Sample Chapter



Modern Advanced Accounting in Canada 7th edition by Hilton – Solution Manual 



CHAPTER 1 A Survey of International Accounting



  1. Explain if and when it may be appropriate for an accountant to prepare

financial statements that are not in accordance with GAAP.

  1. Why is it important to supplement studies of Canadian accounting principles

with studies of the accounting practices used in other countries?

  1. In what manner has there been a shift toward a global capital market in

recent years?

  1. List the factors that have influenced the accounting standards used in a particular


  1. What role does the stage of development of a country’s capital markets have

on the direction taken by the country’s accounting standards?

  1. In what way has the level of inflation influenced the accounting standards of

a particular country?

  1. In what manner does the balance-sheet format used by companies in other

countries differ from the format used by Canadian companies?

  1. Identify some of the financial statement items where U.S. GAAP is different

from IFRSs.

  1. What is the goal of the IASB?
  2. What does the FASB-IASB convergence project expect to achieve? How will

it be carried out?

  1. What evidence is there that IASB pronouncements are becoming acceptable

throughout the world?

  1. Describe the extent of harmonization or convergence of accounting standards

for publicly accountable enterprises in Canada with the standards

published by the IASB.

  1. Explain why complete comparability on a worldwide basis is going to be difficult

to achieve despite a switchover to IFRSs.

  1. Briefly explain why the Canadian AcSB decided to create a separate section

of the CICA Handbook for private enterprises.

  1. Briefly explain why a Canadian private company may decide to follow IFRSs

for public companies, even though it could follow GAAP for private companies.


LO2, 4











LO3, 4



  1. No impairment under U.S. GAAP because undiscounted future cash flows

exceed net book value. Under IFRS, impairment loss is excess of carrying

amount over recoverable amount, which is higher of value in use and fair

value. Accumulated impairment loss decreased during the year by $100

(6,000 2 5,870) 2 (4,800 2 4,770). Therefore, impairment loss reversal during

the year was $100.

  1. (a) Assets decreased at end of the year by $30 (4,800 2 4,770)

(b) The current ratio decreased, which means that liquidity looks worse

under IFRS.

The debt-to-equity ratio increased, which means that solvency looks

worse under IFRSs.

The return on total equity decreased, which makes profitability look

worse under IFRSs.

36 CHAPTER 1 A Survey of International Accounting

In this era of rapidly changing technology, research and development (R&D)

expenditures represent one of the most important factors in the future success

of many companies. Organizations that spend too little on R&D risk being left

behind by the competition. Conversely, companies that spend too much may

waste money or not be able to make efficient use of the results.

In the United States, all R&D expenditures are expensed as incurred. However,

expensing all R&D costs is not an approach used in much of the world. Firms

using IFRSs must capitalize development costs as an intangible asset when they

can demonstrate

(a) the technical feasibility of completing the intangible asset so that it will be

available for use or sale;

(b) its intention to complete the intangible asset and use or sell it;

(c) its ability to use or sell the intangible asset;

(d) how the intangible asset will generate probable future economic benefits—

among other things, the entity can demonstrate the existence of a market for

the output of the intangible asset or for the intangible asset itself or, if it is to

be used internally, the usefulness of the intangible asset;

(e) the availability of adequate technical, financial, and other resources to complete

the development and to use or sell the intangible asset; and

(f) its ability to measure reliably the expenditure attributable to the intangible

asset during its development.


(a) Using basic accounting principles as a guide, provide arguments to support

(i) the IASB approach for reporting R&D costs, and

(ii) the FASB approach for reporting R&D costs .

(b) In your opinion, which approach should become the sole worldwide standard?

Briefly explain.

You are examining the consolidated financial statements of a European company,

which have been prepared in accordance with IFRSs. You determine that property,

plant, and equipment is revalued each year to its current replacement cost, income

and equity are adjusted, and the notes to the financial statements include the following

items as a part of the summary of significant accounting policies:

  • Tangible fixed assets are measured at replacement cost, less accumulated

depreciation. The replacement cost is based on valuations made by internal

and external experts, taking technical and economic developments into

account and supported by the experience gained in the construction of plant

assets throughout the world.

  • Valuation differences resulting from revaluation are credited or debited to equity,

where it is applicable, after deduction of an amount for deferred tax liabilities.

