,000 = $120,000 $10,000 + $4,000 – $5,000 = $9,000 $960,000 – $720,000 + ($60,000 – $48,000) = $252,000

Statement of Cash Flows

22- 31

EXERCISES Ex. 22-62 Choices of statement of cash flows categories under IFRS Under IFRS, choices are allowed in the categorization of interest paid and received and dividends received. Explain what these choices are. Solution 22-62 Under IFRS, there are several choices available for these items: 1. Interest paid/received and dividends received (except dividends received from a significant influence investment) can be recognized in operating activities (assuming they are included in calculating net income). 2.

Interest paid can also be treated as a financing outflow.

Interest and dividends received can also be treated as investing inflows.

Dividends paid can be treated as a financing outflow (highlighting the fact they are returns to shareholders), or an as operating outflow (as a measure of the ability of operations to cover returns to shareholders).

Note, however, once management makes the appropriate choices, they must be applied consistently.

Ex. 22-63 Classification of cash flows and transactions Assuming the company follows ASPE, give: a. three distinct examples of investing activities. b. three distinct examples of financing activities. c. three distinct examples of significant noncash transactions. d. two examples of transactions not shown on a statement of cash flows. Solution 22-63 a. Investing activities: purchase or sale of both tangible and intangible assets purchase or sale of investments in other entities loans or collection of principal of loans to other entities b.

Financing activities: issuance or reacquiring of shares issuance or retirement of debt cash dividends paid

Significant non-cash transactions: acquiring assets by issuing shares or debt capital (finance) leases conversion or refinancing of debt nonmonetary exchanges of assets

Not shown on the statement of cash flows:

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

stock dividends stock splits

Ex. 22-64 Effects of transactions on the statement of cash flows (indirect method) Any given transaction may affect a statement of cash flows (using the indirect method) in one or more of the following ways: Cash flows from operating activities A. Net income will be increased or adjusted upward. B. Net income will be decreased or adjusted downward. Cash flows from investing activities C. Increase as a result of cash inflows. D. Decrease as a result of cash outflows. Cash flows from financing activities E. Increase as a result of cash inflows. F. Decrease as a result of cash outflows. The statement of cash flows is not affected G. Not required to be reported on the statement. Instructions For each transaction listed below, list the letter or letters from above that describe(s) the effect of the transaction on a statement of cash flows (indirect method) assuming the company follows ASPE. Ignore any income tax effects. ____ 1. Redeemed preferred shares with a carrying value of $44,000 for $50,000. ____ 2. Wrote off uncollectible accounts receivable of $3,000 against the allowance for doubtful accounts balance of $12,200. ____ 3. Sold machinery that originally cost $3,000, with a book value of $1,800, for $5,000. ____ 4. Acquired land through the issuance of bonds payable. ____ 5. Sold 1,000 common shares for $25 per share. ____ 6. Sold treasury shares at their carrying value. ____ 7. Paid cash dividends of $8,000. ____ 8. Purchased a patent for $20,000. ____ 9. Recorded depreciation expense of $150,000 for the year. Solution 22-64 1. F 2.

B,C

Statement of Cash Flows

22- 33

*Ex. 22-65 Effects of transactions on the statement of cash flows (indirect method) Indicate for each of the following what should be disclosed on a statement of cash flows (indirect method), assuming the company follows ASPE. If not disclosed, write "Not shown." There may be more than one answer for some items. For an item that is added to net income, write "Add," and for an item that is deducted from net income, write "Deduct." Show financing and investing outflows in parentheses. For example, an answer might be: Deduct $4,700 or Investing ($31,000). If the item is a noncash transaction that should be disclosed separately, write "Noncash." a. The deferred tax liability increased $10,000. b. The balance in “Investment in Kinnear Corp.” increased $12,000 as a result of using the equity method. c. Issuance of a stock dividend increased the common shares account by $56,000. d. Amortization of bond discount, $1,600. e. Machinery, which cost $100,000 with accumulated depreciation of $48,000, was sold for $55,000. f. Issued 3,000 common shares with a market value of $15 per share for machinery. (Show the amount, too.) g. Amortization of patents, $3,000. h. Cash dividends paid, $60,000. *Solution 22-65 a. Add $10,000 b.

Deduct $12,000

Not shown

Add $1,600

Investing $55,000; Deduct $3,000 (gain)

Noncash $45,000

Add $3,000

Financing ($60,000)

*Ex. 22-66 Effects of transactions on the statement of cash flows (indirect method) Assuming ASPE, indicate for each of the following what should be disclosed on a statement of cash flows (indirect method) and in which section. If not disclosed, write, "Not shown." If an item is a noncash transaction that would not be on the statement but should be shown separately, write "noncash." If an item is added to net income, write "Add," and if an item is deducted from net

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

income, write "Deduct." Show financing and investing outflows in parentheses. For example, an answer might be: Deduct $4,700 or Investing ($31,000). There may be more than one answer for some items. a. For 2014, net income was $650,000. b. Amortization of bond premium, $1,100. c. The balance in Retained Earnings was $485,000 at December 31, 2013 and $728,000 at December 31, 2014. A stock dividend was declared and distributed which increased common shares by $280,000. (Show calculation of the cash dividend and indicate how it and the stock dividend would be shown). d. Equipment, which cost $115,000 with accumulated depreciation of $53,000, was sold for $67,000. e. The deferred tax liability increased $18,000. f. Issued 2,000 preferred shares with a fair value of $130 per share for a parcel of land. *Solution 22-66 a. Operating, add $650,000. b.

Operating, deduct $1,100.

Retained earnings 12/31/14 Retained earnings 12/31/13 Increase Stock dividend Net income Cash dividend

$728,000 (or) 485,000 243,000 280,000 523,000 650,000 $127,000

Net income $650,000 Increase in retained earnings 243,000 Total dividends 407,000 Stock dividends 280,000 Cash dividend $127,000

Stock dividend—Not shown Cash dividend—Financing ($127,000) d.

Investing, $67,000. Operating, deduct $5,000 (gain on sale).

Operating, add $18,000.

Noncash, $260,000. (2,000 x $130)

*Ex. 22-67 Preparation of statement of cash flows (indirect method) The following information is taken from Green Lake Corporation's financial statements. Green Lake adheres to ASPE: December 31 2014 2013 Cash ............................................................................................... $ 92,000 $ 27,000 Accounts receivable ........................................................................ 95,000 80,000 Allowance for doubtful accounts ...................................................... (4,500) (3,100) Inventory ......................................................................................... 145,000 175,000 Prepaid expenses ........................................................................... 7,500 6,800 Land................................................................................................ 93,000 60,000 Buildings ......................................................................................... 287,000 244,000

Statement of Cash Flows

22- 35

Accumulated depreciation ............................................................... Patents, net of accumulated amortization........................................ .......................................................................................................

(35,000) 20,000 $700,000

(13,000) 35,000 $611,700

Accounts payable............................................................................ Accrued liabilities ............................................................................ Bonds payable ................................................................................ Common shares.............................................................................. Retained earnings ........................................................................... Treasury shares, at cost .................................................................. .......................................................................................................

$ 90,000 54,000 125,000 100,000 346,000 (15,000) $700,000

$ 84,000 63,000 60,000 100,000 312,700 (8,000) $611,700

For 2014 Year Net income...................................................................................... $53,300 Depreciation expense ..................................................................... 22,000 Amortization of patents ................................................................... 7,000 Cash dividends declared and paid .................................................. 20,000 Gain or loss on sale of patents ........................................................ none Instructions Prepare a statement of cash flows (indirect method) for Green Lake Corporation for calendar 2014. *Solution 22-67 GREEN LAKE CORPORATION Statement of Cash Flows Year ended December 31, 2014 Cash flows provided by operating activities Net income .................................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ...................................................... Amortization of patent ...................................................... Increase in accounts receivable....................................... Decrease in inventory ...................................................... Increase in prepaid expenses .......................................... Increase in accounts payable .......................................... Decrease in accrued liabilities .........................................

$53,300

$22,000 7,000 (13,600) 30,000 (700) 6,000 (9,000)

Cash provided by operating activities ................................................... Cash flows provided by (used in) investing activities Purchase of land ........................................................................... Purchase of buildings .................................................................... Sale of patent ($35,000 - $20,000 - $7,000) ..................................

95,000

(33,000) (43,000) 8,000

Cash used in investing activities .......................................................... Cash flows provided by financing activities Sale of bonds ................................................................................

41,700

(68,000)

65,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Purchase of treasury shares.......................................................... Payment of cash dividends ...........................................................

(7,000) (20,000)

Cash provided by financing activities ...................................................

38,000

Net increase in cash ............................................................................ Cash, January 1, 2014 ......................................................................... Cash, December 31, 2014 ...................................................................

$65,000 27,000 $92,000

*Ex. 22-68 Preparation of statement of cash flows (format provided) Comparative statements of financial position for Burgundy Bay Ltd. are shown below: Burgandy adheres to ASPE. BURGUNDY BAY LTD. Statements of Financial Position

Cash ............................................................................................. Accounts receivable (net) .............................................................. Inventory ....................................................................................... Long-term investments .................................................................. Property, plant & equipment .......................................................... Accumulated depreciation .............................................................

Accounts payable .......................................................................... Accrued liabilities .......................................................................... Long-term notes payable............................................................... Common shares ............................................................................ Retained earnings .........................................................................

___December 31__ 2014 2013 $ 30,900 $ 10,200 48,300 20,300 35,000 42,000 0 15,000 236,500 150,000 (37,700) (25,000) $313,000 $212,500 $ 19,000 19,000 70,000 130,000 75,000 $313,000

$ 26,500 17,000 50,000 90,000 29,000 $212,500

Additional information concerning transactions and events during 2014: 1. Net income was $80,000. 2. Sold the long-term investments for $28,000. 3. Paid cash dividends of $34,000. 4. Purchased machinery costing $26,500, paid cash. 5. Purchased machinery by signing a $60,000 long-term note payable. 6. Extinguished a $40,000 long-term note payable by issuing common shares. Instructions Using the format provided on the next page, prepare a statement of cash flows (indirect method) for calendar 2014 for Burgundy Bay Ltd. BURGUNDY BAY LTD. Statement of Cash Flows Year ended December 31, 2014 Cash provided by operating activities

Statement of Cash Flows

Net income Adjustments to reconcile net income to net cash provided by operating activities:

22- 37

$__________

__________________________________

$__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________ __________

Cash provided by operating activities

__________

Cash provided by investing activities ___________________________________

__________

___________________________________

__________

___________________________________

__________

Cash provided by investing activities

__________

Cash provided by (used in) financing activities ___________________________________

__________

___________________________________

__________

Cash provided by (used in) financing activities

__________

Net increase (decrease) in cash

Cash, January 1, 2014 Cash, December 31, 2014

*Solution 22-68 BURGUNDY BAY LTD. Statement of Cash Flows Year ended December 31, 2014 Cash provided by operating activities Net income ...............................................................................

$ 80,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................................. $ 12,700 Gain on sale of investments ....................................... (13,000) Increase in accounts receivable.................................. (28,000) Decrease in inventory ................................................. 7,000 Decrease in accounts payable .................................... (7,500) Increase in accrued liabilities ...................................... 2,000 (26,800) Cash provided by operating activities .............................................. Cash provided by investing activities Sale of long-term investments .................................................. Purchase of machinery.............................................................

53,200

28,000 (26,500)

Cash provided by investing activities............................................... Cash provided by (used in) financing activities Paid dividends ..........................................................................

1,500

(34,000)

Cash provided by (used in) financing activities ................................

(34,000)

Net increase in cash ....................................................................... Cash, January 1, 2014 .................................................................... Cash, December 31, 2014 ..............................................................

$ 20,700 10,200 $ 30,900

Ex. 22-69 Direct and indirect methods Explain and compare the direct method and the indirect method of preparing a statement of cash flows. Solution 22-69 Only the operating activities section is affected by the choice of method. The investing and financing sections are the same under both methods. The direct method adjusts revenues and expenses to a cash basis by showing the actual cash received from customers (and any other forms of revenue) and the actual amount of cash paid out for suppliers, employees, operating expenses, interest, taxes, etc. The difference between cash revenues and cash expenses is cash net income, i.e., the net cash flow from operating activities. The indirect method adjusts accrual net income to a cash basis. This is done by starting with the accrual net income and adding or subtracting changes in the balances of current assets and current liabilities during the year, and adjusting for noncash items included in net income. Examples of noncash items include depreciation and amortization, bad debts expense, amortization of bond discount or premium, book gains and losses on disposal of assets, and equity method revenues and losses.

Ex. 22-70 Cash flows from operating activities (indirect and direct methods) Presented below is the latest income statement of Oxford Ltd.:

Statement of Cash Flows

Sales .......................................................................... Cost of goods sold ..................................................... Gross profit ................................................................ Operating expenses ................................................... Income before income taxes ...................................... Income taxes.............................................................. Net income .................................................................

22- 39

$380,000 225,000 $155,000 85,000 70,000 28,000 $ 42,000

In addition, the following information related to net changes in working capital is available: Debit Credit Cash .......................................................................... $12,000 Accounts receivable (net) ........................................... 8,000 Inventories ................................................................. $19,400 Salaries payable (operating expenses) ...................... 6,000 Accounts payable ....................................................... 9,000 Income tax payable .................................................... 3,000 Oxford Ltd. also reports that depreciation expense for the year was $13,700 and that the deferred tax liability account increased $2,600. Instructions Prepare a schedule calculating the net cash flow from operating activities that would be shown on a statement of cash flows: a. using the indirect method. b. using the direct method. Solution 22-70 a.

OXFORD LTD. Statement of Cash Flows (Partial) (Indirect Method)

Cash flows from operating activities Net income ............................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable....................................... Decrease in inventories ................................................... Decrease in salaries payable (operating expenses)......... Increase in accounts payable .......................................... Decrease in income taxes payable .................................. Depreciation expense ...................................................... Increase in future income tax liability ............................... Net cash provided by operating activities ............................... b.

$42,000

$ (8,000) 19,400 (6,000) 9,000 (3,000) 13,700 2,600

27,700 $69,700

OXFORD LTD. Statement of Cash Flows (Partial) (Direct Method) Cash flows from operating activities Cash received from customers ($380,000 – $8,000) ..............

$372,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash paid to suppliers ($225,000 – $19,400 – $9,000)........... Operating expenses paid ($85,000 + $6,000 – $13,700) ........ Taxes paid ($28,000 + $3,000 – $2,600) ................................ Net cash provided by operating activities ......................................

$196,600 77,300 28,400

302,300 $ 69,700

Ex. 22-71 Classification of cash flows (indirect method) Note that X in the following statement of cash flows identifies a dollar amount and the letters (A) through (F) identify specific items, which appear in the major sections of the statement of cash flows prepared using the indirect method. Cash flows from operating activities Net income Add (deduct) non-cash expenses: Add Deduct

+X –X

Cash provided by operating activities

Cash flows from investing activities Inflows Outflows

+X –X

Cash provided by (used in) investing activities Cash flows from financing activities Inflows Outflows

(A) (B)

+X –X

(E) (F)

Cash provided by (used in) by financing activities

Net increase (decrease) in cash

Instructions For each of the following items, indicate by letter in the blank spaces below, the section or sections where the effect would be reported assuming the company follows ASPE. Use the code (A through F) from above. If the item is not required to be reported on the statement of cash flows, write the word "none" in the blank. Assume that generally accepted accounting principles have been followed in determining net income and that there are no temporary investments which are considered cash equivalents. ____ 1. Issued preferred shares in exchange for equipment. ____ 2. Accounts receivable increased by $60,000. ____ 3. Accrued estimated income taxes for the year. ____ 4. Amortization of premium on bonds payable. ____ 5. Purchase of long-term investment. ____ 6. The book value of FV-NI investments was reduced to fair value. ____ 7. Declaration of stock dividends. ____ 8. Bad debts expense recorded (company uses the allowance method). ____ 9. Gain on disposal of old machinery.

Statement of Cash Flows

22- 41

____ 10. Declaration and payment of cash dividends. ____ 11. FV-NI investments sold at a loss. Solution 22-71 1. None 2.

None

10. F 11. A

*Ex. 22-72 Calculations for statement of cash flows (indirect method) During 2014, equipment was sold for $15,000. This equipment originally cost $24,000 and had a book value of $14,000 at the date of sale. Accumulated depreciation for equipment was $65,000 at December 31, 2013 and $62,000 at December 31, 2014. Instructions Based on the above information show how the sale (including any gain or loss), and the depreciation expense for 2014 would be shown on a statement of cash flows (indirect method). Include your calculations. *Solution 22-72 1. Sale - cash inflow from investing activities.................. 2.

$15,000

Sale price ................................................................... Book value ................................................................. Gain on sale ...............................................................

$15,000 14,000 $ 1,000

Cost ........................................................................... Book value ................................................................. Accumulated depreciation .......................................... Deduct decrease in accumulated depreciation ........... Depreciation expense ................................................

$24,000 14,000 10,000 (3,000) $ 7,000

Deduct from net Income

Add to net income

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

*Ex. 22-73 Calculations for statement of cash flows (indirect method) Cornwall Ltd. sold a machine that cost $19,000 and had a book value of $11,000 for $13,000. Data from the corporation's comparative statements of financial position are: Dec 31/14 Dec 31/13 Machinery $200,000 $173,000 Accumulated depreciation 48,000 34,000 Instructions Based on the above information, there are four items that need to be shown on a statement of cash flows (indirect method). Calculate these four items. Show your calculations. *Solution 22-73 1. Sale - cash inflow from investing activities.................. 2.

$13,000

$13,000 11,000 $ 2,000

Cost ........................................................................... Book value ................................................................. Accumulated depreciation .......................................... Add increase in accumulated depreciation ................. Depreciation expense ................................................

$19,000 11,000 8,000 14,000 $22,000

Cost of machine sold .................................................. Add increase in machinery ......................................... Purchase of machinery...............................................

$19,000 27,000 $46,000

Deduct from net income

Add to net income

Cash outflow from investing activities

Statement of Cash Flows

22- 43

PROBLEMS Pr. 22-74 Preparation of statement of cash flows (direct method) White Horse Ltd. has prepared the following comparative statements of financial position at December 31, 2013 and 2014: White Horse adheres to ASPE. 2014 2013 Cash .................................................................................... $ 99,000 $ 51,000 Accounts receivable ............................................................. 53,000 39,000 Inventory .............................................................................. 50,000 60,000 Prepaid expenses ................................................................ 6,000 9,000 Property, plant & equipment ................................................. 420,000 350,000 Accumulated depreciation .................................................... (150,000) (125,000) Goodwill ............................................................................... 51,000 58,000 $529,000 $442,000 Accounts payable ................................................................. $ 51,000 Accrued liabilities ................................................................. 20,000 Mortgage payable ................................................................ — Preferred shares .................................................................. 215,000 Common shares ................................................................... 200,000 Retained earnings ................................................................ 43,000 $529,000 1.