  • Depreciation based on replacement cost is applied on a straight-line basis in

accordance with the estimated useful life of each asset.

The provisions of IFRSs permit the use of alternatives to historical cost in the

valuation of assets. IAS 16 specifically notes that as an allowed alternative treatment

to historical cost:

Case 1-1

LO1, 4

Case 1-2



CHAPTER 1 A Survey of International Accounting 37

Subsequent to initial recognition as an asset, an item of property, plant,

and equipment shall be carried at a revalued amount, being its fair value

at the date of the revaluation less any subsequent accumulated depreciation

and subsequent accumulated impairment losses. Revaluations

should be made with sufficient regularity such that the carrying amount

does not differ materially from that which would be determined using

fair value at the balance sheet date.

The auditor of the company has expressed his opinion on the financial statements

and concluded that they present a “true and fair view.”

The use of replacement cost accounting is a departure from the historical cost

principle and represents a fundamental difference in the approach to financial

reporting in this country compared with the United States. The debate as to the relative

importance of relevance and reliability is one that surfaces often in the study

of international accounting issues. Many countries are very strict as to the use of

historical cost for all valuations and in the computation of income and often allow

reductions from historical cost (such as with the application of the lower of cost or

market requirement), but not increases. Others are very flexible in the choice of permissible

approaches, while still others are very strict in that particular alternatives

to historical cost (such as replacement cost or general price-level-adjusted amounts)

must be used.


(a) Can any alternative to historical cost provide for fair presentation in financial

reports, or are the risks too great? Discuss.

(b) Discuss the relative merits of historical cost accounting and replacement cost

accounting. Consider the question of the achievement of a balance between

relevance and reliability and the provision of a “true and fair view” or “fair

presentation” in financial reporting.

(c) Financial statements are now beyond the comprehension of the average person.

Many of the accounting terms and methods of accounting used are simply

too complex to understand just from reading the financial statements.

Additional explanations should be provided with, or in, the financial statements,

to help investors understand the financial statements. Briefly discuss.

( adapted from a case developed by Peter Secord, St. Mary’s University )

John McCurdy has recently joined a consultant group that provides investment

advice to the managers of a special investment fund. This investment fund was

created by a group of NFPOs, all of which have endowment funds, and rather

than investing their resources individually, they have instead chosen a pooled

approach whereby a single fund invests their moneys and distributes the earnings

back to them on an annual basis. The board of directors of the investment fund,

made up of members from each of the NFPOs, meets periodically to review performance

and to make investment decisions.

John has been following the fortunes of Ajax Communications Corporation

for a number of years. Ajax is a Canadian company listed on the TSX. At the

beginning of this past year, Ajax acquired 60% of the shares of Waqaas Inc., a U.S.

company, which was and continues to be listed on the NYSE. Ajax must decide

whether to prepare financial statements for Waqaas in accordance with IFRSs or

U.S. GAAP for reporting to the SEC.

Case 1-3

LO1, 4, 5, 6

38 CHAPTER 1 A Survey of International Accounting

As a starting point, John asked for and received the following comparison of

financial statement information under U.S. GAAP and IFRSs from the controller at

Waqaas (in millions of dollars):


U.S. dollars U.S. dollars

Income statement

Total revenue $3,388.9 $2,611.9

Operating income 89.1 329.1

Income before extraordinary items 14.9 199.4

Net income (66.2) 199.4

Balance sheet

Total current assets $ 862.1 $1,360.7

Investments 233.1 59.2

Property, plant, and equipment, net 889.9 1,866.5

Deferred income taxes 50.3 47.6

Intangibles, net 1,016.4 5,473.0

Other assets 90.8 265.1

Total assets $3,142.6 $9,072.1

Working with this list, John’s next step will be to determine why there is such

a difference in the numbers.


(a) As John McCurdy, outline the initial approach that you will take in order to

determine the reasons for the differences in the numbers.

(b) List some of the obvious items that need resolution, and indicate some of the

possible causes of the discrepancies.

(c) In your opinion, which GAAP best reflects economic reality? Briefly explain.

( adapted from a case developed by Peter Secord, St. Mary’s University )

Roman Systems Inc. (RSI) is a Canadian private company. It was incorporated in

Year 1 by its sole common shareholder, Marge Roman. RSI manufactures, installs,

and provides product support for its line of surveillance cameras.

Marge started the company with a small investment. For Years 7 through

9, the company grew rapidly. Most of the expansion was funded through debt

financing. The rapid growth is attributable to several large contracts signed with

banks for the installation of security camera systems at their branches.

RSI has a June 30 year-end. You, the CA, are with the firm of Sylvain and Charest,

Chartered Accountants (SC). Your firm has performed the audit of RSI since

its incorporation and prepares RSI’s corporate tax returns and those of Marge

Roman and her family.

Marge Roman called you in April Year 12 to inform you that she plans to take

RSI public within the next year. Marge is negotiating with several underwriters,

but no deal is in place yet. She plans to highlight the company’s revenue growth

in its annual press release publicizing its year-end results. Marge wants to show

strong revenue growth to attract investors.

During the telephone conversation, Marge asked you and the partner on the

audit to meet with her some time in early June to discuss and resolve potential

issues related to the June 30 audit of RSI. In prior years, financial statements were

Case 1-4

LO1, 5, 6, 7

CHAPTER 1 A Survey of International Accounting 39

issued in September, but this year the deadline for finalizing the financial statements

will likely be in early August. Marge agreed that you would perform your

interim audit procedures based on RSI’s results as at April 30, Year 12.

It is now June Year 12. The planning and interim work for the fiscal Year 12

audit has been completed. A summary of items noted in the April 30, Year 12,

interim financial statements as a result of work done to date is included in Exhibit I .

You are about to leave for the day when the partner in charge of the account

comes into your office and announces that he has just received a call from Marge

and she would like to meet with him within the next few days. He asks you to

prepare a memo discussing the financial reporting issues arising from the interim

audit work and any other matters that he should raise at the meeting. Ignore any

additional audit procedures that should be considered as a result of the issues

raised during the interim audit.


Prepare the memo.



Pre-tax earnings for the period ended April 30, Year 12, were $1,375,000. For the fiscal years

Year 11 and Year 10, RSI recorded pre-tax earnings of $435,000 and $325,000, respectively.

Marge Roman has received a valuation report valuing the company at $12 million.

Shareholders’ equity as at April 30, Year 12, consisted of:

100 common shares (voting) $100

Retained earnings $9,159,000

New Software

The company has been using a standard general ledger software package originally

installed in Year 6 by a local computer consulting firm and upgraded annually.

In January Year 12, RSI hired BBC to oversee the implementation of a new third-party

package. In March Year 12, RSI began converting its financial reporting system. The new

general ledger software was installed in parallel with the old software and went live on

April 1, Year 12.

The new general ledger software has been used to generate RSI’s financial results

since April 1, Year 12. Starting July 1, Year 12, the old system will no longer be used

in parallel.

To date, RSI has been invoiced $720,000 by BBC. These costs have all been

capitalized in the April 30, Year 12, financial statements. The invoices show the following

services and costs:

Initial review and recommendations $110,000

Cost of new software 200,000

Implementation work 120,000

Training work 225,000

Monthly support fee (April) 25,000

Other consulting (to April 30) 40,000




40 CHAPTER 1 A Survey of International Accounting

In addition, as at April 30, Year 12, RSI also capitalized $70,000 related to the salaries

of four employees who have worked on the accounting software project since January 1,

Year 12. As a result of these individuals being pulled out of their regular jobs to handle the

problem, RSI had to hire two additional employees.

The costs will be amortized beginning on July 1, Year 12, on a straight-line basis over

three years. RSI intends to treat approximately $135,000 of carrying amount for the old

software as part of the cost of the new software by reallocating this balance.


During fiscal Year 11, total product revenue was $18.2 million and maintenance contract

revenue was $5.6 million. For the period ended April Year 12, product revenue was

$13.2 million, and maintenance contract revenue was $5.2 million.

RSI recognizes product revenue when shipment and installation take place. It is RSI’s

standard practice to request a customer sign-off for any installation work. The installation

crew normally gets sign-off on the day of installation. During interim work for fiscal

Year 12, it was noted in the audit file that approximately $640,000 of revenue recognized

in April Year 12 related to work installed and invoiced in April, but customer sign-off was

obtained only in early May. Such situations have not caught anyone’s attention in previous

years. RSI explained that it had recently hired new service technicians who were unfamiliar

with the policy of customer sign-off and, accordingly, had to send technicians back to the

client days after the installation was completed to get the sign-offs.