2. 3.

$ 56,000 14,000 150,000 — 200,000 22,000 $442,000

The Accumulated Depreciation account has been credited only for the depreciation expense for the year. There were no disposals of property, plant and equipment, but new equipment was purchased during 2014. Depreciation expense and a charge for impairment of goodwill have both been included in operating expenses. The Retained Earnings account was debited for cash dividends declared and paid of $46,000, and credited for the net income for the year. The condensed income statement for 2014 is as follows: Sales .......................................................................... $660,000 Cost of sales .............................................................. 363,000 Gross profit ................................................................ 297,000 Operating expenses ................................................... 230,000 Net income ................................................................. $ 67,000

Instructions From the information above, prepare a statement of cash flows (direct method) for calendar 2014. Solution 22-74 WHITE HORSE LTD. Statement of Cash Flows (direct method) Year ended December 31, 2014 Cash provided by operating activities Cash received from customers (1)............................................

$646,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Cash paid to suppliers (2) Operating expenses paid (3) ....................................................

$358,000 189,000

547,000

Net cash provided by operating activities ........................................

99,000

Cash provided by (used in) investing activities Purchase of plant assets ..........................................................

(70,000)

Cash provided by financing activities Payment of cash dividend ........................................................ Payment of mortgage payable.................................................. Sale of preferred shares ...........................................................

(46,000) (150,000) 215,000

Cash provided by financing activities ..............................................

19,000

48,000 51,000 $ 99,000

1. 2. 3.

$660,000 – $14,000 (increase in A/R) $363,000 – $10,000 (decrease in INVT) + $5,000 (decrease in A/P) $230,000 – $25,000 (depreciation) – $7,000 (impairment of goodwill) – $3,000 (decrease in prepaid expenses) – $6,000 (increase in accrued liabilities)

*Pr. 22-75 Preparation of statement of cash flows (indirect method) The net changes in the statement of financial position accounts of Brown Derby Corp. for calendar 2014 are shown below. Brown Derby adheres to ASPE. Account Debit Credit Cash ............................................................................................... $ 92,000 FV-NI investments .......................................................................... $121,000 Accounts receivable ........................................................................ 73,200 Allowance for doubtful accounts ...................................................... 13,300 Inventory ......................................................................................... 74,200 Prepaid expenses ........................................................................... 22,800 Long term investment (100% owned subsidiary) ............................. 20,000 Plant and equipment ....................................................................... 235,000 Accumulated depreciation ............................................................... 155,000 Accounts payable............................................................................ 80,700 Accrued liabilities ............................................................................ 16,500 Deferred tax liability ........................................................................ 15,500 Long term bonds ............................................................................. 80,000 Common shares.............................................................................. 240,000 Retained earnings ........................................................................... 98,000 _______ $668,600 $668,600 Other information regarding the corporation’s 2014 year: An analysis of the Retained Earnings account shows: Retained earnings, December 31, 2013 .......................................... Add: Net income .............................................................................

$1,300,000 287,000

Statement of Cash Flows

Subtotal .................................................................................. Deduct: Cash dividend ................................................................. Stock dividend................................................................. Retained earnings, December 31, 2014 .......................................... 1. 2. 3. 4. 5. 6. 7.

22- 45

1,587,000 $145,000 240,000

385,000 $1,202,000

On January 2, 2014, FV-NI investments costing $121,000 were sold for $150,000. The company paid the cash dividend on February 1, 2014, and distributed the stock dividend on August 1, 2014. Accounts receivable of $16,200 and $19,400 were considered uncollectible and written off in 2014 and 2013, respectively. Major repairs of $25,000 to the equipment were debited to the Plant and Equipment account during the year. The 100% owned subsidiary reported a net loss for the year of $20,000. At January 1, 2014, the cash balance was $136,000. Long term bonds were sold at par.

Instructions Prepare a statement of cash flows (indirect method) for calendar 2014. *Solution 22-75 BROWN DERBY CORP. Statement of Cash Flows (indirect method) Year ended December 31, 2014 Cash provided by operating activities Net income ............................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Equity investment loss ................................................ Depreciation expense ................................................. Gain on sale of FV-NI investments ............................. Decrease in deferred tax liability ................................. Increase in accounts receivable.................................. Increase in inventory .................................................. Decrease in prepaid expenses ................................... Decrease in accounts payable .................................... Increase in accrued liabilities ......................................

$287,000

$ 20,000 155,000 (29,000) (15,500) (59,900) (74,200) 22,800 (80,700) 16,500

Cash provided by operating activities .............................................. Cash flows provided by (used in) investing activities Sale of FV-NI investments ........................................................ Purchase of plant and equipment ............................................. Major repairs to equipment .......................................................

242,000

150,000 (210,000) (25,000)

Net cash provided by (used in) investing activities .......................... Cash provided by (used in) financing activities Payment of cash dividend ........................................................

(45,000)

(85,000)

(145,000)

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

Sale of bonds ...........................................................................

80,000

Net cash provided by (used in) financing activities ..........................

(65,000)

92,000 136,000 $228,000

*Pr. 22-76 Complex statement of cash flows (indirect method) The net changes in the statement of financial position accounts of Black Beauty Inc. for the calendar year 2014 are shown below: Account Cash ............................................................................................... Accounts receivable ........................................................................ Allowance for doubtful accounts ...................................................... Inventory ......................................................................................... Prepaid expenses ........................................................................... Long-term investments.................................................................... Land ............................................................................................... Buildings ......................................................................................... Machinery ....................................................................................... Office equipment ............................................................................. Accumulated depreciation: Buildings .................................................................................. Machinery ................................................................................ Office equipment ...................................................................... Accounts payable............................................................................ Accrued liabilities ............................................................................ Dividends payable ........................................................................... Bonds payable ................................................................................ Preferred shares ............................................................................. Common shares.............................................................................. Retained earnings ...........................................................................

Debit $ 62,800

Credit $ 32,000 7,000

108,600 10,000 72,000 150,000 300,000 50,000 14,000 12,000 10,000 6,000 91,600 36,000 64,000 416,000 30,000 43,600 $852,600

189,600 _______ $852,600

Additional information: 1. Net income for the year was $70,000. 2. Cash dividends of $64,000 were declared December 15, 2014, payable January 15, 2015. A 5% common stock dividend was issued March 31, 2014, when the market value was $22.00 per share. At the time there were 36,000 common shares outstanding. 3. The long-term investments were sold for $70,000. 4. A building which had cost $240,000, with a book value of $150,000, was sold for $200,000, and a new one was purchased. 5. The following entry was made to record an exchange of an old machine for a new one: Machinery............................................................................... 80,000 Accumulated Depreciation—Machinery .................................. 20,000 Machinery .................................................................. 30,000 Cash .......................................................................... 70,000 6. A fully depreciated copier machine, which cost $14,000, was written off.

Statement of Cash Flows

22- 47

7. Preferred shares originally issued for $30,000 were redeemed for $40,000. 8. Black Beauty sold 6,000 common shares on June 15, 2014 for $25 a share. 9. Bonds were sold at 104 on December 31, 2014. 10. Land with a book value of $120,000 was sold for $54,000. Instructions Prepare a statement of cash flows (indirect method) for calendar 2014. *Solution 22-76 BLACK BEAUTY INC. Statement of Cash Flows (indirect method) Year ended December 31, 2014 Cash provided by operating activities Net income ............................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense—buildings ...................................... Depreciation expense—machinery .................................... Depreciation expense—office equipment .......................... Gain on sale of building ..................................................... Loss on sale of long-term investments .............................. Loss on sale of land .......................................................... Decrease in accounts receivable (net)............................... Increase in inventory ......................................................... Increase in prepaid expenses ............................................ Decrease in accounts payable........................................... Increase in accrued liabilities ............................................. Cash provided by operating activities .............................................. Cash provided by (used in) investing activities Sale of long-term investments .................................................. Proceeds from sale of land ....................................................... Purchase of land ...................................................................... Proceeds from sale of building ................................................. Purchase of building ................................................................. Purchase of machinery............................................................. Cash provided by (used in) investing activities ................................

$ 70,000

$102,000 30,000 8,000 (50,000) 2,000 66,000 39,000 (108,600) (10,000) (91,600) 36,000

22,800 92,800

70,000 54,000 (270,000) (7) 200,000 (540,000) (8) (70,000)

Cash provided by financing activities Sale of bonds ........................................................................... Retirement of preferred shares................................................. Sale of common shares............................................................ Cash provided by financing activities .............................................. Net increase in cash ....................................................................... (1) Net change................................................................. Debit to accumulated depreciation on sale ................. Depreciation expense ................................................

(1) (2) (3) (4) (5) (6)

(556,000)

416,000 (9) (40,000) 150,000 (10) 526,000 $ 62,800

$ 12,000 90,000 $102,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

(2) Net change................................................................. Debit to accumulated depreciation on exchange ........ Depreciation expense ................................................

$10,000 20,000 $30,000

(3) Net change................................................................. Write-off ..................................................................... Depreciation expense ................................................

$(6,000) 14,000 $ 8,000

(4) Sale price of building .................................................. Book value ................................................................ Gain on sale ...............................................................

$200,000 150,000 $ 50,000

(5) Carrying value of long-term investments .................... Sale price .................................................................. Loss on sale ...............................................................

$72,000 70,000 $ 2,000

(6) Book value of land...................................................... Sale price ................................................................... Loss on sale ...............................................................

$120,000 54,000 $ 66,000

(7) Net change................................................................. Cost of land sold ........................................................ ...................................................................................

$150,000 120,000 $270,000

(8) Net change................................................................. Cost of building sold ................................................... ...................................................................................

$300,000 240,000 540,000

(9) $400,000 x 1.04 = $416,000. (10) 6,000 × $25 = $150,000. Common shares Sale 6,000 × $25 Stock dividend 36,000 x 5% × $22 Net change

= $150,000 = 39,600 $189,600

Retained Earnings Net income............................................. Dividends (cash) .................................... Dividends (stock) ................................... Preferred share redemption ................... Net change ............................................

$ 70,000 (64,000) (39,600) (10,000) $(43,600)

Pr. 22-77 Advantages and disadvantages of the direct and indirect methods Discuss the advantages and disadvantages of the direct and indirect methods of preparing a statement of cash flows. Solution 22-77 The direct method adjusts revenues and expenses to a cash basis. The difference between cash

Statement of Cash Flows

22- 49

revenues and cash expenses is cash net income, which is equal to net cash flow from operating activities (effectively, reporting income on a cash basis). The indirect method involves adjusting accrual net income to a cash basis. This is done by starting with accrual net income, adjusting for changes in working capital items and adding or subtracting noncash items included in net income. Public companies generally prefer the indirect method, whereas lending officers and investors tend to prefer the direct method, because of the additional information provided. The only section affected by use of the direct vs indirect methods is the operating activities. IFRS and ASPE also encourage the use of the direct method. The principal advantage of the direct method is that it shows operating cash receipts and payments, and is more consistent with the primary objective of a statement of cash flows, which is to provide information about an entity’s cash receipts and cash payments during a specific period. Advocates of this method maintain that such information is useful for estimating future cash flows. A possible disadvantage is that many companies say their data collection methods do not gather the information required to use the direct method, although this argument may be a bit weak given the powerful computer systems available today. As well, supporters of the indirect method say the direct method may incorrectly suggest that net cash flow from operating activities is as good as (or even better than) accrual net income as a performance measure. The principal advantage of the indirect method is that it focuses on the difference between net income reported on the income statement and the actual cash flow from operating activities. Other advantages offered by indirect method advocates are that it is the “familiar” method which has been used for many years, and that it is cheaper to develop the information compared to the information required for the direct method.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

CHAPTER 23 OTHER MEASUREMENT AND DISCLOSURE ISSUES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

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

2 2 3 3 4 4

E E E M H M

24. 25.

4 5

H M

30. 31.

3 4

M M

37. 38.

3 4

E M

44. 45.

4 5

H H

Note:

E = Easy

Item

LO LOD Item LO LOD Multiple Choice–Conceptual 7. 4 H 13. 6 H 8. 4 M 14. 7 M 9. 5 M 15. 7 M 10. 5 M 16. 7 M 11. 5 M 17. 8 M 12. 5 E 18. 8 M Multiple Choice–Computational 26. 5 M 28. 9 M 27. 9 M 29. 9 M Multiple Choice–CPA Adapted 32. 4 M 34. 5 M 33. 4 M 35. 5 M Exercises 39. 4 H 41. 5 E 40. 5 H 42. 5 M Problems 46. 7 M 48. 9 M 47. 8 M

M = Medium

Item

LOD

19. 20. 21. 22. 23.

8 9 9 9 10

M M M M E

36.

43.

H = Hard

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Note:

Item

Type

5. 6.

MC MC

7. 8.

MC MC

9. 10.

MC MC

11. 12.

MC MC

13.

14.

15.

17.

18.

20. 21.

MC MC

22. 27.

MC MC

23.

MC MC = Multiple Choice

Item Type Item Type Learning Objective 2 Learning Objective 3 30. MC Learning Objective 4 24. MC 32. MC 31. MC 33. MC Learning Objective 5 25. MC 34. MC 26. MC 35. MC Learning Objective 6 Learning Objective 7 16. MC 46. Pr Learning Objective 8 19. MC 47. Pr Learning Objective 9 28. MC 36. MC 29. MC 43. Ex Learning Objective 10

Ex = Exercise

Item

Type

Item

Type

38. 39.

Ex Ex

44.

40. 41.

Ex Ex

42. 45.

Ex Pr

48.

Pr = Problem

Other Measurement and Disclosure Issues

23- 3

CHAPTER STUDY OBJECTIVES 1. Understand the importance of disclosure from a business perspective. Information disclosure is important to the proper functioning of capital markets and the allocation of capital. The information provided in financial statements helps investors compare the performance of companies and to assess the relative risks and returns of different investments. The full disclosure principle suggests that information relevant to decision-making should be included in the financial statements. But financial statements are just one of many sources of information for investors and creditors.

2. Review the full disclosure principle and describe problems of implementation. The full disclosure principle calls for financial reporting of any financial facts that are significant enough to influence the judgement of an informed reader. Implementing the full disclosure principle is difficult because the cost of disclosure can be substantial and the benefits difficult to assess. Disclosure requirements for public entities have increased because of (1) the growing complexity of the business environment, (2) the necessity for timely information, and (3) the use of accounting as a control and monitoring device. For private entities, disclosure requirements have decreased due to the lesser complexity of many private entities and the fact that many stakeholders of private entities have greater access to information.

3. Explain the use of accounting policy notes in financial statement preparation. Notes are the accountant’s means of amplifying or explaining the items presented in the main body of the statements. Information that is pertinent to specific financial statement items can be explained in qualitative terms, and supplementary quantitative data can be provided to expand the information in the financial statements. Accounting policy notes explain the accounting methods and policies chosen by the company, thus allowing greater comparability between companies.

4. Describe the disclosure requirements for major segments of a business. If only the consolidated figures are available to the analyst, much information regarding the composition of these figures is hidden in aggregated figures. There is no way to tell from the consolidated data how much each product line contributes to the company’s profitability, risk, and growth potential. As a result, segment information is required by the profession for public entities.

5. Describe the accounting problems associated with interim reporting. Interim reports cover periods of less than one year. There are two viewpoints regarding interim reports. The discrete view holds that each interim period should be treated as a separate accounting period. In contrast, the integral view holds that the interim report is an integral part of the annual report and that deferrals and accruals should take into consideration what will happen for the entire year. IFRS encourages the discrete view approach. The same accounting principles that are used for annual reports should generally be employed for interim reports; however, there are several unique reporting problems. Interim reporting is not mandated by accounting standard setters even for public entities.

6. Discuss the accounting issues for relatedparty transactions. Related-party transactions

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pose special accounting issues. Since the transactions are not at arm’s length, they may have to be remeasured under ASPE, as the exchange value is not necessarily representative of the market or fair value. In the absence of reliable information, the transaction may have to be remeasured to reflect historical values or costs. IFRS does not require remeasurement of related-party transactions whereas ASPE does.

7. Identify the difference between the two types of subsequent events. The first type of events provides additional evidence about an event that existed at the SFP date. These events should be reflected in the SFP and income statement. The second type of event provides evidence about events or transactions that did not exist at the SFP date. These events should be disclosed in notes if they will have a material impact on the future of the company. 8. Identify the major disclosures found in the auditor’s report. If the auditor is satisfied that the financial statements present the financial position, results of operations, and cash flows fairly in accordance with generally accepted accounting principles, an unqualified opinion is expressed. A qualified opinion contains an exception to the standard opinion; ordinarily, the exception is not significant enough to invalidate the statements as a whole. An adverse opinion is required in any report in which the exceptions to fair presentation are so pervasive that a qualified opinion is not justified. A disclaimer of an opinion is appropriate when the auditor has gathered so little information on the financial statements that no opinion can be expressed.

9. Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis. Various techniques are used in the analysis of financial statement data. These include ratio analysis, percentage (common-size) analysis, and examination of related data (in notes and other sources). No one technique is more useful than another. Every situation faced by the analyst is different, and the answers needed are often obtained only on close examination of the interrelationships among all the data provided. Ratio analysis is a starting point in developing information desired by an analyst. While the basic concepts and tools for analysis are provided, keep in mind that there are limitations inherent in individual financial statement analysis techniques. For more complex techniques, you should refer to textbooks and courses that focus entirely on financial statement analysis.

10. Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future. Differences are noted in the chapter and the comparison chart.

Other Measurement and Disclosure Issues

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MULTIPLE CHOICE—Conceptual Answer b a d c d b c a d b a c d c d a b d c b a c b

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.

Description Components of annual report Increased disclosure requirements Disclosure of significant accounting policies Definition of errors and irregularities Segment revenue test Segment revenue test IFRS disclosures for reportable segments IFRS requirements for reporting segmented information IFRS requirements for interim reporting Discrete view for interim reporting IFRS requirements for interim reporting Problems with interim reporting Related-party transactions Subsequent events requiring adjustments Subsequent events requiring disclosure only Accounting for unincorporated businesses Auditor’s unqualified opinion Auditor’s qualified opinion Auditor’s adverse opinion Limitations of financial statement analysis Ratios reflecting financial strength Ratios assessing management performance Guidance given by ASPE and IFRS

MULTIPLE CHOICE—Computational Answer b c a b c c

No. 24. 25. 26. 27. 28. 29.

Description Determine reportable segments. Bonus expense on quarterly income statement Property taxes and repairs recognized in interim period. Calculate current ratio. Calculate inventory turnover. Calculate profit margin on sales.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—CPA Adapted Answer c c b b c d b

No. 30. 31. 32. 33. 34. 35. 36.

Description Significant accounting policies disclosures for plant assets Criteria for reporting segmented information Identification of reportable segments Identification of a reportable segment Annual expenses to be reported in interim statements One time only and annual expense to be reported in interim statements Calculate accounts receivable turnover.