Maintenance contract revenues relate to one-year agreements that RSI signs with

customers wanting product support. During the year, the company changed its revenue

recognition policy on maintenance contracts to recognize revenue based on estimated

costs incurred on the contract. Revenue is recognized as follows: 25% in each of the first

two months of the contract and 5% in each subsequent month. This allocation is based on

a study done by RSI in Year 10, which showed that the costs incurred on the contracts are

mostly incurred in the first two months, during which RSI sends out a technician to perform

preventive maintenance. The preventive maintenance reduces the number of future service

calls and, therefore, overall costs.

ABM Business

As a result of RSI’s strong relationship with its financial institution and Marge’s desire to

diversify RSI’s product line, RSI began selling “Automated Bank Machines” (ABMs) in fiscal

Year 12. The machines are purchased from a large electronic equipment manufacturer that

is responsible for ongoing maintenance of the ABMs. RSI sells the ABMs to restaurants,

bars, and clubs at margins of 5%. The sales revenue is included as product revenue.

The standard ABM sales agreement states that for a three-year period from the date of

sale, RSI receives 40% of the transaction fee charged to customers using the machine, in

addition to the sales revenue. A further 40% of the fee is payable to the financial institution

for managing the cash in the machines, and the remaining 20% is remitted to the machine

owners. The transaction fee charged to customers using an ABM is normally $1.50, and

is set by the financial institution. RSI is not responsible for stocking the ABM with cash or

emptying the cash machine. The financial institution performs all cash management duties

and remits to RSI, at month-end, a statement showing money owed to RSI for its share of the

transaction fee. A day later, the funds are deposited directly into RSI’s main bank account.

A total of 2,830,000 ABM transactions were processed in Year 12 for a total fee of

$4,245,000. RSI has booked transaction-fee revenue of $4,245,000 and an expense of

$2,547,000 related to the fees, attributable to the financial institution and the machine owners.


In January Year 12, RSI needed long-term financing and issued to a third-party venture

capitalist $2,500,000 of debentures maturing in 10 years, with interest at 7.35%.


CHAPTER 1 A Survey of International Accounting 41

The debentures are included as long-term debt in the accounts. The debentures are convertible

at the option of the holder, at a rate of one voting common share for every $5 of

debenture, if RSI issues shares to the public. If RSI does not issue shares to the public

before June 30, Year 13, the debentures are repayable upon demand.

Accounts Receivable

Review of the aging of accounts receivable at April 30, Year 12, showed an amount of

$835,000 in the over-120-day category. According to RSI’s collection department, the balance

relates to payments withheld by one of RSI’s largest customers, Mountain Bank. RSI

had contracted to install security cameras at all of its branches. The work was performed in

August Year 11, a customer sign-off was received at each branch, and invoices were sent in

early September. Mountain Bank refused to pay individual invoices. It wants to pay the total

of all invoices in one payment.

In October Year 11, a few branches of Mountain Bank contacted their head office

and requested that no payment be made to RSI until certain corrections were made to the

angles at which the cameras were installed. Although not required to do so under its agreement

with Mountain Bank, RSI fixed the problems, as M ountain Bank is one of its largest


On June 1, Year 12, $450,000 was received. Mountain Bank asserts that some work

remains to be done at 5 to 10 sites and is withholding final payment until it is completely

satisfied. All amounts related to the contract are recorded as revenues. Internal reports

reveal that it takes a service person approximately one hour to fix the problems at each

branch. No significant materials costs have been incurred for the follow-up visits.

(CICA adapted )

Minink Limited (ML) is a subsidiary of a large public company, federally incorporated

50 years ago. Until this year, ML’s corporate structure consisted of three

operating divisions and a corporate head office. Senior management receives

financial reports on each division on a monthly basis. Bonuses are awarded

annually to divisional managers based on the growth in net income on a

year-over-year basis.

The corporate head office oversees the divisions and provides financial, payroll,

legal, and administrative services. Corporate head office charges the divisions

one-half of the cost of providing these services and absorbs the other half.