EXERCISES Item E23-37 E23-38 E23-39 E23-40 E23-41 E23-42 E23-43

Description Notes to financial statements Segmented reporting (IFRS requirements) Segmented reporting Interim reports Internet financial reporting Income taxes at interim dates Ratios for financial analysis

PROBLEMS Item P23-44 P23-45 P23-46 P23-47 P23-48

Description Segmented reporting (IFRS requirements) Interim reporting Types of subsequent events Auditor’s report Ratio analysis

Other Measurement and Disclosure Issues

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MULTIPLE CHOICE—Conceptual 1. Which of the following items found in an annual report is NOT subject to GAAP? a. financial statements b. management discussion and analysis c. inventory methods d. accounting policies

2. Reasons for increased disclosure requirements do NOT include a. the current government trend toward reducing income taxes. b. the necessity for timely information. c. the complexity of the business environment. d. accounting as a control and monitoring device.

3. Which of the following does NOT need be disclosed in a Summary of Significant Accounting Policies? a. inventory valuation method(s) b. revenue recognition method(s) c. depreciation and amortization method(s) d. claims of shareholders

4. Errors and irregularities are defined as intentional distortions of facts. Yes or No? Errors Irregularities a. Yes Yes b. Yes No c. No Yes d. No No

5. According to IFRS, an operating segment is a reportable segment if a. its operating profit is 10% or more of the combined operating profit of profitable segments only. b. its operating loss is 10% or more of the combined operating losses of segments that incurred an operating loss. c. the absolute amount of its operating profit or loss is 10% or more of the greater, in absolute amount, of (a) the combined reported operating profit of all operating segments that incurred a loss, of (b) the combined reported profit of all operating segments that did report a profit. d. the absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of (a) the combined reported operating profit of all operating segments that did not incur a loss, or (b) the combined reported loss of all operating segments that did report a loss.

6. According to IFRS, a segment of a business is to be reported separately when its reporting revenue (including both sales to external customers and intersegment sales or transfers) exceeds

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10% of the a. total domestic sales only. b. combined revenues of all the enterprise's operating segments. c. combined revenues of all the enterprise’s profitable operating segments. d. combined net income of all the enterprise’s profitable operating segments.

7. IFRS requires that all of the following information about each reportable segment must be provided EXCEPT a. total liabilities. b. interest revenue. c. cost of goods sold. d. income tax expense or benefit.

8. Although ASPE does NOT offer guidance for reporting segmented information, IFRS requires that a. financial statements include selected information on a single basis of segmentation. b. financial statements include selected information on multiple bases of segmentation. c. financial statements disclose results for every segment, regardless of how many there are. d. management segment the enterprise on a geographical basis only.

9. For interim reporting, IFRS does NOT require a a. comprehensive income statement. b. statement of shareholders’ equity. c. statement of cash flows. d. detailed statement of financial position.

10. When using the discrete view to prepare interim statements, two exceptions that are permitted deal with the calculation of a. depreciation and income tax expense. b. income tax expense and employer’s payroll tax expense. c. depreciation and unearned revenue. d. unearned revenue and employer’s payroll tax expense.

11. Which of the following statements is INCORRECT regarding IFRS requirements for interim reporting? a. Only a statement of financial position and statement of comprehensive income are required. b. The same accounting policies should be used as for the annual statements. c. When an accounting change is applied retrospectively, the enterprise must present a statement of financial position for the beginning of the earliest comparative period. d. Condensed financial statements are permitted.

12. Problems with interim reporting include a. how to record depreciation. b. inventory valuation.

Other Measurement and Disclosure Issues

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c. how to present a change in accounting policy/principle. d. revenue recognition.

13. Regarding related-party transactions, a. transactions between related parties are usually presumed to take place at arms length. b. related parties do not include members of the immediate family of company management. c. both IFRS and ASPE deal only with disclosure requirements for such transactions. d. ASPE requires that some related-party transactions be remeasured.

14. Which of the following subsequent events (post-statement of financial position events) would require adjustment of the accounts before issuance of the financial statements? a. major losses as a result of a fire in the company’s plant b. decline in the fair value of investments c. loss on an account receivable (on the books at statement of financial position date) resulting from a customer’s bankruptcy d. lawsuit arising from a customer’s injury due to a defective product

15. Which of the following subsequent events (post-statement of financial position events) would generally require disclosure in the financial statement notes, but NOT adjustment of the accounts? a. retirement of the company president b. settlement of a lawsuit when the event that gave rise to the action occurred prior to the statement of financial position date c. strike by the company’s unionized workers d. issue of a significant number of common shares

16. Accounting issues involved for unincorporated businesses include a. the definition of the economic entity. b. who owns the issued shares. c. segregating the salaries expense for the owner(s) from the salaries expense for the employees. d. provision for income taxes. 17. When an auditor expresses an unqualified opinion about a company’s financial statements, it means that the financial statements a. are free from error. b. present fairly the financial position, results of operations, and cash flows in accordance with GAAP. c. indicate that the company is doing well and would make a good investment. d. contain exceptions due to a departure from GAAP. 18. When an auditor expresses a qualified opinion about a company’s financial statements, it means that the financial statements a. are free from error. b. present fairly the financial position, results of operations, and cash flows in accordance

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

with GAAP. c. indicate that the company is doing well and would make a good investment. d. contain exceptions due to a departure from GAAP. 19. An auditor’s adverse opinion a. although very rare in the past, is frequently seen nowadays. b. means the financial statements are prepared in accordance with GAAP. c. is given when the auditor deems a qualified opinion is not justified. d. means there are some minor exceptions due to a departure from GAAP.

20. Which of the following is NOT a limitation of financial statement analysis? a. Financial statements report on the past. b. Ratio and trend analyses will help identify strengths and weaknesses of a company. c. A single ratio, by itself, is not likely to be very useful. d. Financial statement analysis is not likely to reveal why things are as they are.

21. The ratios that reflect financial strength are a. liquidity and coverage ratios. b. liquidity and profitability ratios. c. profitability and activity ratios. d. activity and coverage ratios.

22. The ratios that assess management performance are a. liquidity and coverage ratios. b. liquidity and profitability ratios. c. profitability and activity ratios. d. activity and coverage ratios.

23. Which statement is INCORRECT regarding guidance given by IFRS and ASPE? a. IFRS provides guidance for interim reporting, while ASPE does not. b. ASPE provides guidance for segmented reporting, while IFRS does not. c. IFRS provides guidance for segmented reporting, while ASPE does not. d. IFRS does not provide guidance for reporting on unincorporated businesses.

Other Measurement and Disclosure Issues

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MULTIPLE CHOICE ANSWERS—Conceptual Item

1. 2. 3. 4.

Ans.

b a d c

Item

5. 6. 7. 8.

Ans.

d b c a

Item

9. 10. 11. 12.

Ans.

d b a c

Item

13. 14. 15. 16.

Ans.

d c d a

Item

17. 18. 19. 20.

Ans.

b d c b

Item

21. 22. 23.

Ans.

a c b

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE—Computational 24. Presented below are four segments that have been identified by Plum Corp.: Operating Segments Total Revenue Profit (Loss) Assets A $150,000 $20,000 $600,000 B 400,000 (35,000) 600,000 C 150,000 3,000 300,000 D 60,000 4,000 150,000 According to IFRS, which segments would be considered reportable segments? a. Segments A, B, and C b. Segments A, B, C, and D c. Segments A and B d. Segments A and D

25. In January 2014, Orange Ltd. estimated that its year-end bonuses to executives for calendar 2014 would be $640,000. In February 2014, $580,000 was paid in bonuses for the 2013 year-end. The estimate for 2014 is subject to year-end adjustment. How much bonus expense should be reflected in Orange's interim income statement for the three months ended March 31, 2014? a. $640,000 b. $580,000 c. $160,000 d. $145,000

26. On January 15, 2014, Truro Corp. paid $240,000 in property taxes on its factory building for the calendar year 2014. In the first week of April 2014, the corporation made unanticipated repairs to its plant equipment at a cost of $600,000. These repairs will benefit operations for the remainder of 2014 only. How should these expenses be reflected in Truro's quarterly income statements? Three Months Ended 3/31/14 6/30/14 9/30/14 12/31/14 a. $ 60,000 $260,000 $260,000 $260,000 b. $ 60,000 $660,000 $ 60,000 $ 60,000 c. $240,000 $600,000 $ -0$ -0d. $210,000 $210,000 $210,000 $210,000

Use the following data to answer questions 27–29. Pear Corp. reported the following data for calendar 2014: Total assets................................................................ $575,000 Current assets ............................................................ 250,000 Total liabilities ............................................................ 230,000 Long term liabilities .................................................... 110,000 Inventories, Dec 31/13 ............................................... 95,000 Inventories, Dec 31/14 ............................................... 85,000 Net sales .................................................................... 1,400,000

Other Measurement and Disclosure Issues

Gross profit ................................................................ Net income .................................................................

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840,000 165,000

27. To two decimals, Pear Corp.’s current ratio for 2014 is a. 1.09. b. 2.08. c. 2.50. d. 5.23. 28. To two decimals, Pear Corp.’s inventory turnover for 2014 is a. 9.33. b. 6.59. c. 6.22. d. 1.60. 29. To two decimals, Pear Corp.’s profit margin on sales for 2014 is a. 6.43%. b. 8348%. c. 11.79%. d. 19.64%.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

MULTIPLE CHOICE ANSWERS—Computational Item

Ans.

Item

Ans.

Item

Ans.

24. 25.

b c

26. 27.

a b

28. 29.

c c

Item

Ans.

DERIVATIONS—Computational No. Answer 24. b

25. 26.

c a

27. 28. 29.

b c c

Derivation Revenue test: Total revenue = $760,000 × 10% = $76,000 Operating profit test: $35,000 × 10% = $3,500 Asset test: Total assets = $1,650,000 × 10% = $165,000 $640,000 ÷ 4 = $160,000 $240,000 ÷ 4 = $60,000 $600,000 ÷ 3 = $200,000 $250,000 ÷ ($230,000 – $110,000) = 2.08 ($1,400,000 – $840,000) ÷ [($85,000 + $95,000) ÷ 2] = 6.22 $165,000 ÷ $1,400,000 x 100 = 11.79%

Other Measurement and Disclosure Issues

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MULTIPLE CHOICE—CPA Adapted 30. Which of the following facts concerning property, plant and equipment should be included in the Summary of Significant Accounting Policies? Depreciation Composition Method of Assets a. No Yes b. Yes Yes c. Yes No d. No No

31. Gooseberry Corp. is a multidivisional corporation that has both intersegment sales and sales to external customers. Gooseberry should report segmented financial information for each division meeting which of the following IFRS criteria? a. segment profit or loss is 10% or more of consolidated profit or loss b. segment profit or loss is 10% or more of combined profit or loss of all company segments c. segment revenue is 10% or more of combined revenue of all the company segments d. segment revenue is 10% or more of consolidated net income

32. Melon Corp. is engaged in manufacturing operations in various industries. The following data pertain to the industries in which operations were conducted for the year ended December 31, 2014. Assets Industry Revenue Profit 12/31/14 A $10,000,000 $1,650,000 $20,000,000 B 8,000,000 1,400,000 17,500,000 C 6,000,000 1,200,000 12,500,000 D 3,000,000 550,000 6,500,000 E 4,250,000 675,000 7,000,000 F 1,500,000 225,000 3,000,000 $32,750,000 $5,700,000 $66,500,000 According to IFRS, how many reportable segments does Melon have? a. three b. four c. five d. six

33. The following information pertains to Apple Corp. and its various divisions for the year ended December 31, 2014: Sales to external customers ............................................ $1,500,000 Intersegment sales of products similar to those sold to external customers ................................................... 450,000 Interest earned on loans to other operating segments ..... 30,000 According to IFRS, Apple has a reportable segment if that segment's revenue equals or exceeds a. $198,000. b. $195,000.

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c. $153,000. d. $150,000.

34. Peach Corp. has estimated that total depreciation expense for the 2014 calendar year will be $60,000, and that 2014 year-end bonuses to employees will be $120,000. In Peach's interim income statement for the six months ended June 30, 2014, what total expense relating to these two items should be reported? a. $ 0 b. $ 30,000 c. $ 90,000 d. $180,000

35. Raspberry Corp. had the following transactions during the quarter ended March 31, 2014: Loss due to theft......................................................... $126,000 Payment of fire insurance for calendar year 2014 ...... 180,000 What amount should be included in Raspberry's income statement for the quarter ended March 31, 2014? Loss from Theft Insurance Expense a. $ 0 $180,000 b. $126,000 $180,000 c. $ 31,500 $ 45,000 d. $126,000 $ 45,000

36. Prune Juice Corp. reported the following data on their 2014 financial statements: Net sales .................................................................... $900,000 Net income ................................................................. $160,000 Average net receivables ............................................. $110,000 To two decimals, the accounts receivable turnover for 2014 is a. 5.63. b. 8.18. c. 12.22. d. 17.78.

Other Measurement and Disclosure Issues

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MULTIPLE CHOICE ANSWERS—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

30. 31.

c c

32. 33.

b b

34. 35.

c d

36.

DERIVATIONS—CPA Adapted No. Answer 30. c 31. c 32. b

33. 34. 35.

b c d

36.

Derivation Conceptual Conceptual Revenue test: $32,750,000 × 10% = $3,275,000 Profit test: $5,700,000 × 10% = $570,000 Asset test: $66,500,000 × 10% = $6,650,000 A, B, C, E. ($1,500,000 + $450,000) × 10% = $195,000 ($60,000 + $120,000) ÷ 2 = $90,000 Loss from theft = $126,000 Insurance expense = $180,000 ÷ 4 = $45,000 $900,000 ÷ $110,000 = 8.18

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

EXERCISES Ex. 23-37 Notes to financial statements An article in Dun's Review made the following comments: "At least every other year, businesses should print the notes in big type and the financial figures in smaller ones." Instructions a. Are notes considered part of the financial statements and what basic purpose do they serve? b. What are the general types of notes? Solution 23-37 a. Notes are an integral part of the financial statements of a business enterprise. They are the accountant's method of more fully disclosing data relevant to the interpretation of the statements. Information pertinent to specific financial statement items can be explained in qualitative terms, and supplementary data of a quantitative nature can be provided to expand on the information in the financial statements. Restrictions imposed by financial arrangements or basic contractual agreements can also be explained in notes. b. The more common types of notes disclose such items as the following: (1) accounting methods used for depreciation, amortization and inventory, (2) contingent assets or liabilities, (3) restrictions required by loan covenants, (4) revenue recognition methods, and (5) purchase commitments.

Ex. 23-38 Segmented reporting (IFRS requirements) IFRS requires the reporting of segmented (disaggregated) financial data about operating segments and also about their products and services, the geographic areas in which they operate, and their major customers. Instructions Identify four of the items of segmented information IFRS requires an enterprise to report. Solution 23-38 IFRS requires that an enterprise report the following segmented information: 1. General information about its reportable segments. 2.

Segment revenues, profit and loss, assets, liabilities, and related information.

3. Reconciliation of the total of the segments’ revenues to total revenues, a reconciliation of the total of operating segments’ profits and losses to its income before income taxes and discontinued operations, and a reconciliation of the total of the operating segments’ assets and liabilities to total assets and liabilities. Reconciliations for other significant items that are disclosed should also be presented. 4.

Information about products and services (revenue from external customers).

5. Revenues from external customers (domestic vs foreign) and capital assets and goodwill (domestic vs. foreign). If the amounts are material, foreign information must be disclosed by country.

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Other Measurement and Disclosure Issues

6. If 10% or more of the revenues are derived from a single customer, the enterprise must disclose the total amount of revenues from each of these customers by segment. Note that ASPE does not provide guidance for reporting segmented information.

Ex. 23-39 Segmented reporting Tangerine Corporation's most recent (condensed) income statement is presented below: Revenues........................................................................................ $2,500,000 Expenses Cost of goods sold ................................................................... $1,000,000 Operating and administrative expenses ................................... 500,000 Depreciation expense .............................................................. 100,000 1,600,000 Income before taxes ....................................................................... 900,000 Income tax expense ........................................................................ 270,000 Net income...................................................................................... $ 630,000 Earnings per share (100,000 shares) ..............................................

$6.30

The following data relates to Tangerine's operating segments: Percent Identified with Segment Hotels Grains Candy Revenues 42% 50% 8% Cost of goods sold 48 49 3 Operating and administrative expenses 35 50 15 Depreciation expense 46 42 12 Included in the amounts allocated to each segment on the above percentages are the following expenses, which relate to general corporate activities: Operating Segment Hotels Grains Candy Totals Operating and administrative expenses $30,000 $22,000 $8,000 $60,000 Depreciation expense 4,000 5,000 3,000 12,000 Instructions (Assume that the corporation adheres to IFRS) a. Prepare a schedule showing the amounts distributed to each segment. b. Based only on the above information, which segments must be reported and why? Solution 23-39 a. Revenues (1) Expenses— Cost of goods sold (1) Operating and admin. exp (2) Depreciation expense (3) Total expenses Operating profit

Operating Segment Hotels Grains Candy Totals $1,050,000 $1,250,000 $200,000 $2,500,000 480,000 145,000 42,000 667,000 $ 383,000

490,000 228,000 37,000 755,000 $ 495,000

30,000 1,000,000 67,000 440,000 9,000 88,000 106,000 1,528,000 $ 94,000 $ 972,000

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

(1) Total times segment percentage. (2) Hotels = ($500,000 × 35%) – $30,000 = $145,000 Grains = ($500,000 × 50%) – $22,000 = $228,000 Candy = ($500,000 × 15%) – $8,000 = $67,000 (3) Hotels = ($100,000 × 46%) – $4,000 = $42,000 Grains = ($100,000 × 42%) – $5,000 = $37,000 Candy = ($100,000 × 12%) – $3,000 = $9,000 b. Two segments, Hotels and Grains, must be reported because they satisfy the revenue test; that is, the segment's revenues are 10% or more of the combined revenues of all operating segments. In addition, both the Hotels and the Grains segments meet the 10% of the operating profit test.

Ex. 23-40 Interim reports A few years ago, a publishing company reported a quarterly net profit figure that exceeded sales for that quarter. Such a situation suggests there are some difficult accounting issues involved in interim reporting. Instructions a. What are the major accounting problems related to interim reports? b. What problem exists with income taxes in interim reports and how does IFRS recommend that income taxes should be reported? c. Many academicians have attempted to predict the year's net income after the first quarter's income is reported. These attempts are generally unsuccessful, no matter how sophisticated the prediction model. What might be the reason for this inability to predict? Solution 23-40 a. The major accounting issues related to interim reporting are the treatment of (1) annually determined items such as income taxes, pension costs, and executive compensation based on annual net income, (2) retrospective accounting changes, (3) earnings per share, and (3) the problem of seasonality. b. The basic question with income taxes is whether, in the preparation of interim income statements, the provision for taxes should reflect the anticipated effective tax rate for the year or be calculated on the basis of actual results for that interim period. IFRS recommends that at the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. This rate should then be used in estimating income taxes on a current year-to-date basis. c. The prediction models are probably unsuccessful because accountants have not treated the problem of seasonality correctly in their interim reports. One of the problems is that fixed nonmanufacturing costs are not charged in proportion to sales. Instead, these costs are charged as incurred, or spread evenly over each quarter. As a result, it is extremely difficult to make accurate predictions because some artificial concepts are used for matching purposes.

Ex. 23-41 Internet financial reporting

Other Measurement and Disclosure Issues

23- 21

Discuss some of the issues involved with corporations reporting their results on the internet rather than in paper based formats. Solution 23-41 Advantages of internet reporting include the possibility of communicating with more users, lower costs of communication, the ability of users to use internet and computer tools to help in analysis of financial statements, more timely information, and the possibility of increased availability of information. Possible disadvantages are the differential access due to less than universal access to the internet and issues around reliability of the information, including the possibility of data corruption by hackers and the unaudited nature of much of the information.

Ex. 23-42 Income taxes at interim dates Discuss how income taxes are handled at interim dates. Solution 23-42 It is not feasible to prepare an accurate estimate of income taxes on interim statements as the tax rate is often dependent on the total taxable income for the year. As a result, interim income taxes are estimated using the annual estimated tax rate applied to the estimated interim taxable income and temporary differences.

Ex. 23-43 Ratios for financial analysis Discuss the four major types of ratios used for financial analysis, and give two examples of each. What would each type likely be used for? Solution 23-43 The four major types of ratios are: 1. Liquidity ratios, which measure the enterprise’s short-term ability to pay obligations as they become due. Examples are the current ratio and the acid-test ratio. 2. Activity ratios, which measure how effectively the enterprise is using its assets, as well as how quickly the asset’s value is realized. Examples are the inventory turnover and asset turnover ratios. 3. Profitability ratios, which measure financial performance and shareholder value creation for a specific time frame. Examples are profit margin on sales and rate of return on common shareholders’ equity. 4. Coverage (solvency) ratios, which measure the degree of protection for long-term creditors and investors, or the enterprise’s ability to meet long-term obligations. Examples are debt to total assets and times interest earned. Liquidity and coverage ratios generally reflect financial strength, i.e. the ability to satisfy the financial requirements of non-ownership interests. Activity and profitability ratios are generally used to assess management performance.

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Test Bank for Intermediate Accounting, Tenth Canadian Edition

PROBLEMS Pr. 23-44 Segmented reporting (IFRS requirements) A central issue in reporting on operating segments of a business enterprise is the determination of which segments are reportable under IFRS. Instructions a. According to IFRS, what are the tests to determine whether or not an operating segment is reportable? b. What is the test to determine if enough operating segments have been separately reported upon, and what is the guideline on the maximum number of operating segments to be shown? Solution 23-44 a. There are three basic tests to be applied to segments of an industry to see if they are significant enough to be separately reportable. If a segment meets any one of the tests, it is deemed significant and reportable. The first test is based on revenue. If a segment's revenue from sales to external customers and intersegment sales and transfers is equal to 10% or more of the enterprise's combined revenues, the segment is reportable. The second test is based on profits or losses. A segment is deemed reportable if the absolute amount of its profit or loss is 10% or more of the greater, in absolute amount, of: The combined profits of all operating segments reporting profits. The combined losses of all operating segments reporting losses. Third, a segment is reportable if its assets equal or exceed 10% of the combined assets of all operating segments of the enterprise. b. Enough operating segments must be separately reported so that the total of revenues from sales to external customers for the reportable segments equals or exceeds 75% of the combined sales to external customers for the entire enterprise. If applying the prescribed tests does not yield the required percentage of revenues described above, additional segments must be reported on until the 75% test is met. The profession recognizes that if an enterprise has many reportable segments, the benefit to the reader may be lost if more than 10 segments are reported. Therefore, it has proposed ten segments as an upper limit for the number of reportable segments. Note that ASPE does not provide guidance for reporting segmented information.

Pr. 23-45 Interim reporting There is ongoing discussion as to the proper method of reflecting results of operations at interim dates. Accordingly, IFRS has made recommendations regarding interim financial reporting. Instructions a. Discuss generally how revenue should be recognized at interim dates and specifically how

Other Measurement and Disclosure Issues

b. c.

23- 23

revenue should be recognized for industries subject to large seasonal fluctuations in revenue and for long-term contracts using the percentage-of-completion method. Discuss generally how product and period costs should be recognized at interim dates. Also discuss how inventory values should be treated at interim dates. Discuss how the provision for income taxes is calculated and reported in interim financial statements.

Solution 23-45 a. Sales and other revenues should be recognized for interim financial statement purposes in the same manner as for annual reporting purposes. This means normally at the point of sale or, in the case of services, at completion of the earnings process. In the case of industries whose sales vary greatly due to the seasonality, revenues should still be recognized as earned, but a disclosure should be made of the seasonal nature of the business. In the case of long-term contracts recognizing earnings on the percentage-of-completion basis, the current state of completion of the contract should be estimated and revenue recognized at interim dates in the same manner as at the normal year-end. b. For interim reporting purposes, product costs (costs directly attributable to the production of goods or services) should be matched with the product and associated revenues in the same manner as for annual reporting purposes. Period costs (costs not directly associated with the production of a particular good or service) should be charged to earnings as incurred or allocated among interim periods based on an estimate of time expired, benefit received, or other activity associated with the particular interim period(s). Also, if a gain or loss occurs during an interim period and is a type that would not be deferred at year-end, the gain or loss should be recognized in full in the interim period in which it occurs. Finally, in allocating period costs among interim periods, the basis for allocation must be supportable and may not be based on merely an arbitrary assignment of costs between interim periods. Inventory losses from a decline in market value at interim dates should be recognized in the appropriate period unless they are temporary and no loss is expected for the fiscal year. c. A corporation would prepare its tax return at year-end and assess taxes payable and related tax balances. It is normally neither cost effective nor feasible (since tax rates are often graduated) to do this for each interim period. Therefore an annual estimated tax rate is calculated, then an estimate is made of interim taxable income and temporary differences and then the annual estimated tax rate is applied.

Pr. 23-46 Types of subsequent events Identify the difference between the two types of subsequent events. Solution 23-46 Type 1 events provide additional evidence about situations that existed at the statement of financial position date, affecting the estimates used in preparing the financial statements and, therefore, will result in required adjustments. These items should be reflected in the final financial statements. To ignore these subsequent transactions is to miss an opportunity to improve the accuracy of the financial statements. Type 2 events provide evidence about situations that did not exist at the statement of financial position date. They arise subsequent to the statement of financial position date, and no

23- 24

Test Bank for Intermediate Accounting, Tenth Canadian Edition

adjustments are made to the accounts. However, they should be afforded note disclosure if they will have a material impact on the future of the enterprise. Pr. 23-47 Auditor’s report Identify the major disclosures found in the auditor’s report. Solution 23-47 If the auditor is satisfied that the financial statements fairly present the financial position, results of operations, and cash flows, in all material respects, in accordance with generally accepted accounting principles, an unqualified opinion is expressed. A qualified opinion contains an exception to the standard opinion; ordinarily the exception is not of sufficient magnitude to invalidate the statements as a whole. A qualified opinion may also be given if there is a scope limitation where the auditor has not been able to obtain sufficient and appropriate evidence. An adverse opinion is required in any report in which the exceptions to fair presentation are so material that a qualified opinion is not justified. A disclaimer of an opinion is appropriate when the auditor has gathered so little information on the financial statements that no opinion can be expressed. In such a case, the financial statements taken as a whole are not presented in accordance with Generally Accepted Accounting Principles.

Pr. 23-48 Ratio analysis The following select information is taken from Blueberry Pie Corp.’s statements of financial position at December 31, 2013 and 2014, and their income statement for calendar 2014: 2014 2013 Assets: Cash ............................................... $ 18,000 $ 22,000 FV–NI investments .......................... 25,000 -0Accounts receivable ........................ 38,000 42,000 Inventory ......................................... 61,000 52,000 Prepaid insurance ........................... 6,000 9,000 Long-term investments .................... 49,000 20,000 Equipment (net)............................... 130,000 130,000 Land ................................................ 33,000 33,000 Goodwill .......................................... 55,000 55,000 Total assets..................................... $415,000 $363,000 Net income............................................. Sales (all on credit) ................................ Cost of goods sold ................................. Interest expense .................................... Income tax expense ...............................

$ 62,250 305,000 123,000 15,600 17,450

Instructions From the above information, to one decimal, calculate the following for 2014: a. Inventory turnover b. Receivables turnover

Other Measurement and Disclosure Issues

c. d.

23- 25

Rate of return on assets Times interest earned.

Solution Pr. 23-48 a. Inventory turnover (cost of goods sold ÷ average INVT): $123,000 ÷ [($61,000 + $52,000) ÷ 2] = 2.2 times b. Receivables turnover (net sales ÷ average A/R): $305,000 ÷ [$38,000 + $42,000 ÷ 2] = 7.6 times c. Rate of return on assets (net income ÷ average total assets): $62,250 ÷ [($415,000 + $363,000 ÷ 2] x 100 = 16% d. Times interest earned (income before interest and taxes ÷ interest exp): ($62,250 + $15,600 + $17,450) ÷ $15,600 = 6.1 times

23- 26

Test Bank for Intermediate Accounting, Tenth Canadian Edition

COMPREHENSIVE EXAMINATION A PART 1 (Chapters 1–6)

Problem A-1 A-2 A-3 A-4 A-5 A-6 A-7

Topic Multiple Choice (various topics) Adjusting and Reversing* Entries Key Concepts and Definitions Discontinued Operations Financial Statement Classifications Income and Retained Earnings Statement Percentage-of-Completion Method

Approximate Time 15 min. 30 min. 10 min. 10 min. 10 min. 35 min. 10 min. 120 min.

A-2

Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

Problem A-1 Multiple Choice (various topics) Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ___1.

Which of the following entities is least likely to be a major player in developing financial reporting standards in Canada? a. International Accounting Standards Board b. (Canadian) Accounting Standards Board c. The Federal government d. Financial Accounting Standards Board

___2.

Financial statements are prepared for the user. Which of the following best describes the responsibility for the preparation of financial statements? a. They are the responsibility of management. b. They are the responsibility of external auditors. c. They are the responsibility of shareholders. d. They are the responsibility of standard setters.

___3. Which of the following is not an objective of financial reporting? a. to provide information about an entity’s economic resources, obligations and equity/net assets b. to provide information that is helpful to investors and creditors and other users in making resource allocation decisions and/or assessing management stewardship c. to provide information that is useful in assessing the economic performance of the entity d. to promote information asymmetry ___4.

A local businessman owns several different companies. His accountant prepares separate annual financial statements for each of these businesses. This is an application of which of the following principle or assumption? a. full disclosure b. periodicity c. economic entity d. matching

___5.

When knowledgeable, independent users achieve similar results or reach consensus regarding the accounting for a particular transaction, which enhancing qualitative characteristic is said to exist? a. comparability b. verifiability c. relevance d. understandability

___6.

A trial balance a. is a list of general ledger account names. b. proves that all transactions have been recorded. c. can be used for the preparation of financial statements. d. can never be used for the preparation of financial statements.

___7.

Which of the following is correct regarding income statement presentation? a. Income from continuing operations is the last line shown on the income statement. b. IFRS does not allow the use of a single step income statement.

Comprehensive Examination-A

c. d.

A-3

Unusual gains or losses must be presented in a separate section after income from continuing operations. IFRS requires that both basic and diluted earnings per share be presented, whereas ASPE does not.

___8.

IFRS requires that expenses are presented in the income statement a. by nature or by function. b. by amount or in alphabetical order. c. by geographical area or by the single-step method. d. by current or non-current.

___9.

Which of the following should not be considered as a current asset on the statement of financial position? a. instalment notes receivable due over eighteen months in accordance with normal trade practice b. prepaid taxes which cover assessments of the following operating cycle of the business c. equity or debt securities held to finance future construction of additional facilities d. spare parts and supplies inventories

___10. The discrete earnings process is one that a. takes place over several accounting periods. b. has a critical event. c. where substantial completion can be deferred. d. must be accounted for by the completed-contract method.

*Problem A-2 Adjusting and Reversing Entries At December 31, 2014, Doberman Corp.’s unadjusted trial balance was as follows: Cash ............................................................................................. $ 39,590 Accounts Receivable ..................................................................... 69,000 Allowance for Doubtful Accounts ................................................... $ 500 Merchandise Inventory .................................................................. 54,720 Prepaid Rent ................................................................................. 24,000 Investment in Mongrel Corp. Bonds .............................................. 70,000 Plant and Equipment ..................................................................... 156,000 Accumulated Depreciation ............................................................ 14,740 Accounts Payable ......................................................................... 11,370 Bonds Payable .............................................................................. 90,000 Common Shares ........................................................................... 170,000 Retained Earnings......................................................................... 97,180 Sales Revenue .............................................................................. 222,000 Cost of Goods Sold ....................................................................... 154,400 Transportation-Out ........................................................................ 11,000 Salaries and Wages Expense ....................................................... 32,000 Interest Expense ........................................................................... 2,040 Rent Revenue ............................................................................... 14,400 Miscellaneous Expense................................................................. 890 Insurance Expense ....................................................................... 6,550 $620,190 $620,190 Additional data: Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

A-4

2. 3.

4. 5. 6. 7.

Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

The balance in the Insurance Expense account contains the premium costs of three policies: Policy 1, remaining cost of $2,550, 1-yr. term, effective May 1, 2013; Policy 2, original cost of $2,700, 3-yr. term, effective Oct. 1, 2014; Policy 3, original cost of $1,300, 1-yr. term, effective Jan. 1, 2014. On September 30, 2014, Doberman received $14,400 rent from a lessee for an eighteen month lease beginning on that date, which was credited to the Rent Revenue account. All depreciable assets are depreciated at 10% per year. However, any acquisitions and disposals during the year are depreciated at half this rate. There were no acquisitions of PPE during 2014. On December 31, 2013, the balance in the Plant and Equipment account was $230,000. On December 28, 2014, the bookkeeper incorrectly credited Sales Revenue for a receipt on account from a regular customer of $10,000. At December 31, 2014, salaries accrued but unpaid were $4,200. Based upon an aging of the accounts, Doberman estimates that 5% of the Accounts Receivable balance on December 31, 2014 will become uncollectible. On August 1, 2014, Doberman purchased, as a temporary investment, $70,000, 6% bonds of Mongrel Corp. at par. The bonds mature on August 1, 2017. Interest payment dates are July 31 and January 31. On April 30, 2014, Doberman rented a warehouse for $2,000 per month, paying $24,000 in advance.

Instructions a. Record the necessary correcting and adjusting entries. b. Indicate which of the adjusting entries may be reversed at the beginning of 2015.

Problem A-3 Definitions and Key Concepts Provide clear, concise answers for the following: 1. What are permanent accounts? 2. What are temporary accounts? 3. How should unusual gains and losses be disclosed in the income statement? 4. Explain the merits of classified financial statements. 5. Explain the concept of free cash flow. 6. Explain the conceptual difference between the earnings and contract-based approaches to accounting for revenues.

Problem A-4 Discontinued Operations During calendar 2014, Collie Ltd. entered into an agreement to sell its Trucking Division to Rottweiler Ltd., in order to focus its efforts on expansion of its other divisions. For purposes of income statement reporting, the Trucking Division qualifies as a separate component of the business. The Trucking Division incurred a net loss of $250,000 from the beginning of the year to the date of sale, December 15, 2014. The combined assets of the Trucking Division had a book value of $7,340,000 and were sold for $9,000,000 on December 15, 2014. Assume Collie has an income tax rate of 40%. Instructions Calculate the amounts Collie should report for the following items in the Discontinued Operations section of the December 31, 2014 income statement: Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination-A

a. b.

A-5

Loss on Operation of Trucking Division. Gain/Loss on Disposal of Trucking Division.

Problem A-5 Financial Statement Classifications Financial statement classifications used by Bulldog Corp. follow: Statement of Financial Position Income or Retained Earnings Statement a. Current Assets j. Sales Revenue b. Investments k. Cost of Goods Sold c. Property, Plant, and Equipment l. Operating Expenses d. Intangible Assets m. Other Revenues and Gains e. Other Assets n. Other Expenses and Losses f. Current Liabilities o. Retained Earnings g. Long-term Debt p. Not on the statements h. Capital Shares i. Retained Earnings Instructions Specify, to the left of each account or item below, the letter of the financial statement classification the account would appear in. Use only the classifications shown. ____ 1. Preferred Shares

_____ 16. Merchandise Inventory

____ 2. Loss on Sale of Equipment

_____ 17. Salaries and Wages Expense

____ 3. Buildings

_____ 18. Merchandise on order with supplier

____ 4. Office Supplies Expense

_____ 19. Interest Revenue

____ 5. Allowance for Doubtful Accounts

_____ 20. Selling Expense

____ 6. Notes Payable—Short Term

_____ 21. Interest Expense

____ 7. Accum. Depreciation—Buildings

_____ 22. Taxes Payable

____ 8. Mortgage Payable due 2027

_____ 23. Insurance Expense

____ 9. Depletion Expense

_____ 24. Advertising Expense

____ 10. Freight-Out

_____ 25. Long-Term Investments

____ 11. Sales

_____ 26. Accounts Receivable

____ 12. Dividends Declared

_____ 27. Land

____ 13. Retained Earnings

_____ 28. Accounts Payable

____ 14. Cash

_____ 29. Error made in calculating prior year’s depreciation expense

___ 15. Sales Discounts

_____ 30. Gain from early retirement of debt

A-6

Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

Problem A-6 Income and Retained Earnings Statements Sheppard Corporation is a private corporation using ASPE. At December 31, 2014, an analysis of the accounts and discussions with company officials included the following account balances and other information: Accounts receivable ....................................................................................... $ 102,000 Accrued interest payable ................................................................................ 1,000 Dividend revenue ........................................................................................... 9,000 Sales .............................................................................................................. 600,000 Purchase discounts ........................................................................................ 9,000 Purchases ...................................................................................................... 360,000 Accounts payable ........................................................................................... 30,000 Loss from fire (net of $7,000 tax) .................................................................... 21,000 Selling expenses ............................................................................................ 64,000 Common shares (20,000 issued; no change during 2014) .............................. 200,000 Accumulated depreciation .............................................................................. 90,000 Long term note payable (due Oct 1, 2018) ..................................................... 100,000 Inventory, Jan 1, 2014 .................................................................................... 76,000 Inventory, Dec 31, 2014 ................................................................................. 62,500 Supplies inventory .......................................................................................... 40,000 Unearned service revenue.............................................................................. 3,000 Land ............................................................................................................... 370,000 Cash ............................................................................................................... 60,000 Franchise ....................................................................................................... 100,000 Retained earnings, Jan 1, 2014 ...................................................................... 135,000 Interest expense ............................................................................................. 8,500 Cumulative effect of change from straight-line to accelerated depreciation (net of $6,000 tax) ...................................................................... (18,000) General and administrative expenses ............................................................. 80,000 Dividends declared and paid .......................................................................... 15,000 Allowance for doubtful accounts ..................................................................... 5,000 Machinery and equipment .............................................................................. 225,000 Unless indicated otherwise, you may assume a 25% income tax rate. General and administrative expenses include depreciation. There are no preferred shares issued. Instructions a. Prepare, in good form, a multiple-step income statement. b. Prepare, in good form, a retained earnings statement.