The Ladium Extraction Division (Extraction) mines ladium, a metal used

in many industrial chemical processes. This division also performs the first

stage in the refining process. The Ladium Processing Division (Processing)

buys ladium from Extraction and further refines the metal before selling it to

customers in North and South Americas. Both stages of the refining process

cause airborne pollutants whose levels the government regulates (see Exhibit II

for new legislation).

Processing’s operations were sold to Donaz Integrated Limited (DIL) effective

August 15, Year 4. An integral part of this sale is a long-term contract

for Extraction to supply ladium to DIL. The negotiations leading up to the

sale lasted nearly a year. An agreement was finally reached after DIL threatened

to break off negotiations. Two offers were made by DIL, summarized in

Exhibit III . ML management favoured the second offer but accepted the first

offer under pressure from its parent company. The balance sheet of Processing

Case 1-5

LO1, 5, 6

42 CHAPTER 1 A Survey of International Accounting


New legislation to be implemented on January 1, Year 5, imposes a quota, or limits, on total

annual emissions of sulphur by the mining industry in Canada. Each company in the mining

industry, depending on its level of production, will annually be allocated a portion of the

fixed, industry-wide quota. All companies will be required to file documents certifying actual

emission and production levels for each calendar year.

At the beginning of each calendar year, the government will grant companies “pollution

rights” that represent their portion of the annual sulphur emission quota. The rights will be

valid for that year only. A company exceeding its own pollution rights (i.e., emitting more

sulphur than it is allowed to emit) will have to buy pollution rights from other companies to

make up the difference. On the other hand, a “clean company” (one emitting less sulphur

than the amount permitted) will be allowed to sell its unused pollution rights. The big mining

companies gained this compromise on the grounds that business should be allowed to find

the least costly, most efficient way of meeting an annual target. “Dirty” companies will have

until March 31 of the following year to purchase pollution rights from clean companies.

Companies that violate the legislation will be subject to heavy fines or closure.

The government’s objective is to give mining companies an incentive to invest in the

innovative technology needed to reduce their current sulphur emission levels. Over time,

the government will lower the emission levels for the industry; therefore, fewer pollution

rights will be granted.



May 2, Year 4

Mr. I. P. Labigne

President and Chief Executive Officer

Minink Limited

Dear Mr. Labigne,

For nearly a year now, we have been negotiating the purchase price of the operating assets

of Minink Limited’s Ladium Processing Division and the related long-term ladium supply

contract. Following our telephone conversation yesterday, this letter confirms that Donaz

Integrated Limited is not prepared to continue these negotiations.

We require a fax confirming acceptance of one of our two offers by midnight on May 4, Year

  1. Our offers are summarized as follows, within the context of the detailed Purchase and Sale

Agreement already agreed to:

1) $398.6 million for the operating assets of the division and $3,450/tonne adjusted annually

for inflation as the price for ladium under the long-term supply contract.

2) $97.1 million for the operating assets of the division and $4,100/tonne adjusted annually

for inflation as the price for ladium under the long-term supply contract.

I look forward to receiving your response by the deadline.

Yours sincerely,

Ms. S.N. Wong, CA

Vice-President, Finance and Chief Financial Officer

Donaz Integrated Limited


CHAPTER 1 A Survey of International Accounting 43


July 31, Year 4

(unaudited, in thousands of dollars)

Year 4 Year 3

Accounts receivable $ 51,223 $ 47,228

Inventories* 23,454 21,460

Prepaid expenses 4,002 5,103

Production equipment, net* 17,846 18,105

Buildings, net* 18,010 19,385

$ 114,535 $ 111,281

Accounts payable and accruals $ 19,123 $ 18,614

Advance from corporate head office 14,569 12,665

Divisional equity 80,843 80,002

$ 114,535 $ 111,281

*Included in Purchase and Sale Agreement with Donaz Integrated Limited




(in thousands of dollars)

Year 4/5 Fiscal Year Budget

Sales (volume 84,000 tonnes @ $3,700 per tonne) $310,800

Variable cost of sales ($3,400 per tonne) 285,600

Contribution margin 25,200


Head office charges 3,100

Fixed costs 9,610


Divisional income before taxes $ 12,490

Additional information:

  1. This budget was prepared on the basis that the Extraction Division would sell its

ladium to the Processing Division.

  1. When annual volumes exceed 90,000 tonnes, variable ladium extraction costs increase

by $562/tonne on the additional volume. New extraction equipment with a useful life

of 5 years must also be purchased, at a cost of approximately $58 million, to handle

annual volumes over 85,000 tonnes.