Problem A-7 Journal entries—percentage-of-completion Terrier Corp. was awarded a contract to build a bridge in a suburb of Calgary at a total contract price of $9,000,000. The estimated total costs to complete the project were $7,000,000. Terrier uses the percentage-of-completion method for all such contracts. Instructions a. Prepare the entry to record construction costs of $4,200,000, on construction in process to date. b. Prepare the entry to record progress billings of $1,800,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination-A

Prepare the entry to recognize the profit that can be recognized to date.

A-7

A-8

Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

Solutions—Comprehensive Examination A Problem A-1 Solution 1. c 2.

10. b

Problem A-2 Solution a. 1. Prepaid Insurance ........................................................................ 2,475 Insurance Expense ................................................................ 2,475 Explanation: Both Policies 1 and 3 have expired, so their costs stay in Insurance Expense. The monthly premium for Policy 2 is $2,700 ÷ 36 = $75. At Dec 31/14, the unexpired portion is 33 months x $75 = $2,475, and needs to be transferred to the asset account. 2.

Rent Revenue .............................................................................. 12,000 Unearned Rent ...................................................................... 12,000 Explanation: Monthly rent is $14,400 ÷ 18 = $800. At Dec 31/14, 15 months x $800 = $12,000 remains unearned, and needs to be transferred to the liability account. 3.

Depreciation Expense .................................................................. 19,300 Accumulated Depreciation ..................................................... Explanation: Equipment retired during 2014 = $230,000 – $156,000 = $74,000. 10% of $156,000 = $15,600 5% of $74,000 = 3,700 Total depreciation = $19,300 4.

Sales Revenue ............................................................................. Accounts Receivable .............................................................

10,000

Salaries and Wages Expense ....................................................... Salaries and Wages Payable .................................................

4,200

19,300

10,000

4,200

Comprehensive Examination-A

A-9

Bad Debts Expense ...................................................................... 2,450 Allowance for Doubtful Accounts ............................................ 2,450 Explanation: Corrected ending A/R balance: $69,000 – $10,000 = $59,000. 5% x $59,000 = $2,950. Since the unadjusted Allowance is $500 Cr, the adjustment is $2,950 – $500 = $2,450 7.

Interest Receivable ....................................................................... Interest Revenue .................................................................... Explanation: $70,000 × .06 × 5 ÷ 12 = $1,750

1,750

16,000

Rent Expense ............................................................................... Prepaid Rent .......................................................................... Explanation: 8 months expired at $2,000 per month = $16,000

1,750

16,000

b. Items 1, 2, 5, and 7: Items No. 1 and No. 2 represent prepaid items that were initially recorded in temporary accounts. Items No. 5 and No. 7 represent accrued items.

Problem A-3 Solution 1. Permanent accounts (also called real accounts) are assets, liability and equity accounts. Unlike temporary accounts, permanent accounts are not closed. 2.

Temporary accounts are revenue and expense accounts. Unlike permanent accounts, they are closed at fiscal year end.

If they are material, they are disclosed separately but must be shown above "income(loss) before discontinued operations” and above the income tax provision. If they are immaterial, they are combined with other gains and losses of the period. Either way, they are included in the company's income form continuing operations.

Classification in financial statements increases their information content. This is accomplished through the grouping of items with similar characteristics and separating items with different characteristics.

Free cash flow can be defined as a measure of a company's level of financial flexibility and is calculated as cash flow from operating activities less capital expenditures and dividends.

The earnings approach focuses on the earnings process itself and how value is added. The contract-based approach focuses on the creation of contractual rights and obligations that are created by sales contracts.

Problem A-4 Solution a. Amount reported for “Loss on Operation of Trucking Division” equals loss incurred from beginning of year to date of sale (Dec 15/14), net of tax. Loss on Operation of Trucking Division ......................................... $150,000 (net of tax of $100,000, ($250,000 × 40%)) b.

Amount reported for “Gain/Loss on Disposal of Trucking Division” equals the gain or loss on the sale of the assets.

A - 10 Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

Gain on Disposal of Trucking Division .......................................... (net of tax of $664,000, ($1,660,000 × 40%))

$996,000

Problem A-5 Solution 1. h 2.

k or l

10. l 11. j 12. o 13. i and o 14. a 15. j 16. a 17. l 18. p 19. m 20. l 21. n 22. f 23. l 24. l Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination-A

A - 11

25. b 26. a 27. c 28. f 29. p 30. m

Problem A-6 Solution a. SHEPPARD CORPORATION Income Statement For the Year Ended December 31, 2014 Sales .................................................................................................... Cost of goods sold: Merchandise inventory, Jan. 1....................................................... Purchases ..................................................................................... Less purchase discounts ............................................................... Net purchases ........................................................................ Merchandise available for sale ...................................................... Less merchandise inventory, Dec. 31............................................ Cost of goods sold.................................................................. Gross profit on sales ............................................................................ Operating expenses: Selling expenses ........................................................................... General and administrative expenses ........................................... Total operating expenses ....................................................... Income from operations ....................................................................... Other revenues and gains: Dividend revenue .......................................................................... Other expenses and losses Interest expense............................................................................ Loss from fire* ............................................................................... Income before income tax .................................................................... Income tax**.................................................................................. Net income for the year ........................................................................ Earnings per common share (optional)***

$600,000 $76,000 $360,000 (9,000) 351,000 427,000 (62,500) 364,500 235,500 64,000 80,000 144,000 91,500 9,000 (8,500) (28,000)

(36,500) 64,000 (16,000) $ 48,000 $2.40

* actual loss $21,000 + $7,000 = $28,000 ** $64,000 x 25% = $16,000 *** $48,000 ÷ 20,000 = $2.40

A - 12 Comprehensive Exam-A for Intermediate Accounting, Tenth Canadian Edition

b. SHEPPARD CORPORATION Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1, as reported .......................................... Cumulative effect of change in depreciation method, net of applicable taxes of $6,000 ................................................... Retained earnings, January 1, as adjusted .......................................... Add: Net income .................................................................................. Subtotal ............................................................................................... Deduct: Dividends declared and paid .................................................. Retained earnings, December 31, 2014 ..............................................

$135,000 (18,000) 117,000 48,000 165,000 (15,000) $150,000

Problem A-7 Solution a. Construction in Process ................................................................ 4,200,000 Materials, Cash, Payables, etc. ............................................. 4,200,000 b.

Accounts Receivable—Construction in Process ........................... 1,800,000 Billings on Construction in Process ........................................ 1,800,000

Construction Expenses................................................................. 4,200,000 Construction in Process (60% complete) ...................................... 1,200,000 Revenue from Long-term Contract......................................... 5,400,000

Comprehensive Examination-A

A - 13

COMPREHENSIVE EXAMINATION B PART 2 (Chapters 7–8)

Problem B-1 B-2 B-3 B-4 B-5 B-6 *B-7

Topic Multiple Choice (various topics) Key Concepts and Definitions Note Receivable FIFO – Perpetual vs. Periodic Year-end Inventory Cutoff Gross Profit Method Bank Reconciliation

Approximate Time 15 min. 10 min. 20 min. 20 min. 25 min. 10 min. 20 min. 120 min.

*This topic is dealt with in an Appendix to the chapter.

B-2

Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

Problem B-1 Multiple Choice (various topics) For each of the following questions, select the letter of the statement which best answers the question and write it on the line to the left of the question. ___1.

When the allowance method is used for accounts receivable, when a customer account is recognized as “bad” and written off a. it is always debited to Allowance for Doubtful Accounts. b. it is always debited to Bad Debt Expense. c. it may be debited to Bad Debts Expense if the amount is immaterial. d. it is only debited to Allowance for Doubtful Accounts under IFRS.

___2.

The following information is available for Steelhead Company: Allowance for doubtful accounts at December 31, 2013 .......................... $ 8,000 Credit sales during 2014 .......................................................................... 400,000 Accounts receivable deemed worthless and written off during 2014 ........ 9,000 As a result of a review and aging of accounts receivable in early January 2015, however, it has been determined that an allowance for doubtful accounts of $7,500 is needed at December 31, 2014. What amount should Steelhead record as bad debt expense for the year ended December 31, 2014? a. $6,500 b. $7,500 c. $8,500 d. $15,500

Use the following information for Questions 3–4. Mackerel Ltd. makes all its sales on account, terms 2/10 n30. They recently sold $15,000 worth of merchandise to Pike Corp. ___3.

Assuming Mackerel uses the gross method to record sales on account, and payment from Pike was received within the discount period, the entry to record the receipt of payment would include a(n) a. additional debit of $300 to accounts receivable. b. credit of $300 to "Sales Discounts." c. credit of $14,700 to accounts receivable. d. credit of $15,000 to accounts receivable.

___4.

Assuming Mackerel uses the net method to record sales on account, and payment from Pike was received within the discount period, the entry to record the receipt of payment would include a(n) a. additional debit of $300 to accounts receivable. b. debit of $300 to "Sales Discounts Forfeited." c. credit of $14,700 to accounts receivable. d. credit of $15,000 to accounts receivable.

___5.

“Net Realizable Value” of an inventory item is now strictly defined as a. the estimated selling price of the item. b. the estimated selling price less estimated costs to sell and complete the item. c. the estimated selling price plus estimated costs to sell and complete the item. d. the original cost price less estimated costs to sell and complete the item.

___6.

In a period of rising prices, the inventory method which tends to give the highest reported

Comprehensive Examination B

B-3

inventory value on the statement of financial position is a. FIFO. b. moving average. c. specific identification. d. weighted-average. ___7.

The following information is available for Varden Inc. for last year: Freight-in ................................................................................ $ 20,000 Purchase returns .................................................................... 62,000 Selling expenses .................................................................... 110,000 Ending inventory..................................................................... 310,000 If the cost of goods sold is equal to 400% of selling expenses, what was the cost of goods available for sale? a. $390,000 b. $420,000 c. $720,000 d. $750,000

___8.

Since it began operations ten years ago, Carp Corp., has been using the weighted average method of inventory valuation. Its 2014 ending inventory was $28,000, but it would have been $70,000 if FIFO had been used. Thus, if FIFO had been used, Carp’s income before income taxes would have been a. $42,000 less over the ten-year period. b. $42,000 greater over the ten-year period. c. $42,000 greater in 2014. d. $42,000 less in 2014.

___9.

The 2014 financial statements of Bass Ltd. reported beginning inventory of $260,000, ending inventory of $290,000, and cost of goods sold of $1,300,000 for the year. To one decimal, Bass’s inventory turnover ratio for 2014 is a. 0.2 times. b. 4.5 times. c. 4.7 times. d. 5.0 times.

__*10. If the month-end bank statement shows a balance of $49,000, outstanding cheques are $16,000, a deposit of $7,000 was in transit at month end, and a cheque for $800 was erroneously charged by the bank against the account, the correct balance in the bank account at month end is a. $48,800. b. $40,800. c. $40,200. d. $40,000.

Problem B-2 Definitions and Key Concepts Provide clear, concise answers for the following: 1. What are cash and cash equivalents and how are they reported? 2. Identify the main differences between ASPE and IFRS with respect to the accounting for receivables. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

B-4

Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

Identify the inventory categories of a manufacturing company and describe how they are related.

Problem B-3 Note Receivable On December 31, 2013, Coho Corp. sold product to Ling Limited, accepting a 3%, four-year promissory note of $400,000 in exchange. Interest is payable annually on December 31, starting December 31, 2014. Coho Corp. normally pays 6% interest to borrow funds. Ling Limited, however, normally pays 8% to borrow funds. The product sold is carried on Coho’s books at a manufactured cost of $255,000. Assume Coho uses the perpetual inventory system. Instructions On Coho’s books, a. Prepare the required journal entries to record the transaction at December 31, 2013. Assume that the effective interest method is used. Use the interest tables on the following page (if needed) and round all values to the nearest dollar. b. Prepare all appropriate entries for 2014 in relation to this note. c. Prepare all appropriate entries for 2015 in relation to this note. For use on Problem B-3 (if needed) Table 1 Future Value of 1 Periods 1 2 3 4 5

2% 1.02000 1.04040 1.06121 1.08243 1.10408

3% 1.03000 1.06090 1.09273 1.12551 1.15927

4% 1.04000 1.08160 1.12486 1.16986 1.21665

6% 1.06000 1.12360 1.19102 1.26248 1.33823

8% 1.08000 1.16640 1.25971 1.36049 1.46933

6% 0.94340 0.89000 0.83962 0.79209 0.74726

8% 0.92593 0.85734 0.79383 0.73503 0.68058

Table 2 Present Value of 1 Periods 1 2 3 4 5

2% 0.98039 0.96117 0.94232 0.92385 0.90573

3% 0.97087 0.94260 0.91514 0.88849 0.86261

4% 0.96154 0.92456 0.88900 0.85480 0.82193

Table 3 Future Value of Ordinary Annuity of 1 Periodic Rents 1 2 3 4 5

2% 1.00000 2.02000 3.06040 4.12161 5.20404

3% 1.00000 2.03000 3.09090 4.18363 5.30914

4% 1.00000 2.04000 3.12160 4.24646 5.41632

6% 1.00000 2.06000 3.18360 4.37462 5.63709

8% 1.00000 2.08000 3.24640 4.50611 5.86660

Comprehensive Examination B

B-5

Table 4 Present Value of Ordinary Annuity of 1 Periodic Rents 1 2 3 4 5

2% 0.98039 1.94156 2.88388 3.80773 4.71346

3% 0.97087 1.91347 2.82861 3.71710 4.57971

4% 0.96154 1.88609 2.77509 3.62990 4.45182

6% 0.94340 1.83339 2.67301 3.46511 4.21236

8% 0.92593 1.78326 2.57710 3.31213 3.99271

Problem B-4 Journal entries for perpetual and periodic inventory systems Sockeye Corporation is a supplier of electronic components used in the manufacture of computers. The company uses the FIFO cost flow method. During the month of September 2014, Sockeye’s inventory records for part CAP-0256, showed the following transactions: Date

Transaction

Units Purchased

Unit Cost

Sep 1 Sep 8 Sep 17 Sep 23 Sep 30

Balance Purchase Sale Sale Purchase

900 400

$1.50 $1.58

650

Units Sold

Unit Selling Price

(800) (250)

$4.19 $4.29

$1.79

Instructions a. Assuming Sockeye uses a perpetual inventory system; prepare the journal entries for each of the above listed transactions. b. Assuming Sockeye uses a periodic inventory system; explain how the journal entries as compared to part a. would differ. Be specific. Do not prepare journal entries. c. What would be the difference in total cost of goods sold between parts a. and b.? Explain your answer.

Problem B-5 Year-end Inventory cutoff Salmon Corp.'s business year ends on December 31. They use the periodic inventory system. Listed below are purchase transactions which occurred during the last few days of 2014 or during the first few days of 2015. The inventory, determined by physical count, was taken after the close of business on December 31, 2014. The only adjusting entry recorded to date has been to enter the December 31 physical inventory on the books and to remove the beginning inventory. Instructions a. On the accompanying chart, indicate the effect of each of the following transactions on the ending inventory and on reported net income for 2014, by writing the words overstated, understated, or no effect in the appropriate column. Both columns must be answered for each transaction. b. Prepare all necessary correcting entries for 2014. Dec 31/14 Physical 2014 Inventory Income Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

B-6

Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

An invoice for $6,000, terms f.o.b. shipping point, was received and recorded on Dec 30. The invoice shows that the merchandise was shipped on Dec 29, and the receiving report indicates the merchandise was received on Jan 2.

______

_______

An invoice for $250, terms f.o.b. shipping point, was received and recorded on Dec 30. The invoice shows that merchandise was shipped on Dec 29, and the receiving report shows the merchandise was received on Dec 31.

______

_______

An invoice for $1,000, terms f.o.b. shipping point, was received and recorded on Jan 2. The invoice shows the merchandise was shipped on Dec 30, and the receiving report indicates the merchandise was received on Dec 31.

______

_______

An invoice for $800, terms f.o.b. destination, was received and recorded on Dec 30. The receiving report shows the merchandise was received on Jan 2.

______

_______

An invoice for $150, terms f.o.b. destination, was received and entered December 29. The receiving report indicates that the merchandise was received December 31.

______

_______

An invoice for $400, terms f.o.b. destination, was received and recorded on January 2. The receiving report indicates the merchandise was received on Dec 31.

______

_______

Merchandise costing $14,000 and with a selling price of $20,000 was on consignment to Tilapia Ltd., and was on that company's premises on Dec 31. No entry has been yet been made regarding this consignment.

______

_______

Problem B-6 Gross profit method On December 31, 2014, the entire inventory of Cod Corp. was destroyed by a flood. Sales and purchases for the year had been $2.3 million and $1.1 million, respectively. The beginning inventory (Jan 1, 2014) was $350,000. In the past, Cod’s gross profit has averaged 40%. Cod uses the periodic inventory system. Instructions a. Calculate the estimated cost of inventory destroyed. b. Prepare journal entries at December 31, 2014 to close the sales and related cost of goods sold accounts.

*Problem B-7 Bank Reconciliation Following is the general format of a bank reconciliation with the various categories numbered (1) through (4). Balance per bank statement

$XX,XXX

Comprehensive Examination B

Items to be added: Items to be deducted: Corrected bank balance

(1) (2) $YY,YYY

Balance per books Items to be added: Items to be deducted: Corrected cash balance

$AA,AAA (3) (4) $YY,YYY

B-7

Instructions a. To the left of the following items, write the number of the place in which the reconciling items would appear on a November bank reconciliation. If any items would not appear on the bank reconciliation, put an NA beside the item. ____ 1. The October bank service charge of $25 was recorded in the books in November. ____ 2. An NSF cheque in for $450 was returned with the November bank statement. This cheque will be redeposited in December. The firm has not yet made an entry for this. ____ 3. The first $5,000 deposit shown on the November bank statement was recorded in the books on October 31. ____ 4. The November service charge of $21 is included on the November bank statement. ____ 5. The bank collected a $4,500 note receivable for the firm during November plus $125 interest. The firm has not yet recorded this receipt. ____ 6. $15,000 of cheques written in November have not cleared the bank by November 30. ____ 7. All $18,000 of cheques written in October, which had not cleared the bank at October 31, cleared the bank in November. ____ 8. A cheque written in November was recorded in the books at $1,330. However, this cheque cleared the bank in November for $1,303 (which was the correct amount). This cheque was issued as a payment on account. ____ 9. A $15,000 deposit in transit at November 30 is included in the books, but does not show on the bank statement. ____ 10. The bank, in error, credited the firm’s account for $300 in November for another firm’s deposit. b.