  1. The carrying amount of Extraction’s equipment and buildings that are dedicated to

ladium extraction at July 31, Year 4, was $76 million.


at July 31, Year 4, is found in Exhibit IV , and selected information on Extraction

is in Exhibit V .

The third division is the Mining Equipment Division (Equipment) which

designs, builds, and sells sophisticated mining equipment. During Year 4, Equipment

built six Crushones. Crushones are a new breed of open-pit mining machines

44 CHAPTER 1 A Survey of International Accounting

that have a very high output relative to capital cost. The provincial government

agreed to fund 90% of the total production costs of $165.46 million. In return,

the provincial government is entitled to 90% of the net proceeds on sale of the

Crushones. Management expects that due to the nature of these machines, ML

may have to wait several years to sell the Crushones that have been built. As of

late July Year 4 the six Crushones were included in inventory and measured at

their production cost of $165.46 million.

ML is the largest subsidiary of its parent and its financial statements are material

to its parent’s financial statements. The parent company has reported losses

for the past few years, and the price of its shares has dropped. The parent company

plans to issue additional shares in the near future.

The request for proposal for the audit of ML and its parent company for the

year ended August 31, Year 4, resulted in the appointment of your firm, Douglas

& Co., Chartered Accountants (DC). DC has already sent out an engagement letter

to ML and corresponded with the previous auditors, who said they knew of

no reason why DC should not accept the engagement. You, the CA, have been

selected as the audit senior for the assignment. The manager in charge of the audit

has requested that you prepare a memo covering the major accounting issues arising

from this year’s audit of ML.

It is now early August Year 4. Ian Kao, the audit partner, has met with the CFO

of ML who is in charge of coordinating the external audit. The partner’s notes

from these meetings are summarized in Exhibit VI .


Prepare the memo requested by the audit manager.


  1. In February Year 4, ML started to receive $3 million per month from the provincial government

to help fund research and development (R&D) into new mining techniques. ML

has recorded these funds as revenue. R&D work will commence in September Year 4.

  1. The Purchase and Sale Agreement with DIL specifies that Extraction must sell between

102,000 and 124,000 tonnes of ladium per year to DIL at the agreed price. The price

for any sales beyond this range will be agreed upon at the time the order is made.

Extraction is not permitted to sell to any other party. The duration of the agreement is

9 years from the closing of the sale.

  1. Selling costs for the disposal of Processing are expected to amount to $6.7 million.
  2. In response to public pressure to reduce pollution and protect the environment, the

Canadian government will require all companies in the mining industry to maintain

emissions at or below levels prescribed under the new legislation by allocating pollution


In June Year 4, ML purchased equipment that will reduce emission levels below

the prescribed level. ML will therefore be able to sell pollution rights to other companies

when the new legislation comes into effect. The equipment purchased by ML

was more expensive than other equipment it could have purchased that would have

reduced emissions only to the level prescribed for Year 5. Management wants to

know how to account for the pollution rights.


( CICA adapted )

CHAPTER 1 A Survey of International Accounting 45

IAS 16, “Property, Plant, and Equipment” requires assets to be initially measured

at cost. Subsequently, assets may be carried at cost less accumulated depreciation,

or they can be periodically revalued upward to current value and carried at

the revalued amount less accumulated depreciation. If revalued, the adjustment

is reported in other comprehensive income. Subsequent depreciation is based

on the revalued amount. U.S. GAAP does not allow assets to be revalued at an

amount exceeding historical cost less accumulated depreciation.

ABC Ltd. lists its shares on an exchange that allows it to report either in accordance

with U.S. GAAP or by using IFRSs. On January 1, Year 1, it acquired an

asset at a cost of $10 million, which will be amortized on a straight-line basis over

an estimated useful life of 20 years. On January 1, Year 3, the company hired an

appraiser, who determined the fair value of the asset (net of accumulated depreciation)

to be $12 million. The estimated useful life of the asset did not change.


(a) Determine the depreciation expense recognized in Year 2, Year 3, and Year 4 under

(i) the revaluation treatment allowed under IAS 16, and

(ii) U.S. GAAP.

(b) Determine the carrying amount of the asset under the two different sets

of accounting requirements at January 2, Year 3; December 31, Year 3; and

December 31, Year 4.