Prepare any journal entries required by the information contained in a. above.

B-8

Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

Solutions — Comprehensive Examination B Problem B-1 Solution 1. a 2.

*10. b Solutions to computational Multiple Choice Questions: 2. $8,000 – $9,000 + $8,500 = $7,500 7.

$310,000 + (400% x $110,000) = $750,000

$1,300,000 ÷ (260,000 + $290,000) ÷ 2 = 4.7

*10. $49,000 – $16,000 + $7,000 + $800 = $40,800

Problem B-2 Solution 1. Cash and cash equivalents are financial assets. Cash consists of coins, currency and available funds on deposit at a bank, as well as negotiable instruments. Cash equivalents are highly liquid short-term investments that can be exchanged for known amounts of cash. Together they are usually reported as current asset, “cash and cash equivalents,” in the statement of financial position, unless the funds are restricted or otherwise encumbered. 2.

The two standards are for the most part very similar. Differences include the disclosure requirements, which are more extensive under IFRS, and the use of the effective interest method for the amortization of discounts and premiums for financial assets (required by IFRS, but optional under GAAP).

Manufacturing companies typically have three inventory categories: raw materials, work-inprocess and finished goods. Their relationship can be seen in that both the raw materials and the finished goods are included in the finished goods inventory. Specifically, the raw materials can be traced directly to the end product.

B-9

Comprehensive Examination B

Problem B-3 Solution a. Dec 31/13 Notes Receivable .......................................................................... 333,758 Sales Revenue ....................................................................... Cost of Goods Sold ....................................................................... Inventory ................................................................................ Computation of PV of note: (using 8%)* $400,000 × .73503 = 400,000 x 3% = 12,000 × 3.31213 = Present value of note Face value of note Amount of discount

333,758

255,000 255,000

$294,012 39,746 333,758 400,000 $ 66,242

OR 4 N 8 I 12000 PMT 400000 FV CPT PV = 333,757 *8% is used because it represents the borrowing rate at which Ling can obtain financing. In similar transactions, this is the rate that an independent borrower and lender would consider reasonable as it represents the market’s estimation of the riskiness of the customer. b.

Dec 31/14 Cash ............................................................................................. Interest Income ...................................................................... Notes Receivable .......................................................................... Interest Income ...................................................................... $333,758 × .08 = $26,701 – $12,000 = 14,701

Dec 31/15 Cash ............................................................................................. Interest Income ...................................................................... Notes Receivable .......................................................................... Interest Income ...................................................................... ($333,758 + $14,701) × .08 = $27,877 – $12,000 = $15,877

12,000 12,000 14,701 14,701

12,000 12,000 15,877 15,877

Problem B-4 Solution a. Sep 1 Balance would have been carried over from previous month. Sep 8 Inventory........................................... ............................................. Accounts Payable................................................................... To account for purchase (400 x $1.58 = $632) Sep 17 Accounts Receivable........................... .......................................... Sales........................................................... ............................

632 632

3,352 3,352

B - 10 Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

To record sale (800 x $4.19 = $3,352) Cost of goods sold............................. ........................................... Inventory................................................................................ To update inventory and cost of goods sold (800 x $1.50 = $1,200) Sep 23 Accounts Receivable....................... ............................................. Sales ..................................................................................... To record sale (250 x $4.29 = $1,072.50) Cost of goods sold............................ ............................................ Inventory................................................................................ To update inventory and cost of goods sold (100 x $1.50) + (150 x $1.58) = $387 Sep 30 Inventory ...................................................................................... Accounts Payable .................................................................. To account for purchase (650 x $1.79 = $1,163.50)

1,200 1,200

1,072.50 1,072.50

387 387

1,163.50 1,163.50

b. Under the periodic system, the entries to account for purchases would include a debit to purchases, rather than inventory. This is an expense account and is closed at the end of the accounting period. Under the periodic system, there would be no interim entries to update inventory and cost of goods sold. These entries are deferred until the end of the accounting period when cost of goods sold is recognized as a residual amount. c. Total cost of goods sold would not differ between parts a. and b. Sockeye uses the FIFO cost flow formula, which assumes that older goods are sold first. This cost flow is the same under both the perpetual and the periodic system.

Problem B-5 Solution a. 1. Understated/Understated 2. No effect/No effect 3. No effect/Overstated 4. No effect/Understated 5. No effect/No effect 6. No effect/Overstated 7. Understated/Understated b.

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

6,000 6,000

None

Comprehensive Examination B

Purchases .............................................................................. Accounts Payable ............................................................ Note the Jan 2 entry would need to be reversed

1,000

Accounts Payable................................................................... Purchases. ...................................................................... (JE should be in 2015)

800

1,000

800

None

Purchases .............................................................................. Accounts Payable ............................................................

400

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

13,000

B - 11

400

13,000

Problem B-6 Solution a. Beginning inventory .......................................................... $ 350,000 Add: Purchases................................................................. 1,100,000 Cost of goods available ..................................................... 1,450,000 Sales ................................................................................. $2,300,000 Less 40% .......................................................................... (920,000) 1,380,000 Estimated inventory lost .................................................... $ 70,000 b. Sales ............................................................................................. 2,300,000 Income Summary ..................................................................... 2,300,000 Cost of Goods Sold ....................................................................... 1,380,000 Inventory Loss from Fire................................................................ 70,000 (Beginning) Inventory ............................................................... 350,000 Purchases ................................................................................ 1,100,000

*Problem B-7 Solution a. 1. NA 2.

B - 12 Comprehensive Exam-B for Intermediate Accounting, Tenth Canadian Edition

10. 2 b.

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

450

Service Charge ...................................................................... Cash ...............................................................................

Cash ...................................................................................... Notes Receivable ............................................................ Interest Revenue ............................................................

4,625

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

450

4,500 125

Comprehensive Examination B

B - 13

COMPREHENSIVE EXAMINATION C PART 3 (Chapters 9–12)

Problem C-1 C-2 C-3 C-4 C-5 C-6

Topic Multiple Choice (various topics) Assignment of Costs Key Concepts and Definitions Rational Entity Impairment Model Depreciation Methods Equity Investment

Approximate Time 35 min. 10 min. 15 min. 25 min. 20 min. 15 min. 155 min.

C-2

Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

Problem C-1 Multiple Choice (various topics) Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ____1.

When the declining-balance method is used, depreciation expense for a given asset will a. decline by a constant amount each year. b. be the same each year. c. decrease rapidly at first, then slowly over the life of the asset. d. vary from year to year in relation to changes in output.

____2.

Norway Corporation acquired land, buildings, and equipment from a bankrupt competitor at a lump-sum price of $132,000. At the time of acquisition, Norway paid $12,000 to have the assets appraised. The appraisal disclosed the following fair values: Land .................................................................................... $96,000 Buildings.............................................................................. 76,800 Equipment ........................................................................... 19,200 What costs should be assigned to the land, buildings, and equipment, respectively? a. $96,000, $76,800, and $19,200. b. $66,000, $52,800, and $13,200. c. $72,000, $57,600, and $14,400. d. $48,000, $48,000, and $48,000.

____3.

Current Canadian practice indicates that the maximum period over which an intangible asset should be amortized is a. 20 years. b. 28 years. c. 40 years. d. its useful life or legal life, whichever is shorter.

____4.

Purchased goodwill represents a. the excess of the price paid over the fair value of the net assets obtained in a business combination. b. the excess of the price paid over the book value of the net assets obtained in a business combination. c. the difference in the aggregate amount of the market prices of the shares of the combining companies. d. a tangible asset.

____5.

As it is generally used in accounting, what is depreciation? a. It is a process of asset valuation for balance sheet purposes. b. It applies only to long-lived intangible assets. c. It is used to indicate a decline in market value of a long-lived asset. d. It is an accounting process that allocates long-lived asset cost to accounting periods.

Use the following data to answer questions 6–9. On July 1, 2014, Bosnia Corp. purchased a new piece of equipment for $300,000. The equipment has an estimated useful life of 5 years and an estimated residual value of $25,000. Bosnia uses the calendar year as its fiscal year, and records depreciation to the nearest month. The equipment is a Class 8 asset with a maximum CCA rate of 20%.

Comprehensive Examination C

C-3

____6.

What would the straight-line depreciation be for fiscal 2014? a. $60,000 b. $55,000 c. $30,000 d. $27,500

____7.

What would be the double declining-balance depreciation for 2015? a. $72,000 b. $96,000 c. $110,000 d. $120,000

____8.

If Bosnia expensed the total cost of the equipment at the time of purchase, what was the effect on 2014 and 2015 income before taxes, assuming Bosnia uses straight-line depreciation? a. $245,000 understated and $55,000 overstated b. $270,000 understated and $30,000 overstated c. $272,500 understated and $55,000 overstated d. $300,000 understated and $30,000 overstated

____9.

If, at the beginning of 2016, Bosnia decides the equipment still has five more years of life beyond December 31, 2015, with the same residual value, what would be the straight-line depreciation for 2016? (Assume straight-line used in all years.) a. $30,000 b. $32,083 c. $38,500 d. $55,000

____10. Other comprehensive income includes changes in equity a. related to non-owner sourced transactions. b. related to payment of dividends. c. due to errors of other years. d. due to unusual gains and losses of the current year. ____11. The cost model of accounting for PP&E assets a. should be applied to investment property only. b. should be applied to other PP&E assets only. c. can be applied to all classes of PP&E including investment property. d. is not appropriate under current Canadian GAAP. ____12. When an investor is using the equity method and the investee reports net income, the journal entry on the investor’s books will include a a. debit to the Investment account. b. credit to Retained Earnings. c. credit to the Investment account. d. debit to Investment Income or Loss. ____13. Under IFRS, which of the following is a condition for an investment to be classified as current? a. It must be a cash equivalent. b. It must be accounted for under the cost model. c. It is held primarily for trading purposes. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

C-4

Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

It may be held or trading purposes, but could be held for long-term appreciation as well.

____14. Russia Inc. owns bonds that are accounted for under the fair value through net income model. On December 31, 2014, the bonds have a carrying value of $248,700. The fair value at that date is $245,000. The entry to record the year-end adjustment will include a debit to a. FV–NI Investments. b. Investment Income or Loss. c. Unrealized Holding Loss on FV–OCI Investments. d. Other Comprehensive Income. ____15. If Latvia Inc. acquired a 30% interest in Lithuania Ltd. on January 1, 2014 for $90,000, and during 2014 Lithuania reported net income of $50,000 and paid a total cash dividend of $20,000, applying the equity method would result in an increase (decrease) to Latvia’s Investment in Lithuania Ltd. account for 2014 of a. $50,000. b. $30,000. c. $9,000. d. $(20,000). ____16. A replacement, which extended the life of a PPE asset, but did not increase the quality or quantity of units produced by the asset, cost $20,000. This expenditure should be debited to a. the related asset account. b. the related asset’s accumulated depreciation account. c. an expense account. d. retained earnings. ____17. Property, plant, and equipment are conventionally presented in the balance sheet at a. historical cost less residual value. b. historical cost less accumulated depreciation. c. fair value less residual value. d. fair value less book value. Use the following information for questions 18–19. Mongolia Corp. is considering acquiring Tibet Corp. The following information relates to Tibet Corp.: Net tangible assets at cost............................................................ $5,000,000 Net tangible assets at fair value .................................................... $5,500,000 Average net income for the past four years .................................. $ 475,000 Normal rate of return for the industry ............................................ 8% ____*18. What is the amount of goodwill if average excess earnings for the past four years are to be capitalized at the normal rate of return for the industry? a. $400,000 b. $437,500 c. $440,000 d. $500,000 ____*19. What is the total amount that Mongolia should be willing to pay for Tibet if average excess earnings for the past four years are to be capitalized at 14%? Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination C

a. b. c. d.

C-5

$5,750,000 $5,700,000 $5,250,000 $4,600,000

Use the following information for questions 20–21. On July 1, 2014, Bosnia Corp. purchased a new piece of equipment for $300,000. The equipment has an estimated useful life of 5 years and an estimated residual value of $25,000. Bosnia uses the calendar year as its fiscal year. The equipment is a Class 8 asset with a maximum CCA rate of 20%. ____*20. What is the maximum CCA for 2014? a. $60,000 b. $55,000 c. $30,000 d. $27,500 ____*21. Assuming maximum CCA was claimed in 2014, what is the maximum CCA for 2015? a. $48,000 b. $49,500 c. $54,000 d. $54,500 * This topic is dealt with in an Appendix.

Problem C-2 Assignment of Costs Match the following cost items with the appropriate accounts: a. Land c. Land Improvements b. Buildings d. Other ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

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

Interest cost incurred during building construction. Back taxes on land purchased to be used for building site. Assessment by city for drainage system. Building permits. Landscaping shrubs planted after building has been constructed. Demolition costs of building on land bought for plant site. Interest costs incurred after completion of building construction. Recording fees for land. Architect's fees. Grading and filling building site. Parking lots. Fences.

Problem C-3 Key Concepts and Definitions Provide clear, concise answers for the following: 1. What are the major categories of intangible assets? 2. What are the two models that are used to account for the impairment of intangible assets? Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

C-6

Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

3. Define depreciation accounting. 4. Does depreciation accounting provide funds? If not, what does provide funds? What does depreciation accounting do related to funds?

Problem C-4 Rational Entity Impairment Model Albania Corporation's balance sheet includes the following asset: Equipment .................................................................................... Less: Accumulated depreciation ................................................... Carrying amount (book value) ......................................................

$110,000 (20,000) $90,000

After performing its annual review for impairment, Albania obtains the following data: Asset value in use ........................................................................ $64,000 Fair value less selling costs .......................................................... $67,000 Instructions Assuming Albania uses the rational entity impairment model: a. Calculate the recoverable amount. b. Calculate the impairment loss. c. Prepare the entry to record the impairment loss.

Problem C-5 Depreciation Methods A machine costing $180,000 has an estimated residual value of $15,000 and an estimated service life of ten years. What is the annual depreciation for each of the first two full years under the following methods? 1.

Double declining-balance: a. Year one $______________ b. Year two $______________

2. Units of production. Lifetime production is estimated at 110,000 units; the machine produced 12,000 units in Year one and 18,000 in Year two: a. Year one $______________ b. Year two $______________ 3.

Straight-line depreciation method: a. Year one $______________ b. Year two $______________

*4. CCA (assume this is a Class 10 asset with a 30% CCA rate): a. Year one $______________ b. Year two $______________.

Problem C-6 Equity Investments On January 2, 2014, Azerbaijan Corp. invested $3,200,000 in Georgia Inc. for 40% of its outstanding common shares. At this time, the book value (equity) of Georgia Inc. was $8,000,000. Georgia pays out 25% of its net income in dividends each year. Azerbaijan elects two of five members of Georgia’s board of directors. During 2014, Azerbaijan received a cash dividend of $150,000 from Georgia Inc. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination C

Instructions a. Record the initial purchase of the Georgia Inc. shares by Azerbaijan Corp. b. Calculate Georgia Inc.’s net income for 2014. c. Record the 2014 journal entries related to this investment on Azerbaijan’s books.

C-7

C-8

Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

Solutions — Comprehensive Examination C Problem C-1 Solution 1. c 2.

10. a 11. c 12. a 13. c 14. b 15 c 16. a 17. b *18. b *19. a *20. c *21. c Solutions to computational multiple choice questions: 2. Total fair value is $192,000; paid $132,000, which is 68.75% of FV Land: $96,000 x 68.75% = $66,000 Building: $76,800 x 68.75% = 52,800 Equjpment: $19,200 x 68.75% = 13,200 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination C

6. $300,000 – $15,000 x ½ = $27,500 7. 2014: $300,000 × 2 ÷ 5 × ½= $60,000 2015: $300,000 – $60,000) × 2 ÷ 5 = $96,000 8. 2014: understated by cost of $300,000 and overstated by lack of depreciation expense of $27,500 = net of $272,500 understated 2015: overstated by depreciation exp not recorded of $55,000 9. ($300,000 – $27,500 – $55,000 – $25,000) ÷ 5 = $38,500 15. ($50,000 – $20,000) x 30% = $9,000 (increase) *18. Normal rate of return $5,500,000 x 8% = $440,000; excess is $475,000 – $440,000 = $35,000. Goodwill = $35,000 ÷ 8% = $437,500 *19. $5,500,000 (FV) + ($35,000 ÷ 14%) = $5,750,000 *20. $300,000 x 20% x ½ = $30,000 *21. ($300,000 – $30,000) x 20% = $54,000

Problem C-2 Solution 1. b 2.

a or c

10. a 11. c 12. c

C-9

C - 10 Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

Problem C-3 Solution 1. The major categories are marketing-related, customer-related, artistic-related, contract-based and technology-based intangible assets. 2.

The two models are the cost recovery impairment model and the rational entity impairment model. The first is used for ASPE and the latter is used in IFRS.

3. Depreciation accounting is the systematic and rational allocation of the cost of plant assets to the periods benefited from the use of the assets. 4. Depreciation accounting does not provide funds. Revenues provide funds. Depreciation accounting retains funds by reducing income taxes and dividends.

Problem C-4 Solution a. Recoverable amount: The recoverable amount is the higher of the asset's value in use of $64,000 and its fair value less selling costs of $67,000. Thus, the recoverable amount is $67,000. b. Impairment loss: Carrying amount ........................................................................... Recoverable amount .................................................................... Impairment loss ............................................................................ c. Journal entry: Loss on impairment ...................................................................... Accumulated impairment loss ................................................

$90,000 $67,000 $23,000

23,000 23,000

Problem C-5 Solution 1. a. $180,000 x 2 ÷ 10 = $36,000 b. ($180,000 – $36,000) x 2 ÷ 10 = $28,800 2.

Depreciation per unit ($180,000 – $15,000) ÷ 110,000 = $1.50 a. 12,000 x $1.50 = $18,000 b. 18,000 x $1.50 = $27,000

a. & b. (same both years) ($180,000 – $15,000) ÷ 10 = $16,500

*4. a. b.

$180,000 x 30% x ½ = $27,000 ($180,000 – $18,000) x 30% = $45,900

Problem C-6 Solution a. Investment in Associate. ............................................................... 3,200,000 Cash ...................................................................................... 3,200,000 b.

Total dividend paid by Georgia = $150,000 ÷ 40% = $375,000 Therefore net income for year = $375,000 ÷ 25% = $1,500,000

Comprehensive Examination C

Investment in Associate.(40% x $1,500,000)................................. Investment Income or Loss ....................................................

600,000

Cash ............................................................................................. Investment in Associate..........................................................