(c) Summarize the differences in profit and shareholders’ equity over the 20-year

life of the asset using the two different sets of accounting requirements.

Assume that future appraisals indicated that the fair value of the asset was

equal to carrying amount.

Fast Ltd. is a public company that prepares its consolidated financial statements

in accordance with IFRSs. Its net income in Year 2 was $200,000, and shareholders’

equity at December 31, Year 2, was $1,800,000.

Fast lists its shares on a U.S. stock exchange. Although no longer required to

do so, Fast has decided to voluntarily provide a U.S. GAAP reconciliation. You

have identified the following four areas in which Fast’s accounting principles differ

from U.S. GAAP.

  1. Fast Company gathered the following information related to inventory that

it owned on December 31, Year 2:

Historical cost $100,000

Replacement cost 95,000

Net realizable value 98,000

Normal profit margin as percentage of cost 20%

  1. Fast incurred research and development costs of $500,000 in Year 1. Thirty percent

of these costs were related to development activities that meet the criteria for

capitalization as an intangible asset. The newly developed product was brought

to market in January Year 2 and is expected to generate sales revenue for 10 years.

  1. Fast sold a building to a bank at the beginning of Year 1 at a gain of $50,000

and immediately leased the building back for a period of five years. The

lease is accounted for as an operating lease.

Problem 1-1

LO4, 5, 6

Problem 1-2

LO4, 5, 6


46 CHAPTER 1 A Survey of International Accounting

  1. Fast acquired equipment at the beginning of Year 1 at a cost of $100,000. The

equipment has a five-year life with no expected residual value and is depreciated

on a straight-line basis. At December 31, Year 1, Fast compiled the following

information related to this equipment:

Expected future cash flows from use of the equipment $85,000

Present value of expected future cash flows from use of the equipment 75,000

Fair value (net selling price), less costs to dispose 72,000


(a) Determine the amount at which Fast should report each of the following on

its balance sheet at December 31, Year 2, using (1) IFRSs and (2) U.S. GAAP.

Ignore the possibility of any additional impairment or reversal of impairment

loss at the end of Year 2.

(i) Inventory

(ii) Research and development

(iii) Deferred gain on lease

(iv) Equipment

(b) Prepare a reconciliation of net income for Year 2 and shareholders’ equity at

December 31, Year 2, under IFRSs to a U.S. GAAP basis.

Harmandeep Ltd. is a private company in the pharmaceutical industry. It has been

preparing its financial statements in accordance with ASPE. Since it has plans to

go public in the next 3 to 5 years, it is considering changing to IFRSs for the current

year. It wishes to adopt policies that will maximize the return on shareholders’

equity. Based on the draft financial statements prepared in accordance with ASPE,

its net income for Year 5 is $400,000, and its shareholders’ equity at December 31,

Year 5 is $3,500,000.

Harmandeep has engaged you to reconcile net income and shareholders’

equity from ASPE to IFRSs. You have identified the following five areas for which

IFRSs differs from ASPE:

  1. Impaired loans—original versus market rate of interest
  2. Interest costs—capitalize versus expense
  3. Actuarial gains/losses—recognize immediately or defer and amortize
  4. Compound financial instrument—debt versus equity components
  5. Income taxes—future income tax method or taxes payable method

Harmandeep provides the following information with respect to each of these

accounting differences.

Impaired Loans

One of Harmandeep’s debtors is in financial difficulty and defaulted on its loan

payment during the year. The outstanding balance on this loan receivable at the

end of Year 5 was $220,000. Harmandeep agreed to accept five annual payments of

$50,000 with the first payment due at December 31, Year 6, as a full settlement of

the loan. The original interest rate on the loan was 8%. The market rate of interest

for this type of loan is 6%. No adjustment has been made for the impairment of the

loan receivable.

Problem 1-3

LO5, 6, 7

CHAPTER 1 A Survey of International Accounting 47

Interest Costs

Harmandeep arranged a loan of $800,000 to finance the construction of a warehouse.

$400,000 was borrowed on March 1, Year 5, and another $400,000 was borrowed on

October 1, Year 5. The loan is repayable over 5 years with an interest rate of 6%, with

the first payment due on September 30, Year 6. The warehouse was nearly complete

at the end of Year 5. No interest has been accrued on the loan at the end of Year 5.