150,000

C - 11

600,000

150,000

C - 12 Comprehensive Exam-C for Intermediate Accounting, Tenth Canadian Edition

COMPREHENSIVE EXAMINATION D PART 4 (Chapters 13–17)

Problem D-1 D-2 D-3 D-4 D-5 D-6 D-7 D-8

Topic Current liabilities. Derivatives. Cash dividends. Stock dividends and stock splits. Earnings per share concepts. Convertible bonds. Basic and diluted earnings per share. Long-term liabilities.

Approximate Time 25 min. 20 min. 10 min. 10 min. 10 min. 15 min. 20 min. 35 min. 145 min.

D-2

Comprehensive Exam-D for Intermediate Accounting, Tenth Canadian Edition

Problem D-1 Current liabilities In each box of cereal that it produces, Crackle Cereal Corp. includes a special coupon. The purchaser may redeem 10 coupons for a cheese grater (premium). Each grater costs Crackle $0.90. During 2014, Crackle purchased 6,000 graters and sold 200,000 boxes of cereal @ $3.50 per box. Based on past experience, Crackle estimates that 60% of the coupons will be redeemed. During 2014, 45,000 coupons were presented for redemption. During 2015, 8,000 graters were purchased. As well, Crackle sold 300,000 boxes of cereal at $3.75 per box, and 90,000 coupons were presented for redemption. Instructions (show any calculations) Prepare all the journal entries that would be made regarding the cereal sales and the premium plan in both 2014 and 2015.

Problem D-2 Derivatives On January 3, Turkey Ltd. purchases a call option for $200 from Peacock Corp. to buy 1,000 Quail Inc. shares at an exercise price of $42 per share. The option expires May 1. At this time the current market price of Quail shares is also $42. On March 31 (Turkey’s year end), the market value of the Quail shares is $53, and the fair value of the option has increased to $14,000. On April 15, Turkey takes delivery of (buys) the Quail shares as agreed in the option contract. The market value of Quail’s shares is now $54. Instructions (show any calculations) a. Calculate the intrinsic value and the time value of this option at 1. January 3 2 March 31 b. Prepare general journal entries for the following dates: 1. January 3 2. March 31 3. April 15

Problem D-3 Cash dividends At December 31, 2014, Mississippi Corp. has the following shares outstanding (all no par value): 150,000 common shares .............................................................. $ 1,150,000 $6 preferred, 5,000 shares ........................................................... $ 500,000 The preferred shares are cumulative and participating up to an additional 4%. Dividends have not been paid since December 31, 2011. Mississippi now wishes to declare a total cash dividend of $240,000. Instructions Prepare the entry for the dividend declaration, separating the dividend into the common and preferred portions. Show all calculations.

Problem D-4 Stock dividends and stock splits Stock dividends and stock splits are common forms of corporate share distribution to shareholders. Consider each of the numbered statements below, and decide whether it: A. Applies to both stock dividends and stock splits. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination D

D-3

B. Applies to stock splits only. C. Applies to stock dividends only. D. Applies to neither. (In each instance, assume the issuing corporation has only one class of shares.) Instructions Print next to the number of each statement below, the single capital letter of the description which applies to the statement. Statements ____ 1. There is no transfer between retained earnings and share capital accounts. ____ 2. There is no change in the total shareholders' equity of the issuing corporation. ____ 3. The retained earnings account is increased. ____ 4. Book value decreases. ____ 5. Retained earnings in the amount of the distribution are transferred to share capital. ____ 6. Book value increases. ____ 7. The total number of shares outstanding is increased. ____ 8. The distribution is a multiple as compared to a percentage of the number of shares previously outstanding.

Problem D-5 Earnings per share (EPS) concepts Indicate which of the following types of securities would be included in the calculation of "basic earnings per share," and which would be included in the calculation of "diluted earnings per share." Place a "B" before those which affect only basic EPS, a "D" before those which affect only diluted EPS, a "BD" before those which affect both basic and diluted EPS, and an "N" before those securities which do not affect EPS calculations. Assume that, where applicable, the securities are dilutive. ____ ____ ____ ____ ____ ____ ____ ____

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

Notes payable Executive stock options Convertible bonds Cumulative, nonconvertible preferred shares Warrants to purchase additional common shares Common shares Nonconvertible bonds Convertible preferred shares

Problem D-6 Convertible bonds On January 1, 2014, Nebraska Corp. issued $5,000,000 (par value) 8%, 10-year convertible bonds at par. Interest is to be paid annually on December 31. Each $10,000 bond carries the right to purchase 100 Nebraska common shares for $20 each during the life of the bond. The current market rate for similar non-convertible bonds is 9%. Instructions a. Calculate how much of the bond proceeds to allocate to the bond and how much to the option. Nebraska adheres to IFRS. b. Prepare the journal entry to record the issuance of the bond. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

D-4

Comprehensive Exam-D for Intermediate Accounting, Tenth Canadian Edition

Problem D-7 Basic and diluted earnings per share The following data relate to Nevada Ltd. for the calendar year 2014: Net income (30% tax rate) ............................................................ $3,500,000 Average number of common shares outstanding during 2014 ........................................................ 1,000,000 shares 10%, cumulative convertible preferred shares: convertible into 80,000 common shares................................. $1,600,000 8% convertible bonds; convertible into 75,000 common shares ..................................................................... $2,500,000 Stock options, exercisable at $25 per share ................................. 90,000 shares All the convertible securities and stock options were outstanding all year. The average market price of the common shares in 2014 was $30. Instructions Calculate: a. basic earnings per share b. diluted earnings per share.

Problem D-8 Long-term liabilities 1. On March 31, 2010, Grape Corp. sold $1,000,000 (par value) 8%, 10-year bonds for $961,500 including accrued interest. The bonds were dated January 1, 2010. Interest is paid semi-annually on January 1 and July 1. On April 1, 2014, Grape purchased half of the bonds on the open market at 99 plus accrued interest and retired them. The corporation uses the straight-line method for amortization of bond premiums and discounts. a. Calculate the amount of the gain or loss on retirement of the bonds. b. Prepare the journal entries required on April 1, 2014 to record retirement of the bonds. Assume that interest and premium or discount amortization have been recorded through January 1, 2014. c. Prepare the journal entry on July 1, 2014 to record interest and premium or discount amortization. 2.

On January 1 of the current year, Lemon Ltd. issued $500,000 (par value) 10%, six year bonds when the market rate was 9%, receiving $522,430 cash proceeds. Interest is payable annually on December 31. The corporation uses the effective interest method for amortization of bond premium or discount. a. Calculate the interest expense for the first year. b. Calculate the interest expense for the second year.

On July 1, 2014, Mango Inc. issued $400,000 (par value) 10%, ten year bonds, with interest payable semi-annually on January 1 and July 1. The bonds were issued at $454,360 to yield 8%. The corporation uses the effective interest method for amortization of bond premium or discount. a. Prepare the journal entry on the date the bonds were issued. b. Prepare the adjusting entry at December 31, 2014, the end of the fiscal year. c. Prepare the entry for the interest payment on January 1, 2015.

Comprehensive Examination D

D-5

Solutions — Comprehensive Examination D Problem D-1 Solution 2014 Premium Inventory (6,000 x $0.90) ............................................... Cash (or Accounts Payable) ...................................................

5,400 5,400

Cash (or Accounts Receivable) (200,000 x $3.50) ........................ Sales ......................................................................................

700,000

Premium Expense ......................................................................... Premium Inventory ................................................................. 45,000 ÷ 10 = 4,500 × $0.90 = $4,050

4,050

Premium Expense ......................................................................... Estimated Liability for Premiums ............................................

6,750

700,000

4,050

6,750

200,000 × 60% = 120,000 coupons 120,000 – 45,000 redeemed = 75,000 ÷ 10 = 7,500 to be redeemed in 2015 7,500 × $0.90 = $6,750 Note total expense for year = 120,000 ÷10 = 12,000 x $0.90 = $10,800 ($4,050 + $6,750) 2015 Premium Inventory (8,000 x $0.90) ............................................... Cash (or Accounts Payable) ...................................................

7,200 7,200

Cash (or Accounts Receivable) (300,000 x $3.75) ........................ 1,125,000 Sales ...................................................................................... Estimated Liability for Premiums (balance from 2014) 7,500 x $0.90 Premium Expense 1,500 x $0.90 ..................................................... Premium Inventory ................................................................... 90,000 ÷ 10 = 9,000 x $0.90 = $8,100

6,750 1,350

Premium Expense ............................................................................ Estimated Liability for Premiums ...............................................

14,850

1,125,000

8,100

14,850

300,000 x 60% = 180,000 180,000 – 15,000 redeemed = 165,000 ÷ 10 = 16,500 to be redeemed in 2014 16,500 x $0.90 = $14,850 Note total expense for year = 180,000 ÷10 = 18,000 x $0.90 = $16,200 ($1,350 + $14,850)

Problem D-2 Solution a. 1. Jan 3 intrinsic value $42 – $42 = $0; time value $200 – $0 = $200 2. Mar 31 intrinsic value ($53 – $42) x 1,000 = $11,000; time value $14,000 – $11,000 = $3,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

D-6

Comprehensive Exam-D for Intermediate Accounting, Tenth Canadian Edition

1. Jan 3 Derivatives—financial assets ........................................................ Cash ......................................................................................

200

2. Mar 31 (year end) Derivatives—financial assets ($14,000 – $200) ............................ Gain .......................................................................................

13,800

3. Apr 15 Investment (1,000 x $54 – fair value) ............................................ Loss ............................................................................................. Derivatives—financial assets ................................................. Cash (1,000 x $42 – option price) ..........................................

Problem D-3 Solution Retained Earnings ........................................................................ Dividends Payable, Preferred ................................................ Dividends Payable, Common.................................................

200

13,800

54,000 2,000 14,000 42,000

240,000 110,000 130,000

Calculations: Arrears—5,000 × $6 × 2 ........................................... Current to pfd—5,000 × $6 ....................................... Common—$1,150,000 × 6% .................................... Participating 4%* ......................................................

Preferred $ 60,000 30,000 $69,000 20,000 $110,000

Common

Total $ 60,000 30,000

69,000 61,000 81,000 $130,000 $240,000

*$500,000 x 4% = $20,000 to preferred; balance to common

Problem D-4 Solution 1. B 2.

Comprehensive Examination D

D-7

Problem D-5 Solution 1. N 2.

Problem D-6 Solution a. Note that IFRS requires the use of the residual method. Annual interest $5,000,000 x 8% = $400,000 PV of bond is 10 N 9 I 400000 PMT 5000000 FV CPT PV => 4,679,117 Allocation of issue price to bond and option (residual method) Bond $4,679,117 (PV) Option $5,000,000 – $4,679,117 = $320,883 b.

Journal entry to record issuance of the convertible bond Cash ............................................................................................. 5,000,000 Bond Payable ......................................................................... 4,679,117 Contributed Surplus—Stock Options ...................................... 320,883

Problem D-7 Solution $3,500,000 – $160,000 a. Basic EPS = ——————————— = $3.34 1,000,000 Pref dividend is $1,600,000 x 10% = $160,000 b. Basic Options Subtotal Convertible bonds Subtotal Convertible preferred Subtotal

Shares (denominator) 1,000,000 **15,000 1,015,000 75,000 1,090,000 80,000 1,170,000

Numerator $3,340,000 0 3,340,000 * 140,000 3,480,000 160,000 3,640,000

EPS $3.34 $3.29 $3.19 $3.11

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Comprehensive Exam-D for Intermediate Accounting, Tenth Canadian Edition

*($2,500,000 × .08) × (1 – .30) = $140,000 ** 90,000 minus # shares that can be bought back for treasury, i.e., (90,000 x $25) ÷ $30 = 75,000

Problem D-8 Solution 1. a. Face amount of bonds ........................................................... Total selling price ................................................................... Less accrued interest ($1,000,000 × .08 × 3 ÷ 12) ................. Carrying value at Mar 31/10................................................... Discount at Mar 31/10 ($1,000,000 – $941,500) .................... Less discount amortization ($58,500 ÷ 117 × 48 months) ...... Unamortized discount ............................................................ Carrying value at Apr 1/14 .....................................................

$1,000,000 $961,500 20,000 $941,500 $58,500 24,000 34,500 $965,500

Carrying value of half of the bonds ........................................ Less acquisition price ($500,000 × .99) ................................. Loss on retirement ................................................................. b.

$482,750 495,000 $ 12,250

Interest Expense.................................................................... Bonds Payable ($250 × 3) .............................................. Cash ($1,000,000 × .08 × 3 ÷ 12 × ½ ) ........................... (To accrue interest to Apr 1/14)

10,750

Bonds Payable $500,000 – ($34,500 x ½) ............................. Loss on Retirement of Bonds ................................................. Cash ............................................................................... (To remove carrying value of bonds)

482,750 12,250

Interest Expense.................................................................... Bonds Payable ($58,500 ÷ 117 × 6 mos. × ½ ) ............... Cash ($500,000 x 8% x ½)..............................................

21,500

750 10,000

495,000

1,500 20,000

First year expense: $522,430 × .09 = $47,018.70

Second year interest expense: $50,000 – $47,018.70 = $2,981.30 Premium amortization (first year). $522,430 – $2,981.30 = $519,548.70 Book value of bonds at the beginning of the second year. $519,548.70 × .09 = $46,759.38 Interest expense.

Cash ...................................................................................... 454,360.00 Bonds Payable................................................................ 454,360.00

Interest Expense.................................................................... 18,174.40 Bonds Payable ...................................................................... 1,825.60 Interest Payable ($400,000 x 10% x ½) .......................... 20,000.00 (Interest expense: $454,360 × .08 × ½ = $18,174.40)

Comprehensive Examination D

D-9

Interest Payable ..................................................................... 20,000.00 Cash ................................................................................ 20,000.00

D - 10 Comprehensive Exam-D for Intermediate Accounting, Tenth Canadian Edition

COMPREHENSIVE EXAMINATION E PART 5 (Chapters 18–21)

Problem E-1 E-2 E-3 E-4

Topic Accounting changes and error corrections Deferred income taxes Pension calculations and accounting Leases

Approximate Time 30 min. 25 min. 35 min. 25 min. 115 min.

E-2

Comprehensive Exam-E for Intermediate Accounting, Tenth Canadian Edition

Problem E-1 Accounting changes and error corrections Wyoming Corp.’s reported pretax incomes for 2014 and the previous two years as follows: 2014 2013 2012 $150,000 $125,000 $95,000 2014’s income was correctly determined after taking into account the following accounting changes and error corrections made during the year (the errors were made in previous years but were not discovered until 2014). The incomes for 2012 and 2013 do not take these items into account and are stated at the amounts determined at the time. 1. Early in 2014, Wyoming determined that equipment purchased in January 2012 for $124,000, with an estimated life of five years and residual value of $4,000, is now estimated to have a total seven year life (from the date of purchase), but will have only a $2,000 residual value. Wyoming is using straight-line depreciation for this equipment. 2. Wyoming discovered that depreciation expense had been understated by $17,000 in 2013, owing to the fact that an adjusting entry for depreciation on machinery was not recorded. 3. On January 1, 2011, Wyoming bought a truck for $108,000, with a $12,000 estimated residual value and a six-year life. At that time, the bookkeeper debited an expense account for this purchase. Wyoming uses straight-line depreciation for its trucks. 4. Wyoming, in reviewing its allowance for doubtful accounts during 2014, has determined that 1% is the appropriate amount of bad debt expense to be recorded. The company had used 1.5% as its rate in 2013 and 2012 when the expense had been $14,000 and $10,000, respectively. Wyoming would have recorded $24,000 in bad debt expense for 2014 if they had used the old rate. 5. At the beginning of 2014, Wyoming decided to change from the average cost method of valuing inventories to FIFO, and used FIFO all during 2014 (perpetual system). They have determined that the opening inventory at January 1, 2014, which was $55,500 using average cost, would have been $52,500 using FIFO. Assume this change will make their financial statements as reliable and more relevant. Instructions a. For each of the situations above, prepare the journal entry or entries Wyoming Corp. would have prepared to adjust for them during 2014. If you think no entry was prepared, write “none.” Ignore income taxes. b. After recording each situation in part a., prepare the appropriate year-end adjusting entry (entries) that should have been made at December 31, 2014. If you think no entry would be required, write “none.” Ignore income taxes.

Problem E-2 Deferred income taxes In 2014, the first year of its existence, Virginia Ltd.'s accountant, in preparing both the income statement and the tax return, developed the following list of items creating differences between accounting and taxable income: 1. The company sells its merchandise on an installment contract basis. In 2014, Virginia elected, for tax purposes, to report the gross profit from these sales in the years the receivables are collected. However, for financial statement purposes, the company recognized all the gross profit in 2014. These procedures created a $240,000 difference between book and taxable incomes for 2014. Future collections of installment receivables are expected to result in taxable amounts of $120,000 in each of the next two years. 2. The company depreciates all of its property, plant and equipment using CCA for tax purposes and straight-line for accounting purposes. This resulted in $42,000 excess CCA over accounting depreciation. This temporary difference will reverse equally over the three year Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination E

E-3

period from 2015–2017. On July 1, 2014, Virginia leased part of its building to Swift Books Ltd. on a two-year operating lease. The monthly rent is $30,000, and Swift paid the first year's rent in advance (July 1, 2014 to June 30, 2015). Virginia reported the entire amount on its tax return. This resulted in a $180,000 difference between book and taxable incomes. Virginia sold $150,000 of bonds issued by the Government of Canada at a gain of $18,000, which was included as other income in its income statement. A taxable capital gain of $9,000 was reported for tax purposes. In 2014, Virginia insured the lives of its chief executives. The premiums paid were $12,000 and this amount was shown as an expense on the income statement. However, this amount was not deductible for tax purposes.

Virginia is a publicly accountable enterprise adhering to IFRS. Their 2014 income statement showed "Income before income taxes" of $900,000. The currently enacted income tax rate (and for the foreseeable future) is 40%. Except for those items mentioned above, there are no other differences between book and taxable incomes. Instructions a. Calculate the income tax payable for 2014. b. Prepare a schedule of future taxable/deductible amounts at the end of 2014. c. Prepare a schedule of the deferred tax asset and deferred tax liability at the end of 2014. d. Calculate the net deferred tax expense (benefit) for 2014. e. Prepare the journal entry (entries) recording income tax expense, income tax payable, and deferred income taxes for 2014. f. How would the income tax expense and any deferred taxes be disclosed on the financial statements?

Problem E-3 Pension calculations and accounting On January 1, 2014, Vermont Ltd. reported the following balances relating to their defined benefit pension plan: Defined benefit obligation ........................................... $1,600,000 Fair value of plan assets ............................................ 1,600,000 Other data related to the pension plan for calendar 2014 are: Current service cost ................................................... 70,000 Contributions to the plan ............................................ 102,000 Benefits paid .............................................................. 100,000 Actual return on plan assets ....................................... 96,000 Interest (discount) rate ............................................... 9% Vermont uses the immediate recognition approach. Instructions a. Calculate the defined benefit obligation at December 31, 2014. b. Calculate the fair value of plan assets at December 31, 2014. c. Calculate pension expense for 2014. d. Prepare the journal entries to record the pension expense and the contributions for 2014.

E-4

Comprehensive Exam-E for Intermediate Accounting, Tenth Canadian Edition

Problem E-4 Leases On January 1, 2014, Garfield Corp. (lessor) entered into a noncancellable lease agreement with Odie Corp. (lessee) for machinery which was carried in Garfield’s accounting records at $2,265,000 and had a fair value of $2,400,000. Minimum lease payments under the lease agreement, which expires on December 31, 2023, total $3,550,000. Payments of $355,000 are due each January 1. The first payment was made on January 1, 2014 when the lease agreement was finalized. The interest rate of 10% which was stipulated in the lease agreement is the implicit rate set by the lessor. The effective interest method is being used. Odie expects the machine to have a ten-year life with no residual value, and be depreciated on a straight-line basis. Collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the costs yet to be incurred by Garfield. Both entities are small private corporations that follow ASPE. Instructions a. From the lessee's viewpoint, what kind of lease is the above agreement? From the lessor's viewpoint, what kind of lease is the above agreement? b. Ignoring income taxes, what should be the income reported by Garfield from the lease for calendar 2014? c. Ignoring income taxes, what should be the expenses incurred by Odie from this lease for the calendar 2014? d. What journal entries should be recorded by Odie Corp. on January 1, 2014? e. What journal entries should be recorded by Garfield Corp. on January 1, 2014?

Comprehensive Examination E

E-5

Solutions — Comprehensive Examination E Problem E-1 Solution 1. a. None. b. Depreciation Expense ............................................................ 14,800 Accumulated Depreciation—Equipment .......................... Acc Dep to date ($124,000 – $4,000) ÷ 5 = $24,000 x 2 = $48,000 [($124,000 – $48,000) – $2,000] ÷ 5 = $14,800 2.

a. b.

Retained Earnings .................................................................. Accumulated Depreciation—Machinery ........................... None

17,000 17,000

Truck ...................................................................................... 108,000 Accumulated Depreciation—Truck .................................. Retained Earnings ........................................................... Acc Dep ($108,000 – $12,000) ÷ 6 = $16,000 x 3 = $48,000 Depreciation Expense ............................................................ 16,000 Accumulated Depreciation ............................................... None Bad Debt Expense ($24,000 ÷ 1.5)......................................... Allowance for Doubtful Accounts ..................................... Retained Earnings .................................................................. Inventory (beginning) ....................................................... None

14,800

48,000 60,000

16,000

16,000 16,000 3,000 3,000

Problem E-2 Solution a. Income tax payable: Pretax financial income ................................................................. $900,000 Permanent differences: Government of Canada bonds................................................ (9,000) Executive insurance premiums ............................................... 12,000 Temporary differences: Installment contracts .............................................................. (240,000) Excess CCA ........................................................................... (42,000) Rental income ........................................................................ 180,000 Taxable income ............................................................................. 801,000 Tax rate ......................................................................................... 40% Income tax payable ....................................................................... $320,400

E-6

Comprehensive Exam-E for Intermediate Accounting, Tenth Canadian Edition

2015 Future taxable (deductible) amounts: Installment sales Depreciation Unearned rent

2016

2017

Total

$120,000 $120,000 14,000 14,000 (180,000)

$14,000

$240,000 42,000 (180,000)

Future Taxable (Deductible) Temporary differences Amounts Installment sales ........................... $240,000 Depreciation ................................. 42,000 Rent .............................................. (180,000) Totals ..................................... $102,000

Tax Rate 40% 40% 40%

Deferred Tax____ (Asset) Liability $ 96,000 16,800 $(72,000) _______ $(72,000) $112,800

Deferred tax asset at end of 2014................................................. Deferred tax asset at beginning of 2014 ....................................... Deferred tax (benefit)....................................................................

$(72,000) -0$(72,000)

Deferred tax liability at end of 2014 .............................................. Deferred tax liability at beginning of 2014 ..................................... Deferred tax expense ...................................................................

$112,800 -0$112,800

Deferred tax expense ................................................................... Deferred tax (benefit).................................................................... Net deferred tax expense for 2014 ...............................................

$112,800 (72,000) $ 40,800

Current Tax Expense.................................................................... Deferred Tax Expense.................................................................. Deferred Tax Asset....................................................................... Deferred Tax Liability ............................................................. Income Tax Payable ..............................................................

320,400 40,800 72,000

Income statement Income before income taxes......................................................... Income tax expense: Current .................................................................................. Deferred ................................................................................ Net income ................................................................................... Statement of financial position Long-term assets: Deferred tax asset ................................................................. Long-term liabilities: Deferred tax liability ...............................................................

112,800 320,400

$900,000 $320,400 40,800

361,200 $538,800

$72,000 $112,800

OR Long-term liabilities: Deferred tax liability ($112,800 – $72,000) ............................

$40,800

Comprehensive Examination E

E-7

Problem E-3 Solution a. Defined benefit obligation, Jan 1 ................................................... $1,600,000 Current service cost ...................................................................... 70,000 Interest cost (9% × $1,600,000) .................................................... 144,000 Benefits paid ................................................................................. (100,000) Defined benefit obligation, Dec 31 ................................................. $1,714,000 b.

Fair value of plan assets, Jan 1 ..................................................... $1,600,000 Actual return.................................................................................. 96,000 Contributions ................................................................................. 102,000 Benefits paid ................................................................................. (100,000) Fair value of plan assets, Dec 31 .................................................. $1,698,000

Current service cost ...................................................................... Interest cost (9% × $1,600,000) .................................................... Actual return on plan assets .......................................................... Pension expense...........................................................................

$70,000 144,000 (96,000) $118,000

Pension Expense .......................................................................... Net Defined Benefit Liability/Asset ..........................................

118,000

Net Defined Liability/Asset ............................................................ Cash.......................................................................................

102,000

118,000

102,000

Problem E-4 Solution a. From the viewpoint of the lessee (Odie Corp.), the lease is a capital (finance) lease because the present value of the minimum lease payments ($2,400,000) exceeds 90% of the fair market value of the leased property. The lease term also is in excess of 75% of the property's estimated economic life. For those same reasons and because of the predictable collectibility, absence of uncertainties surrounding costs yet to be incurred by the lessor, and presence of a dealer's profit, the lease is a sales-type lease to the lessor, Garfield Corp. b.

Profit on sale ................................................................................. $135,000 Interest on outstanding balance ($2,400,000 – $355,000) × 10% .............................................. 204,500 Income of lessor in 2014 ............................................................... $339,500

Interest on outstanding balance ($2,400,000 – $355,000) × 10% .............................................. $204,500 Depreciation ($2,400,000 ÷ 10) ..................................................... 240,000 Expenses incurred by lessee in 2014 ............................................ $444,500

Machinery under Lease ................................................................. 2,400,000 Obligations under Lease......................................................... 2,400,000 Obligations under Lease ............................................................... Cash.......................................................................................

355,000 355,000

Lease Receivable.......................................................................... 3,550,000

E-8

Comprehensive Exam-E for Intermediate Accounting, Tenth Canadian Edition

Cost of Goods Sold ...................................................................... 2,265,000 Sales Revenue ...................................................................... 2,400,000 Inventory................................................................................ 2,265,000 Unearned Interest Income ..................................................... 1,150,000 Cash ............................................................................................. Lease Receivable ..................................................................

355,000 355,000

Comprehensive Examination E

E-9

COMPREHENSIVE EXAMINATION F PART 6 (Chapters 22–23)

Problem F-1 F-2 F-3 F-4 F-5

Topic Multiple choice Statement of cash flows (indirect method) Statement of cash flows (direct method) Segmented reporting Limitations of financial statement analysis

Approximate Time 15 min. 30 min. 30 min. 10 min. 15 min. 100 min.

F-2

Comprehensive Exam-F for Intermediate Accounting, Tenth Canadian Edition

Problem F-1 Multiple choice Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ____1.

In preparing a statement of cash flows, which of the following transactions would be considered a financing activity? a. purchasing new equipment b. recording net income c. selling common shares d. purchasing inventory

____2.

Which of the following items represents a potential outflow of cash? a. amortization of goodwill b. net loss from operations c sale of plant assets at a loss d. declaration of a stock dividend

____3.

For the year ended December 31, 2014, Oregon Corp. reported net income of $600,000. Additional information is as follows: Purchase of new equipment ......................................... $1,000,000 Depreciation of plant assets.......................................... 375,000 Cash dividends paid on common shares ...................... 200,000 Sale of long-term bonds................................................ 75,000 Impairment of goodwill .................................................. 35,000 Based on the information given above, using the indirect method, what is the cash provided by operating activities in the statement of cash flows for 2014? a. $ 885,000 b. $ 975,000 c. $1,010,000 d. $1,085,000

____4.

For the year ended December 31, 2014, Rhode Corp. reported net income of $1,400,000. Additional information is as follows: Purchase of new equipment ......................................... $ 300,000 Depreciation on plant assets......................................... 600,000 Cash dividends paid on common shares ...................... 150,000 Proceeds from sale of old equipment............................ 180,000 Issuance of preferred shares ........................................ 200,000 Purchase of long-term investment (equity method) ....... 120,000 Based on the information given above, what is the cash provided by (used in) investing activities in the statement of cash flows for 2014? a. $(240,000) b. $(390,000) c. $260,000 d. $580,000

____5.

Which of the following would not normally be considered an example of a related party? a. bondholders b. company management c. investors where there is significant influence or joint control d. immediate family members of company management

Comprehensive Examination F

F-3

____6.

In considering interim financial reporting, the International Accounting Standards Board (IASB) recommends that such reporting should be viewed as a. a "special" type of reporting that need not follow generally accepted accounting principles. b. useful only if activity is evenly spread throughout the year so that estimates are unnecessary. c. reporting for an integral part of an annual period. d. reporting for a discrete accounting period.

____7.

For interim reporting, the problem of seasonality is handled by a. estimating the seasonality effects and pro-rating them over the year. b. recognizing and accruing revenues and expenses when they are earned or incurred. c. deferring the recognition of certain revenues and expenses so that income can be more evenly spread throughout the year. d. spreading the seasonality effects retroactively across the previous interim periods.

____8.

Net income divided by average total assets is called the a. asset turnover. b. profit margin. c. rate of return on assets. d. price earnings ratio.

____9.

Cash dividends divided by net income is called the a. price earnings ratio. b. earnings per share. c. rate of return on common share equity. d. payout ratio.

Problem F-2 Statement of cash flows (indirect method) CAROLINA CORPORATION Comparative Statements of Financial Position December 31 2014 Cash ............................................................................. $ 43,000 Accounts receivable, net ............................................... 35,000 Inventory ....................................................................... 114,000 Land .............................................................................. 120,000 Building ......................................................................... 200,000 Accumulated depreciation ............................................. (50,000) Equipment ..................................................................... 1,030,000 Accumulated depreciation ............................................. (118,000) $1,374,000 Accounts payable .......................................................... $ 115,000 4% Bonds payable ........................................................ 320,000 Common shares ............................................................ 750,000 Retained earnings ......................................................... 189,000 $1,374,000

2013 24,000 38,000 82,000 190,000 200,000 (40,000) 600,000 (94,000) $1,000,000 $

$ 100,000 -0750,000 150,000 $1,000,000

F-4

Comprehensive Exam-F for Intermediate Accounting, Tenth Canadian Edition

Additional data: 1. Net income for the year was $84,000. 2. Cash dividends were paid. 3. Land was sold for $80,000. 4. Old equipment was sold for $70,000. This equipment had cost $150,000 and had accumulated depreciation of $60,000 to date of sale. New equipment was purchased to replace it. Instructions Prepare a statement of cash flows for calendar 2014, using the indirect method.

Problem F-3 Statement of cash flows (direct method) TEXAS CORPORATION Comparative Statements of Financial Position December 31 2014 Cash ........................................................................... $ 43,000 Accounts receivable, net ............................................. 35,000 Inventory..................................................................... 114,000 Land ........................................................................... 120,000 Building....................................................................... 200,000 Accumulated depreciation........................................... (50,000) Equipment .................................................................. 1,030,000 Accumulated depreciation........................................... (118,000) ................................................................................... $1,374,000 Accounts payable (merchandise purchases only) ....... Salaries payable ......................................................... 4% Bonds payable ...................................................... Common shares ......................................................... Retained earnings ...................................................... ...................................................................................

$ 115,000 20,000 300,000 750,000 189,000 $1,374,000

2013 24,000 38,000 82,000 190,000 200,000 (40,000) 600,000 (94,000) $1,000,000 $

$ 100,000 -0-0750,000 150,000 $1,000,000

TEXAS CORPORATION Income Statement For year ended December 31, 2014 Sales ............................................................................ $ 1,075,000 Cost of goods sold ........................................................ 640,000 Depreciation expense ................................................... 94,000 Salaries expense .......................................................... 140,000 Rent expense ............................................................... 72,000 Other operating expenses, including bond interest ....... 14,000 Net loss on sale of assets ............................................. 10,000 Income taxes expense.................................................. 21,000 Net income ................................................................... $ 84,000 Additional Data: 1. The bonds were sold at par on July 1, 2014. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

Comprehensive Examination F

2. 3. 4.

F-5

Cash dividends were paid. Land was sold for $80,000. Old equipment was sold for $70,000. This equipment had cost $150,000 and had accumulated depreciation of $60,000 to date of sale. New equipment was purchased to replace it.

Instructions Prepare a statement of cash flows for calendar 2014, using the direct method.

Problem F-4 Segmented reporting Utah Ltd. is a diversified corporation which has developed the following information about its five segments: A B C D E Total sales $200,000 $ 850,000 $150,000 $ 160,000 $ 290,000 Operating profit (loss) (125,000) 240,000 20,000 (150,000) (5,000) Total assets 800,000 2,900,000 600,000 1,700,000 2,800,000 Instructions Identify which segments would be considered as reportable segments by applying the following tests: a. revenue test b. operating profit or loss test c. assets test

Problem F-5 Limitations of financial statement analysis A CICA research study identified four sources of uncertainty as being important when considering the usefulness of financial statement information to a decision-maker. Briefly discuss these sources of uncertainty, and any other limitations that may be present when doing financial statement analysis.

F-6

Comprehensive Exam-F for Intermediate Accounting, Tenth Canadian Edition

Solutions — Comprehensive Examination F Problem F-1 Solution 1. c 2.

c ($600,000 + $375,000 + $35,000 = $1,010,000

a ($180,000 – $300,000 – $120,000 = $(240,000)

Problem F-2 Solution CAROLINA CORPORATION Statement of Cash Flows (indirect method) Year ended December 31, 2014 Cash flows provided by operating activities Net income ................................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable ........................................... Increase in inventory.............................................................. Increase in accounts payable ................................................ Gain on sale of land ............................................................... Loss on sale of equipment ..................................................... Depreciation expense—building ............................................ Depreciation expense—equipment ........................................ Cash provided by operating activities ........................................... Cash flows provided by (used in) investing activities Sale of land .................................................................................. Sale of equipment ........................................................................ Purchase of equipment ................................................................. Cash used in investing activities ................................................... Cash flows provided by (used in) financing activities Payment of cash dividends ........................................................... Issuance of bonds ........................................................................

$ 84,000

$ 3,000 (32,000) 15,000 (10,000) 20,000 10,000 84,000

90,000 174,000

80,000 70,000 (580,000) (430,000)

(45,000) 320,000

Comprehensive Examination F

Cash provided by financing activities.............................................

275,000

19,000 24,000 $ 43,000

F-7

Problem F-3 Solution TEXAS CORPORATION Statement of Cash Flows (direct method) Year ended December 31, 2014 Cash flows provided by operating activities Cash received from customers ............................................... $1,078,000 Cash paid out for merchandise purchases.............................. (657,000) Cash paid for salaries ............................................................. (120,000) Cash paid for rent ................................................................... (72,000) Cash paid for other expenses & bond interest ........................ (14,000) Cash paid for income taxes .................................................... (21,000) Cash provided by operating activities ............................................

194,000

Cash flows provided by (used in) investing activities Sale of land ................................................................................... 80,000 Sale of equipment ......................................................................... 70,000 Purchase of equipment ................................................................. (580,000) Cash used by investing activities ................................................... (430,000) Cash flows provided by financing activities Payment of cash dividends ........................................................... Issuance of bonds ......................................................................... Cash provided by financing activities............................................. Net increase in cash ............................................................................ Cash, January 1, 2014 ......................................................................... Cash, December 31, 2014 ...................................................................

(45,000) 300,000 255,000 19,000 24,000 $ 43,000

Problem F-4 Solution a. Revenue test—a segment is reportable if its total sales are $165,000 or more (10% × $1,650,000). Segments A, B, and E satisfy the revenue test. b. Operating profit or loss test—a segment's absolute profit or loss must be $28,000 or more [10% of the absolute greater of $260,000 or ($280,000)]. Segments A, B, and D satisfy the operating profit or loss test. c. Assets test—a segment's identifiable assets must be $880,000 or more (10% × $8,800,000). Segments B, D, and E satisfy the assets test. Segments A, B, D, and E are reportable because they passed at least one of the tests.

F-8

Comprehensive Exam-F for Intermediate Accounting, Tenth Canadian Edition

Problem F-5 Solution There are four sources of uncertainty: 1. Uncertainty about the nature and role of financial statements. Misunderstanding the nature, purpose, terminology used, and method of preparation of financial statements can lead users to misinterpret and/or place inappropriate reliance on the information. 2. Uncertainty about the nature of business operations portrayed in the financial statements. The unpredictability of business activities due to factors such as economic environment, technology, and competitors’ actions causes uncertainty. Knowledge of the type of business activities carried out is important in determining the extent of the uncertainties present. 3. Uncertainty due to limitations of financial statement measurements and disclosures. The conceptual framework, CICA Handbook recommendations, and accounting practice dictate that various principles be followed and methods used. Uncertainty occurs when there is recognition that the resulting measurements and disclosures are not well understood or are thought to be incomplete or to lack relevance in a particular decision context. 4. Uncertainty about management’s motives and intentions. Management is responsible for determining the accounting policies and methods used to prepare the financial statements. Choice of a policy or method should be based on reflecting underlying economic reality. This source of uncertainty suggests, however, that users may suspect that management’s choices are more motivated by a need to “manage earnings” – e.g. to maximize bonuses over time, or to avoid debt covenant violations. Other limitations of ratio analysis include: 5.

Ratios are based on historical cost, which can lead to distortions in measuring performance.

6. Accounting necessarily involves estimates. Estimated items (such as depreciation, site restoration costs, and bad debts) can be significant, and ratios based on significant estimates may be less credible. 7. Achieving comparability among companies in a given industry may be difficult. Different enterprises often apply different accounting policies. Therefore, the analyst must identify basic differences in their accounting methods and make adjustments accordingly.

Comprehensive Examination F

F-9