Actuarial Gains/Losses

Harmandeep instituted a defined benefit pension plan in Year 3. The first actuarial

evaluation, which was done as at June 30, Year 5, indicated an actuarial gain of

$150,000. The expected average remaining service life of the employee workforce

was 15 years at the time of the actuarial evaluation. The actuarial gain has not yet

been recognized in the preliminary financial statements.

Compound Financial Instrument

Harmandeep issued bonds for proceeds of $1,000,000 on December 31, Year 5. The

bonds are convertible into common shares at any time within the next five years.

The bonds would have been worth only for $950,000 if they did not have the conversion

feature. The proceeds on the bonds have been recognized as long-term

debt in the preliminary financial statements.

Income Tax

Harmandeep’s income tax rate has been and is expected to continue at 40%.

Assume that any adjustments to accounting income for the above items are fully

deductible or taxable for tax purposes. The preliminary financial statements reflect

the tax payable method of accounting for income taxes. If the future income tax

method were adopted, future tax liabilities should be set up for $300,000 at the

end of Year 4 and $340,000 at the end of Year 5.


Prepare a schedule to convert net income and total shareholders’ equity from the

preliminary financial statements amounts to amounts under ASPE and IFRSs.

Where accounting choices exist, choose policies that minimize return on total

shareholders’ equity under ASPE and maximize return on total shareholders’

equity under IFRSs.

Andrew Ltd. is a large private company owned by the Andrew family. It operates

a number of ski resorts in a very competitive industry. Its main competition comes

from a couple of public companies. Andrew has been using ASPE in the past but

has come under pressure from its bank to convert to IFRSs. Its bank is particularly

concerned with the debt to equity ratio and the return on total shareholders’ equity.

Andrew reported the following on its preliminary Year 6 financial statements

in compliance with ASPE:

You have identified four areas where Andrew’s accounting policies could have

differences between ASPE and IFRSs. Where choices exist under ASPE, Andrew

has adopted allowable policies that maximize net income and shareholders’ equity.

Problem 1-4

LO5, 6, 7

Net income $3,000 Total debt $25,200

Total shareholders’ equity 21,800

48 CHAPTER 1 A Survey of International Accounting

The controller at Andrew provides the following information for the four


Intangible Assets

Andrew owns a number of intangible assets and depreciates them over their useful

lives, ranging from 3 to 7 years. The patents are checked for impairment on an

annual basis. Relevant values pertaining to these patents were as follows:

Property, Plant, and Equipment

Andrew acquired equipment at the beginning of Year 4 at a cost of $1,250. The

equipment has an estimated useful life of 10 years, an estimated residual value of

$50, and is being depreciated on a straight-line basis. At the beginning of Year 6,

the equipment was appraised and determined to have a fair value of $1,090; its

estimated useful life and residual value did not change. The company could adopt

the revaluation option in IAS 16 to periodically revalue the equipment at fair value

subsequent to acquisition.

Research and Development Costs

Andrew incurred research and development costs of $200 in Year 6. Of this

amount, 40% related to development activities subsequent to the point at which

criteria indicating that the creation of an intangible asset had been met. As of yearend,

development of the new product had not been completed.

Redeemable Preferred Shares

In Year 4, Andrew issued redeemable preferred shares to the original founders

of the company in exchange for their previously held common shares as part of

a tax planning arrangement. The preferred shares were assigned a value of $100

and have been reported in shareholders’ equity in the preliminary financial statements.

The common shares, which had a carrying amount of $100, were cancelled.

The preferred shares would be classified as long-term debt under IFRSs and

would need to be reported at their redemption value of $1,800.

The CEO is concerned about the impact of converting Andrew’s financial

statements from ASPE to IFRSs.


(a) Calculate the two ratios first using ASPE and then using IFRSs. Prepare a

schedule showing any adjustments to the numerator and denominator for

these ratios. Ignore income taxes.

(b) Explain whether Andrew’s solvency and profitability look better or worse

under IFRSs after considering the combined impact of the four areas of


Dec 31, Yr5 Dec 31, Yr6

Carrying amount before impairment $12,000 $9,800

Undiscounted future cash flows 12,100 9,840

Value in use 11,700 9,400

Fair value 11,600 8,600